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Israel approves new innovation box regime and reduces tax rates from 1 January 2017

Executive summary

On 15 December 2016, the Israeli Parliament’s Finance Committee approved law amendments that introduce an innovation box regime for intellectual property (IP) based companies, enhance tax incentives for certain industrial companies, and reduce the standard corporate tax rate and certain withholding rates starting 2017.

Detailed discussion

Innovation Box regime

The new regime was tailored by the Israeli Government to a post-base erosion and profit shifting (BEPS) world, encouraging multinationals to consolidate IP ownership and profits in Israel along with existing Israeli research and development (R&D) functions.

Tax benefits created to achieve this goal include a reduced corporate income tax rate of 6% on IP-based income and on capital gains from future sale of IP. The 6% rate would apply to qualifying Israeli companies that are part of a group with global consolidated revenue of over ILS10 billion (US$2.5 billion).

Other qualifying companies with global consolidated revenue below ILS 10 billion would be subject to a 12% tax rate. However, if the Israeli company is located in Jerusalem or in certain northern or southern parts of Israel, the tax rate is further reduced to 7.5%.

Additionally, withholding tax on dividends would be subject to a reduced rate of 4% for all qualifying companies (unless further reduced by a treaty).

Entering into the regime is not conditioned on making additional investments in Israel and the company could qualify if it invested at least 7% of the last three years’ revenue in R&D (or ILS 75M R&D expense per year) and met one of the following three conditions:

1. Have at least 20% R&D employees (or more than 200 R&D employees)

2. Venture capital investment of ILS8 million was previously made in the company

3. Average annual growth over three years of 25% in sales or employees

Companies not meeting the above conditions may still be considered as a qualified company under the discretion of the Israeli Innovation Authority in the Economy Ministry. Lastly, companies wishing to exit from the regime in the future will not be subject to clawback of tax benefits.

The Finance Committee also approved a stability clause in order to encourage multinationals to invest in Israel. Accordingly, companies will be able to confirm the applicability of tax incentives for a 10 year period under a ruling process.

The new law comes into effect on 1 January 2017. Further, in line with the new Organisation for Economic Co-operation and Development (OECD) Nexus Approach, the Finance Minister will promulgate regulations to ensure companies are benefiting from the regime to the extent qualifying R&D expenditures are incurred. The regulations were set to be finalized by 31 March 2017.

Enhancement of current tax incentives regime

Tax incentives in Israel are also available to certain Israeli industrial companies and to R&D centers (operating on a cost plus basis) under two tracks: (i) a “Preferred Enterprise;” and (ii) a “Special Preferred Enterprise,” aimed at large enterprises that meet certain investment requirements.

Accordingly, a Preferred Enterprise is eligible to a reduced corporate income tax rate of 16%. However, if the company is located in Jerusalem or in certain northern or southern parts of Israel, the tax rate is further reduced to 9%. On 15 December 2016, the Finance Committee approved a further 1.5% reduction in the tax rate for such locations, from 9% to 7.5%.

Reduction in the standard corporate tax rate

The Finance Committee approved an amendment to the Income Tax Ordinance that reduces the standard corporate tax rate from 25% to 23%. The reduction will occur gradually, and starting 1 January 2017 the rate will reduce to 24%, and be further reduced to 23% starting 1 January 2018.

Moreover, withholding tax rates on interest, royalties, or consideration from capital gains paid to corporations are generally based, under the domestic law, on the standard corporate income tax rate. Therefore, withholding tax rates on interest, royalties and capital gains related to corporate investors will be reduced to 24% as of 1 January 2017, and to 23% as of 1 January 2018 (unless further reduced in accordance with treaties).

Impact

The new BEPS Action 5 guidelines on R&D intra-group outsourcing have limited the application of global IP regimes in certain cases due to lack of substantial activity. In contrast, the new Israeli tax incentives uniquely rely on the fact that Israel is home to hundreds of R&D centers of the largest multinationals, thus creating a BEPS compliant opportunity to integrate Israeli developed IP within global structures of multinationals.

Companies should carefully review the new legislation and examine its benefits to their existing or potential investments in Israel.

EYG no. 04406-161Gbl

Download this Tax Alert as a PDF file

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