Global tax pressures are shifting multinational companies towards greater alignment of intellectual property (IP) ownership and substance, and the implications for corporate location strategies are potentially massive. An OECD and G20 initiative targeting base erosion and profit shifting (BEPS) – tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low- or no-tax locations – looks to spur the most significant changes to international corporate taxation in 30 years. Under the OECD’s Inclusive Framework on BEPS, more than 100 countries and tax jurisdictions have pledged to implement anti-BEPS measures.
Under the new BEPS guidelines, income from IP should be allocated to entities that perform and control a company’s so-called Dempe functions (development, enhancement, maintenance, protection and exploitation of intangibles). Multinational companies will have to provide tax authorities with a country-by-country breakdown of global profits, taxes paid, and other indicators. Old ‘patent box’ IP regimes will be phased out due to lack of substance and any new regimes should be dependent on the level of R&D carried out by the taxpayer company unit itself.
These changes have sparked worry among many countries that rely on tax advantages to attract FDI. But for others, the clampdown presents an opportunity. Israel, which has a large concentration of both R&D and productive activity, feels it has a strong hand to play under the new tax landscape and has revised its set of policies accordingly.
There are more than 200 industrial multinationals doing R&D in Israel along with an additional 100 services-based multinational companies. Almost one-third of these 200 are also manufacturing in Israel, according to figures from Dun & Bradstreet Israel and Invest in Israel, the country's investment promotion agency within the Ministry of Economy and Industry. Under the revised rules these numbers could very well grow substantially. Israel already ranks first in the world for number of researchers engaged in R&D per capita as well as number of engineers per 10,000 people.
“Over the past decade Israeli innovation has been heavily pursued by multinational enterprises through acquisitions of Israeli companies and the establishment of R&D centres. As global IP structures are increasingly scrutinised, the new Israeli Innovation Box regime will enable these companies to consolidate profits and substance in a low-tax IP jurisdiction,” says Sharon Shulman, tax managing partner at EY Israel.
Seeing the benefits
Benefits of the Innovation Box 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 more than NIS10bn ($2.5bn).
Other qualifying companies with global consolidated revenue below NIS10bn 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).
The regime is designed so that most R&D entities of multinationals can qualify.
The Israeli government is hopeful of increased co-location activity by global companies operating in Israel as well as new R&D entrants to the market and was recently in London promoting the new tax policies, approved by the Israeli parliament in December 2016, to UK-based companies. The event was lead by Invest in Israel.
“Multinationals already make up the majority of R&D spending in Israel. The BEPS recommendations are an additional opportunity for multinational companies operating in Israel. Our new Innovation Box creates a strong value proposition,” says Gilad Be'ery, director of economic strategy at Invest in Israel.