Eight international companies that expressed interest in investments in Israel have announced that they are "sitting on the fence" following US President Donald Trump's tax reform, sources inform "Globes."
Minister of Finance Moshe Kahlon has declared a number of times that several major international companies were expressing interest in investing in Israel following the tax reform passed last year. That reform guaranteed reduced tax rates of 6% for corporate tax and 4% on dividends for high tech companies with an annual turnover of $10 billion. These rates are believed to be the lowest in the world. In a recent internal discussion, however, one of Kahlon's advisors said that eight international companies that had been in touch with the Ministry of Finance had suspended the contacts after the US president's tax reform bill passed.
Kahlon and his staff did not mention names of the companies interested in Israel, other than HP, which is already active here, and Intel, which is slated to announce its decision to establish its next plan in Israel at an investment of $5 billion.
At the same time, sources inform "Globes" that the recommendations by the National Economic Council and Ministry of Finance economists, which will be presented to Netanyahu and Kahlon soon, indicate that the professional staff in the cabinet is objecting to a further cut in corporate tax in response to the US reform.
"Don't boast about relations with the US"
Sources inform "Globes" that the Israeli government has begun discussions with the US administration in an attempt to revise clauses in the tax convention between the two countries in order to avoid harm to economic activity in Israel as a result of the US tax reform. Professional sources believe that various arrangements in Trump's tax reform are liable to cause major companies like Check Point Software Technologies Ltd. (Nasdaq: CHKP), Intel, and Microsoft to transfer their business from Israel to the US. On the other hand, professional sources warn that Israel is liable to jeopardize its relations with other trade powers around the world if it does not act wisely and discretely in relations with the US. "This reform is arousing turmoil around the world. It is true that we have a special relationship with the US, but we should not boast about it," government sources told "Globes."
The tax reform sponsored by the US administration, which became effective at the beginning of this year, is known primarily for cutting the corporate tax rate in the US from 35% to 21%. In contrast to the prevailing impression, Israel is less worried about the tax cut and more about the other arrangements in the reform, which are liable to give large companies an incentive for moving activities from Israel to the US. Israeli government sources told "Globes" that the main concern in Israel was focusing on the effect of the reform on a relatively small group of fewer than 10 companies whose volume of activity exceeds $500 million, and which have substantial business in the US. This group, which includes Intel, Microsoft, and Israeli company Check Point, is affected by various arrangements in the reform, but the effect varies from one company to another. "Each company has its own specific problems," the sources told "Globes," so the best solution for us will not be based on cutting the corporate tax rate or changing a specific item, but by handling each case individually. Cutting taxes is a marginal part of the problem."
One of the most worrisome arrangements for Israel is entitled "base erosion and anti-abuse tax (BEAT)." This arrangement is designed to prevent companies from moving their activity outside the US. It states that a 10% tax will be imposed on US companies with a business turnover of over $500 million, with no option of deducting payments to a foreign related company, including expenses for services, intellectual property, and interest. The problem for Israeli companies is the services item, because there is concern that the definition of services will also include R&D expenses. This clause is especially relevant to a company like Check Point, which will be unable to obtain recognition of R&D expenses outside Israel.
Another arrangement likely to pose a problem for companies like Intel is entitled global intangible low-taxed income (GILTI). This is a tax with an effective 10.5% rate levied on non-financial activity. The problem in this arrangement is non-recognition of tax that was already paid outside the US on the same activity. The arrangement states that the tax already paid outside the US will not be deducted from the tax rate unless the foreign tax is 13.125% or more.
Government sources believe that this arrangement is liable to affect the business in Israel of companies like Intel and Microsoft, which classify their activity in Israel as cost plus. "The question of services and R&D is critical for Israel," an Israeli source says, adding, "For other countries like Switzerland, for example, the most sensitive point is registration of intellectual property. Every country will deal with this reform according to its needs and sensitivity."
Against the Trajtenberg recommendations
The best-known part of the US reform is the cut in corporate tax from 35% to 21%. Corporate tax in Israel is currently 23%, so on paper, the US is now ahead of Israel in what is called the "race to the bottom." Kahlon and Netanyahu hurriedly declared that they were considering cutting the corporate tax rate in Israel to below 23%, against the recommendations by the Trajtenberg Committee, which stated in 2012 that corporate tax cuts indirectly contributed to an increase in the cost of living in Israel, and recommended raising back up to 25%.
The government's professional staff believes that cutting the corporate tax will not affect the intensification of competition between Israel and the US. Asked about this question recently, Israel Tax Authority head Moshe Asher explained that in Israel, the full 23% corporate tax is paid by companies all of whose business is in the domestic market, which means that they are indifferent to taxes in the US. Asher said that companies that export to the US and other markets already pay reduced tax rates between 7.5% and 16% - a lower rate than the new tax rate in the US. It should be kept in mind that major companies like Intel pay even lower taxes in Israel under a special track designed for them classified as "strategic."
What are worrying professional sources in Israel are the other arrangements included in the tax reform designed to reduce recognition of expenses paid outside the US and the deduction of losses from profit. The logic behind these arrangements is a switch from a global tax method to the territorial tax method prevailing in most countries around the world. "This is a momentous reform based on the idea that those working in the US will gain - in other words, maximizing the advantages of the US environment, which is friendlier to business than the environment in other countries, such as Israel," a government source told "Globes."
Netanyahu's announcement that Israel would approach the US concerning the tax reform affects the most sensitive subject for Israel today: how to deal with the difficult consequences of this reform. In this context, US government sources are recommending that Israel act with great caution in order to avoid jeopardizing relations with other countries that regard the tax reform as no less of a significant threat than Israel does. "The most sensitive aspect here is not the reform, but how Israel copes with it," government sources told "Globes." "We are in a state of uncertainty in this matter, because we are one of many players. As long as we have not seen how the international system responds, especially powers like the European Union and China, it would not be correct for us to take the slightest step, because this is an interdependent system. If everyone takes a certain measure, it would be wrong for Israel to move in a different direction. What is important is to see what the world does in this matter, what we can achieve with the US, and how we can ensure that Israel will continue to be attractive and create an environment that will encourage the next startup. It is true that Israel has an open channel to the US, and that there is a tax convention with the US that gives Israel special advantages, but we must not boast about it."
Companies whose business in Israel is liable to be affected by the tax reform include Check Point, Intel, HP, HP Enterprise, and Microsoft.
"Trump's tax reform has reduced Israel's competitive advantage. There may no longer be any justification for remaining here"
"Up until now, Israel's competitive advantage was in taxes. Now, following Trump's tax reform, this gap has narrowed, and does not necessarily justify remaining here," a source in a multinational company operating in Israel told "Globes." He added, "The most important aspect of the US president's reform is corporate tax, because this tax is fixed, and it will be cut by more than 10%. When you acquire a company, you have to decide where its activity will be, and the question is what Israel will do to give the US a fight. The problem was that the development of the companies was not in the US, and the purpose of the reform is to bring those companies back home. It is probably preferable for each company to work in the US, where most of the business activity takes place."
Intel Israel CEO Yaniv Garty explained that the reform would have a major effect on the viability of foreign investments in Israel. "Continuation of foreign investments in Israel depends above all on the attractiveness of the investment," he recently wrote in a "Globes" column… The new tax reform is liable to detract from the attractiveness of many economies around the world, particularly the Israeli economy, especially in high-tech, manufacturing, and R&D.
"The reform is designed to create an incentive for bring production jobs back to the US and for the creation of supporting businesses. The transferal of production lines to the US from various countries is of great importance, because production has a big economic effect on the Israeli economy. In addition to outstanding engineers, technicians and other engineering personnel are also employed in this sector." He said that the Israeli government had the responsibility for dealing with the effects of the reform, and was doing this. "It is a dramatic measure, and the relevant parties in government are therefore currently analyzing and considering the effect on the economy. A reassessment of the tax structure in Israel and the set of solutions have costs, however, and this should be recognized. It should be kept in mind that a decision by multinational not to invest and a decline in the viability of investment in Israeli companies will have a negative impact on exports and jobs, both directly and indirectly."
"There was a great incentive for leaving R&D in Israel"
Advocate and accountant Binyamin Tovi, a partner in the Shekel & Co. law firm and head of its international taxation department, who handled the Intel-Mobileye deal, and who represents HP in Israel, told "Globes" that the first aim is to bring the profits that have accumulated in recent years back to the US through a one-time tax of 8-15%. "The reform is now going to also change the future through a general cut in corporate tax from 35% to 21%. This is a tremendous cut. Through this step, Trump wants to attract foreign investors to the US. From my experience in dealing with large international customers, they always prefer to avoid transferring business and profits to the US because of high taxes," Tovi said, adding that in cases in which it is decided to transfer companies' activities to the US, "We made sure that the profits attributed to this activity would be as small as possible, because taxes in Israel were substantially lower than they were in the US. This is, of course, in addition to the benefits granted to companies like Teva and Intel under the Law for the Encouragement of Capital Investments. In Israel, you can get a tax rate of 7.5-16% in certain circumstances. These tax rates are much lower than they were in the US, and there was a strong incentive to leave R&D in Israel, instead of transferring it to the US."
Now, however, these considerations have changed. "Trump's reform," Tovi says, "is making it much more convenient for these companies to start doing business in the US. I don't think that companies with no connection to the US, and which get benefits in Israel, will decide to move their activity to the US, but companies with an inherent connection to the US, whether through customers or through investors, may decide to transfer their activity because the gap in the tax rates has narrowed."
Tovi disagrees with Garty about his call to the Israeli government to cut the corporate tax rate even further in order to compete with the conditions in the US. "If I were the legislator in Israel, I wouldn't touch the Law for the Encouragement of Capital Investments, because there are nevertheless very good and competitive tax rates in comparison with the rest of the world. What I would change is the requirements for eligibility for those benefits."
Published by Globes [online], Israel Business News - www.globes-online.com - on February 27, 2018
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