Israel set to miss out on tax haven bonanza

British Virgin Islands

Israel's political deadlock is hampering officials seeking to attract tech companies to Israel who are being forced out of tax havens.

Tax havens around the world are being forced to clamp down on companies registered in their territory that have no 'economic substance' and are introducing new rules of reporting for offshore companies that will be forced to move elsewhere and seek out a home in a western country. This provides an opportunity for Israel to attract such companies and bring in billions of shekels annually.

The Israel Tax Authority is well aware of this opportunity in the new international environment of financial transparency as part of global pursuit of tax collection and the desire to shut down tax havens. At the start of the year, the Israel Tax Authority even planned a road show in Silicon Valley led by the authority's chief Eran Yaacov, Ministry of Finance director general Shai Babad and other senior officials to show large international tech companies with offshore holdings, the tax advantages in Israel - such as the Law for the Encouragement of Capital Investments.

However, the elections in April froze all the plans and the elections in September buried them. The Israel Tax Authority is now seeking a new way to open a channel of communications to these companies, without waiting for political stability, which may not be on the horizon.

International demand for 'economic substance'

Following pressure from the EU and OECD, tax havens as they are called, with very low or zero tax rates, and no reporting demands, have adopted legislation requiring companies incorporated in their territory to have 'economic substance.' These countries (many of them called offshore because they are islands) include the British Virgin Islands, Cayman Islands, Bermuda, Guernsey, Jersey, the Isle of Man, Barbados and Curacao.

The new legislation on tax havens includes several new demands that is likely to provoke companies to leave those countries. Among other things there is a requirement for a 'proper' physical presence in the tax haven. For companies engaged in finance, financing and intellectual property, the requirement is even higher. For example, the British Virgin Islands will require such companies to submit to the authorities information about revenue, the number of employees linked to operations, the number of employees based on the island and their names, the address of the offices, and details about equipment.

An additional requirement for offshore companies will be to show relevant activities - 'economic substance,' in other words that they have employees, offices, management, expenditure and more.

In Mauritius, Panama and the Seychelles, slightly different legislation was recently enacted, which also deal with 'economic substance,' which is based on the requirement for a proper number of employees and the proper need for operational expenditure in order to receive tax benefits.

These new rules will have a dramatic influence at both national and international level. A large part of the companies registered in these countries simply have nothing much to report. Many of these companies do not even have a single room in the offshore countries in which they are registered, and for sure their R&D is not conducted there.

These rules will influence Israeli companies dealing in international infrastructures and companies that do business in Africa, and which are registered in various tax havens, as well as thousands of smaller companies set up by Israelis in tax havens. On an international level, all the large tech companies own IP rights in offshore countries, and many of them will now be compelled to seek a new home. For Israel there is a brief window of opportunity to take in many foreign global companies.

The window of opportunity will close at the end of 2020

EY Israel tax managing partner Sharon Shulman explained, "This new legislation is the final nail in the coffin of the offshore structure."

He added, "This exodus from tax havens is an opportunity for Israel to open its borders to these companies and bring IP into Israel, especially due to the tax legislation here. There is here an opportunity for Israel to make big money. Israel has enacted the "Law for Preferred Technology" and "Special Preferred Technology" with 6% tax for large companies and guaranteed benefits for 10 years even if the law is changed, and this is all to persuade the large tech companies to come to Israel."

Are the companies now shopping around countries for a new home?

Shulman: There are better tax policies in many other countries. Countries like Ireland, Switzerland and Singapore have been seriously meeting with these companies recently and considering what can be done to bring them to their countries and they are in a better situation than Israel because they were a preferred location for these companies already. Israel needs to do some public relations for itself and meet with these companies and their CEOs and show them what the country can offer them and invite them to conduct negotiations with Israel."

Legislation in Israel already exists

The platform already exists because there is legislation with tracks for very unique benefits compared with the rest of the world, which lets the government grant benefits to whoever brings IP to Israel, and even if the law is changed, Israel will protect the promised benefits for 10 years. If we will miss 2020, then we've missed out on the money. The opportunity will close at the end of 2020."

Shulman is calling on Israeli legislators to enact laws that will benefit non-technology companies, so that companies leaving former tax-shelter companies will come to Israel. "There will be countries that will profit a great deal from this move. They will receive this activity and benefit from very large businesses, and not only in technology sectors," Shulman argues. "The first companies to respond to the new tax rules the US-based multinationals, because their structure is very receptive to holding intellectual property like patents in offshore companies. They will probably be exiting the offshore regimes and looking for onshore countries with an ordinary tax regime."

The new legislation in tax shelters is the result of an international effort to combat unreported capital and the shadow economy, which have undergone dramatic changes in recent years. Furthermore, the properly-run countries are tired of having companies operating in their territory earning huge sums and being incorporated in tax shelters. Regulators all over the world have declared war on tax evaders and money launderers, and have started letting loose their arrows on a global scale.

The result has been a great many initiatives and information exchanges between countries, with the world becoming more financially transparent.

Founding a company in a tax shelter is not a crime. Quite a few businesspeople around the world, including in Israel, chose to incorporate their companies in offshore countries for tax reasons. In some countries, including Israel, there is a duty to report an overseas holding in every foreign company, but there is no obligation to report that company's income, the number of its employees, or other details.

Shulman says, "The big picture is that the base erosion and profit shifting (BEPS) project (initiated by the G20 Forum in cooperation with the OECD, aimed at combating tax planning) is fighting against companies with no economic substance by changing the principles of transfer prices (the price set for international deals carried out by related companies). It ruled that profit could be attributed only to companies with activity of senior executives. Tax benefits cannot be given for intellectual property if the company itself does not do any research and development. This started the pressure on these international structures."

A company or partnership that does not comply with the reporting duty is likely to find itself facing fines varying from $20,000 to $75,000 for each entity, plus prison terms between six months and two years. Furthermore, a company or partnership that does not comply with the economic substance rules (or does not correct faults) will be exposed to substantial fines. These can range from $5,000 to $400,000 for each entity, plus the possibility of the company or partnership being removed from the local registry of companies, which could be regarded as liquidation in the country of residence of the parent company holding the liquidated company.

Various tax shelters have also established authorization for exchanges of information with other territories about economic or legal owners.

Shulman comments, "Someone who founded a company in the Virgin Islands knew that he or she had to take into account tax considerations in Israel and other countries. But he or she never needed people in the Virgin Islands, or had to file reports there. In effect, such owners operated there in darkness. These tax regimes were very prevalent in offshore countries. That era is over."

Published by Globes, Israel business news - en.globes.co.il - on November 11, 2019

© Copyright of Globes Publisher Itonut (1983) Ltd. 2019

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