Why Trump’s Proposed Tax Cuts Could Spell Trouble for Israel

Plan would make it more attractive for Israeli firms to move their headquarters to the U.S. and could discourage American companies from buying Israeli startups

U.S. President Donald Trump’s proposal, unveiled last week, to slash America’s corporate tax rate could have a big impact on Israeli companies and undercut a similar tax-cut plan Finance Minister Moshe Kahlon has been working on, tax experts say.

The biggest threat is to the Israeli high-tech sector where the lure of a super-low 15 percent tax rate that Trump proposed last Wednesday could prove irresistible to many startups, said Sharon Schulman, a managing partner in the tax practice at Ernst & Young Israel.

“At a rate of 15 percent, we would definitely see a return of the phenomenon of ‘Israeli’ technology companies whose major market is the United States incorporating when they are first formed as American companies — something that without a doubt is a clear risk to the Israeli economy in the long run,” he said.

Yaniv Erlich, who heads the tax department at the Tel Aviv law firm Gross, Kleinhendler, Hodak, Halevy, Greenberg & Company, said for existing companies – tech and non-tech – enjoying the benefits of Trump’s proposed taxes would involve sacrifices because it would mean moving management and control of the company to the United States, including relocating the CEO.

Many Israeli startups, in fact, do that but the trend would grow and expand to companies that have no other reason to relocate to the U.S. except for the tax advantages. Moreover, Israeli startup entrepreneurs are likely to face pressure from their American investors to relocate.

Brian Krzanich, chief executive officer of Intel Corp., from left, Amnon Shahua, chairman and chief technology officer of Mobileye, and Klaus Froehlich, member of the management board at BMW, view the BMWi Inside Future concept vehicle during a press event at the 2017 Consumer Electronics Show (CES) in Las Vegas, January 4, 2017.
David Paul Morris / Bloomberg

“American investors have an interest in the company being American and that the entrepreneur behind it be nearby,” said Monte Silver, an attorney with Eitan, Mehulal & Sadot in Herzliya. “Now it will be easier for them to insist on it.”

The Trump tax cut, if it happens, could also deter U.S. companies from buying Israeli tech companies, like Intel’s $15.3 billion purchase of Mobileye last month.

One of the reasons the White House wants to lower taxes is to coax U.S. companies to repatriate some $2.6 trillion in profits they’ve kept overseas to avoid paying the steep U.S. tax rate, which is today 35 percent — and, adding in state and other taxes, can run as high as 40 percent.

In a lot of cases, U.S. multinationals have used those trapped profits to buy Israeli startups, which enables them to use the money productively without it ever returning to the U.S.

“If the [Trump] reform is approved it will mean fewer financial resources outside the U.S. That in turn will mean less interest is buying Israeli companies and greater interest in buying American companies,” explained Eldar Ben-Ruby, an attorney at Meitar Liquornik Geva Leshem Tal in Ramat Gan.

The Trump plan, of which only the barest outlines have been released, would turn the U.S. corporate tax rate from among the highest in countries belonging to Organization for Economic Cooperation and Development to among the lowest.

Although the tax cut is controversial — not the least because it comes hand in hand with other changes that have been widely faulted for benefitting the wealthiest — the president says the corporate tax cut will encourage companies to invest in the U.S. and create more jobs.

With those same considerations in mind, Kahlon has also been working on a plan to reduce Israel’s corporate tax rate for high-tech companies, including foreign multinationals. The baseline Israeli rate has been going down, with the latest reduction from 25 to 24 percent this year and 23 percent in 2018.

The Law for Encouraging Capital Investment entitles high-tech companies to pay reduced tax rates of 16 percent if they are based in the center of the country and only 9 percent if they are in the periphery. Low Israeli corporate rates have encouraged Israeli companies with operations in the U.S. to book as much income as possible in Israel rather than the U.S. but Trump threatens to change that calculation.

“Now, Israeli companies will need to examine their entire tax strategy and Israel will have to think about its tax law as well,” warned Amir Chenchinski, a tax expert at Ernst & Young Israel.

In an effort to lure more high-tech companies to Israel and keep those already here, Kahlon is aiming to lower Israel’s rate for tech companies to between 6 and 12 percent, with the lowest rate for big companies developing intellectual property in Israel and registering it here. But, E&Y’s Schulman said Trump now creates a dilemma for the finance minister.

“Trump’s tax reforms put Israel in a trap,” he said. “On the one hand, he [Kahlon] can’t leave the corporate tax rate at 24 percent if the U.S. rate is going down to 15 percent. Also, rates for tech companies will have to go below 12 percent is he is going to preserve Israel’s competitiveness. On the other hand, that creates a risk of debt repayments and bigger budget deficits.”