Israel Chemicals and the state's missing billions

Eli Tsipori

No company better illustrates the scandal of the tax breaks and other benefits enjoyed by our leading companies.

Even the Ministry of Finance now gets it. In the austerity plan that it is now formulating, it recommends raising somewhat the ridiculously low tax rates on exporter companies set by the Law for the Encouragement of Capital Investment.

The fact that the companies have a strong lobby and everything is done hush-hush on the grounds of confidentiality of tax assessments has enabled them for many years to gorge on the public purse, to an astronomical extent, without the numbers being revealed. In this network are senior Ministry of Finance officials promoting tax agendas that suit the giant companies, where they are likely to land after they finish their public service; there are several very strong accounting firms with people too close to the Tax Authority and even involved in drafting tax legislation; and there's the Tax Authority, where there are quite a few professionals who are supposed to deal with the accounting firms and giant companies, and who ultimately find themselves landing on a senior chair at one of those very accounting firms. This stew is unhealthy, and, worst of all, it's concocted at our expense.

Last week, "Globes" revealed the full numbers behind Teva's tax payments. It's embarrassing, provoking, and scandalous. With due respect to Teva, a wonderful company that has built up a wonderful industry in Israel, an average annual tax rate of 3.7% when the official rate in the years concerned was 36%, later falling to 25% - is that not a bit rich? Companies like Teva should be given incentives. It's right that they should receive tax breaks and pay less than the official rate, but everything in life is a matter of proportion. We have gone too far, to the point that the huge tax breaks no longer serve the fine slogans of employment, growth, and so on.

In late December 2010, the Knesset passed the new Law for the Encouragement of Capital Investment, which came into force at the beginning of 2011. The old tax benefit tracks were abolished, and instead two new tax tracks were introduced: "preferred enterprise", and "special preferred enterprise", with a uniform, reduced tax rate on all the revenues of the companies entitled to the benefits.

For a preferred enterprise, the law provides a tax rate of 10% in development area A, and 15% in the rest of the country. In the tax years 2013-2014, the rates will fall to 7% and 12.5%, and from 2015, the rates will continue to fall to lows of 6% and 12%. A special preferred enterprise (such as Teva) will pay 5% in area A and 8% in the rest of the country for ten years. This is a little more than the 0% on certain tracks under the previous law, but these are still miserable rates, described by the promoters of the law themselves as "among the lowest tax rates in the world."

The jewel in the crown of the new law was the exclusion of mining, minerals production enterprises and oil exploration enterprises. This meant mainly Israel Chemicals Ltd. (TASE: ICL), of the Israel Corporation (TASE: ILCO) group. The Ministry of Finance and minister Yuval Steinitz rightly boast about this exclusion, but they don't exactly paint a full picture.

Israel Chemicals is one of the giant companies that for years enjoyed benefits under the Law for the Encouragement of Capital Investment, but it is not precisely in the same class as Intel, Teva, Iscar, or Check Point Software Technologies Ltd. (Nasdaq: CHKP). Israel Chemicals is the scandal of the law. It received huge tax breaks, paid miserably low royalties, and for years the regulators slept at their posts. After all, it derives most of its profits from a mineral resource that belongs to the state, and a non-depleting resource at that. It cannot threaten to leave, like the other companies, since it cannot pack up the Dead Sea and abandon Israel for a more generous tax haven. It is simply stuck with us, for better or worse. It turns that it's mainly for better (the locations of the company near the Dead Sea and the Port of Eilat also benefit it, because transport is easier and production costs are lower).

Israel Chemicals is also the only company from whose financial statements it is possible to understand the dimensions of the scandal. Teva and Check Point avoid reporting on tax benefits (they only report overall tax rates) because they are dual-listed, while Intel in Israel is a sort of private company, and Iscar enjoys the warm and protective bosom of Warren Buffett and the Wertheimer family.

So, these are the numbers. In five years, the Law for the Encouragement of Capital Investment gave Israel Chemicals huge tax benefits to the tune of NIS 2.5 billion, a gift for which it has no need whatsoever. We have reported this figure in the past, but the impression created that the new law stops the tax benefit junket is simply incorrect. The new law does not cancel tax benefits that enterprises were entitled to on the old tracks up to December 2012, and the enterprises will be able to enjoy tax breaks on account of their investments under the old rules. Since these tax tracks are multi-year (generally ten years), Israel Chemicals will continue to enjoy tax benefits (some of them 0% tax!) deep into the next decade. Israel Chemicals is set up with the old tax benefits for the next ten years that is the true scandal. The state did decide to exclude it from the new law, but at the same time awarded it benefits estimated to be in the billions of shekels over the next decade. Is it any wonder that the Ministry of Finance hides the figures?

The argument that it is not possible retroactively to hit tax benefits that have been given sounds persuasive enough and is, on the face of it, justified, but actually it's completely misleading. It's a pity that those who drafted the new law, headed by former Ministry of Finance director-general Haim Shani, fell into the trap of this argument. After all, the state gave a retroactive benefit to companies in the new law when it allowed them a huge discount on their trapped profits, i.e. profits on activities meriting tax breaks that are supposed to be subject to full tax rates when they are distributed, so why is it not possible to touch retroactively the tax benefits of Israel Chemicals or any other company? It certainly is possible, and it should be done immediately. It's still not too late. What is more, every tax expert knows the hackneyed saying "there are no property rights in tax"; in other words, no company has acquired a right to tax breaks for ever, including Israel Chemicals.

Next: Israel Chemicals has accumulated trapped profits, like all its companions at the bowl of cream that the law provides. How much has it accumulated? We took another look at the annual financial statements and discovered in a tiny note stating that Israel Chemicals' trapped profits amount to NIS 5 billion. At a full rate of tax (25%), this means NIS 1.2 billion that would have accrued to the state's coffers. But Steinitz gave the companies a gift in the form of a reduced tax rate, and so Israel Chemicals will pay only a few hundred million shekels (depending on the track it chooses). In other words, another gift of at least NIS 500 million.

Under the Dead Sea Franchise Law, Israel Chemicals paid the state royalties at a rate of some 5% on the value of products at the factory gate, less certain expenses (nice definitions that can always be played around with). In 2010, the state woke up, and, in accordance with the contract, demanded a review of the royalty rate on the quantity of potash produced annually, which is over 3 million tonnes (potash is Israel Chemicals' biggest bonanza, and it largest profit component, being responsible for about 62% of its total operating profit). In addition, there are also royalties on phosphates.

So, in 2012, a new royalty agreement was signed, as part of the agreement on salt harvesting in the Dead Sea. It was determined that Israel Chemicals would pay a royalty rate of 10% on potash sales from 2010 above 3 million tonnes, and that from 2012 it would pay that rate on potash sales over 1.5 million tonnes.

Israel Chemicals has an annual potash production capacity of 6 million tonnes (from extraction in Israel, Spain and the UK mainly from Sedom in Israel), and it sells about 5 million tonnes a year. This means that we should see the rise in royalties this year, but the state has missed out on previous years, and that miss is worth hundreds of millions of shekels, if not billions.

The bottom line of the benefits that have been and will be given is a loss that could reach NIS 8-10 billion, even without taking into account the losses from the unnecessary privatization, which amount to tens of billions (because of the rise in the value of Israel Chemicals).

The greatest hutzpa is that Israel Chemicals thinks that CEO Nir Gilad should be paid more. More! As though the millions showered on him are not enough. And why? The claim is that companies of the order of size of Israel Corp., such as the private equity firms Blackstone and KKR, which have values of $2-6 billion, pay their managers more. Something like five times more. Oh really? First of all, it looks as though at Israel Corp. they don't know how to examine a company's valuation: Blackstone is worth about $21 billion and KKR $12 billion, while Israel Corp. is worth just $5 billion. Apart from that, what is this ridiculous comparison between private equity firms and a holding company which is entirely built on the country's minerals and a global potash cartel?

It can be assumed that Nir Gilad knows some other numbers much better: the huge tax breaks Israel Chemicals receives, and the miserable royalties that Israel Chemicals paid the state. He should actually know them better than anybody; he, after all, was the Accountant General of the State of Israel.

Published by Globes [online], Israel business news - - on February 17, 2013

© Copyright of Globes Publisher Itonut (1983) Ltd. 2013

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