Buried deep inside the government’s annual fiscal report is an interesting comment that appears almost as an afterthought: “Until state revenues from the tax reach 1 billion shekels [$280 million], the tax revenues are being deposited in a non-budgetary fund managed by the accountant general, whose balance as of December 31, 2016 was 459 million shekels (in 2015 it was 459 million shekels). In 2016 there were no revenues from this tax.”
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What the report was referring to in its obtuse language was the sovereign wealth fund, where much of the riches Israel is supposed to earning from its natural resources are to be deposited. Specifically, the fund was supposed to be the recipient of the windfall tax on natural resource profits, popularly known as the Sheshinski tax, after the professor whose government committee proposed the tax.
Israel has basically two big natural resources: The gas that lies under the Mediterranean and the potash deposits in the Dead Sea area. The first is controlled by the Noble Gas-Delek Group cartel, which owns and operates the Tamar and Leviathan fields; the second is in the hands of Israel Chemicals.
The Bank of Israel had once optimistically talked about the sovereign wealth fund eventually holding $125 billion, although it later cut that forecast to 265 billion shekels by the year 2040. TheMarker predicted that the 1 billion mark would be crossed in 2019, which now seems all but impossible.
The fact that the fund right now has a mere 459 million shekels and that not a shekel more was added to it during 2016 raises some serious questions about how the Sheshinski tax was designed and/or whether the companies liable to pay it are engaged in sophisticated tax planning to avoid it.
Some experts go as far as to say that the windfall tax is fundamentally flawed. It set the royalties the government collects on gas at a low 12.5%, in order to encourage companies to risk capital in gas drilling and exploration, while setting a high rate on high profits. In the case of ICL, it’s a top rate of 42% and in the case of gas it’s 50%.
So where’s the money?
In the case of ICL, the Sheshinksi tax was supposed to kick in when the company was earning a 14% rate of return of capital, at which point it is liable for a 25% tax, rising to 42% if the return exceeds 20% annually. There was a time when ICL was generating those kinds of profits, but the price of its key chemical, potash, has been in the doldrums for some time.
In the case of natural gas profits, the government does begin collecting the Sheshinski tax until the operators accumulate profits of between 1.5 and 2.3 times their investment in exploration and development. The idea was to incentivize companies to explore for gas and oil by ensuring those that find it they earn back a sufficient return.
By that measure, Tamar – the only field right now in production – has to earn more than $8 billion before the state begins to collect the tax, a figure that isn’t likely to be reached before 2021. For Leviathan, accumulated taxes have to reach $6 billion. But that field hasn’t begun production, and the clock hasn’t even started ticking.
It’s not that Noble, Delek and ICL aren’t paying taxes. They are already liable for royalties in revenues and for corporate income tax. When the Sheshinksi tax kicks in, the energy companies will be paying 62 agorot to the state for every shekel of profit.
That’s an extraordinarily high rate, so high that shareholders are likely to forget the low-tax years that preceded it and resent how much Israel is taking. On top of that the tax is structured in a complicated way, so that companies have an incentive to try to evade it and the means to legally do so.
They have it all over the tax authorities because they are big, sophisticated businesses and know their businesses better than the bureaucrats who are supposed to watching over them.
The Israel Tax Authority is confident it can cope with the problem and says it has formed a special committee to watch over the gas profits. But it requires the kind of expertise that doesn’t exist in Israel and if the taxmen are going to do their job, they should bring in overseas experts. It would be money well spent.