Investment
Incentives in Israel
Prepared by L. Marc Zell, Adv. and Keith Shaw, Adv.,
Zell & Co., Jerusalem and Tel Aviv, An Affiliate of the
FANDZ International Law Group.
This note deals with the
investment incentives available to foreign investors in Israel, primarily
within the framework of the Encouragement of Capital Investments Law 1959
(the Law). Note that an update of this article
is in progress.
By way of brief introduction, eligibility for receipt of incentives
and the granting of approvals is dealt with by the Investment Centre at
the Ministry of Industry and Trade, which has the powers granted to it
by the Law. Incentives are awarded to successful applications which are
categorised as one of “approved enterprise”, “approved
property” or “approved investment or loan”. Only the first
of these is relevant for present purposes.
It is also worthwhile noting that for the purpose of determining allocation
of incentives, Israel has been divided into three National Priority Regions,
with the effect that more attractive incentives are available for an enterprise
in a higher priority region. Essentially, Region A comprises the Upper
Galilee, Golan Heights, Jordan Valley and the Southern Negev, Region B
the Lower Galilee and the Northern Negev, and Region C the remainder of
the country.
“Approved Enterprise”
The Board of the Investment Centre will consider a number of criteria
in deciding whether to award approved enterprise status, of which those
relevant are as follows:
a) International market: the Board will consider the ratio of potential
export sales to total sales. For Region C, the guideline is that 50-60%
of sales should be direct exports (the figure for Region B, by comparison,
is 45%). As the condition relates to potential rather than actual export
sales, attention may be given to the likelihood of successfully setting
up a foreign marketing operation and an overseas distribution network.
If the Board is doubtful as to such success, it may also require the adoption
of a specific marketing plan, non-adherence to which could result in cancellation
of the approved enterprise status.
As a general principle, and particularly in the higher priority regions,
approvals are readily granted to enterprises creating significant job
opportunities, enterprises producing import substitutes, and infrastructure
enterprises.
b) Size of project: there is currently a tendency towards granting approved
enterprise status to smaller firms which are able to maximise productivity
and use of equipment; this is true particularly with regard to the software
and high-tech industries.
c) Innovative technologies: conceivably the most relevant for current
purposes, consideration will be given to innovative technologies particularly
in the areas of industrial chemicals, electronics, software and communications,
and, most relevantly, bio-technology.
To qualify as such, an approved enterprise must be owned by one of the
following:
a) an Israeli company
b) a foreign incorporated company duly registered at the Israeli Companies
Registry
c) a cooperative society
d) a non-resident limited partnership duly registered in Israel
e) a partnership comprising all or some of the above
f) whomever the Board agrees to.
In this regard, it is of particular importance to note that a change
in the ownership structure of an approved enterprise, as well as a change
in the location of the enterprise, or a change deriving from a corporate
merger or division of an approved enterprise, requires the prior approval
of the Investment Centre.
The incentives available
In its application for approved enterprise status (the procedure for
which will be discussed below), a company must, in certain circumstances,
choose between the various benefits available. Once made, the decision
cannot be changed. The benefits fall into four categories, as follows:
a) Grants
These are available, in the form of investment grants and capital grants,
to finance the purchase of potentially up to 34% of fixed assets for the
approved enterprise. However, the availability varies according to the
National Priority Regions, and at present grants are available with regard
to Region C only to enterprises which are involved with tourism. Given
that the capital grants which are currently available are expected to
be substantially reduced for 1997, and on the assumption that this is
indicative, it seems unlikely that the position with regard to Region
C will change. There does exist a special exception for high-tech and
skill-intensive enterprises, but this extends only to enterprises located
in an area surrounding and near to Jerusalem.
b) Reduced tax rates
In general, a company which owns an approved enterprise is liable to
a reduced company tax rate of only 25% (as opposed to 36%) of attributable
income, for the seven years beginning in the year during which the enterprise
first earned taxable income, provided that twelve years have not passed
since the enterprise commenced, or fourteen years from the grant of the
approval, whichever is the earlier.
Further, dividends paid to shareholders from profits earned during the
seven year period are liable to tax at a rate of only 15%, if paid during
the seven years or within the twelve years thereafter.
There are, however, additional tax benefits available to companies owned
by foreign investors, this being defined as where the percentage of foreign
investment in share capital together with shareholder loans exceeds 25%.
Here, the relevant period of benefits is ten years rather than seven,
and tax rate is determined on a sliding scale depending upon the percentage
of foreign investment. For a company with over 90% foreign control, the
applicable tax rate will be 10% for the relevant ten year period.
Again, a dividend paid by a foreign-controlled company from profits of
the approved enterprise earned during the period of benefits is liable
to tax only at 15%, but here in addition there are no restrictions on
the timing of its payment.
Additionally, the Board has the power to determine that a particular
company is a “foreign investors’ capital intensive company”,
meaning that the company is highly capitalised, and that the amount of
foreign investment is greater than 74%, and not less than $20 million.
Such a company will be entitled to an additional five year incentive period
provided that during these five years, 80% of its income is from exports.
A final note is that a foreign company owning an approved enterprise
through a branch operation, as opposed to an Israeli company, is subject
to an additional 15% “branch tax” on its earnings after company
tax, in place of the dividend withholding tax, though this may be deferred
if it can be shown that the profits were re-invested in the enterprise
and not transferred abroad.
c) Alternative benefits - tax holidays
A company which has a taxable income from an enterprise approved after
1 April 1986 may choose this system as an alternative to the incentives
outlined above. This system is not available to a branch of a non-Israeli
company, nor to an approved enterprise not owned by a company.
Under this system, the recipient company will be entitled to exemption
from company tax on undistributed profits, for a particular period which
is determined by the location of the enterprise and the percentage of
foreign control. For the balance of the period of benefits (see b) above),
if any, the company will be taxed at the reduced rate as per b) above.
Companies located in Region C are entitled to a two year exemption period
(the corresponding figures are 6 years for Region B and 10 for Region
A). Companies with more than 25% foreign ownership, which under b) above
enjoy a 10 year period of benefits, therefore have a further 8 years during
which they are taxed at the reduced rate. For companies not so owned,
which as noted above have a period of benefits of only seven years, the
reduced tax period consequently extends for only another 5 years.
In order to encourage the re-investment of earnings, dividends which
are distributed out of tax-exempt profits will be subject to company tax
at the rate which would have been payable had the company not chosen the
tax holiday. In addition, as previously, the dividend itself will be subject
to 15% withholding tax.
It is thought that scheme c) is particularly attractive to enterprises
in Region C which are not entitled to grants, and to enterprises whose
investment in fixed assets is relatively small in comparison to anticipated
turnover and taxable income.
d) Accelerated depreciation
The tax incentives detailed in b) and c) above include accelerated depreciation,
at rates which range from 200% (for machinery and equipment) to 400% (for
buildings) of the standard depreciation rates of such assets. The rates
are accordingly 8-20% for buildings, and 15-20% for machinery and equipment,
and are available for the first five years of the asset’s operation.
In a case of unusual wear and tear on equipment, the abovementioned rate
of 200% may be increased to 250% with the consent of the Assessing Officer.
Depreciation is calculated on the cost of the relevant fixed assets after
the deduction of any government grants.
e) Approved foreign specialists
A further incentive available relates to a foreign resident, who has
never been an Israeli resident, and who has been approved by the Investment
Centre and engaged by an approved enterprise for a particular project.
Such individual pays income tax at a reduced rate of 25%, on income up
to a maximum of $75,000. The period of benefit is three years, but the
Board may extend it for a further five years.
f) Loan guarantees
Companies applying for approved enterprise status for industrial or tourism
projects may request government guarantees for bank loans. This may be
either together with or instead of a government grant (in the latter case
a larger guarantee is available. Unlike grants, the guarantees are available
in all three regions.
The aim of the guarantees is to assist companies who lack the necessary
capital for investment, or which are unable or have difficulty in providing
the requisite loan security. They are available for the purchase of fixed
assets, as well as for working capital, land, leasing and rental fees,
start-up expenses, marketing and research and development expenses (if
no other State aid has been received), and acquisition of know-how.
The maximum guarantee available is generally 52.5% of the approved investment
(being 75% of a loan itself limited to 70% of the approved investment),
but rises to 59.5% (85% of a loan limited to 70% of the approved investment)
for enterprises in their start-up period. The minimum paid-up capital
required is $100,000 for Region C ($75,000 for Regions A and B), and it
must constitute not less than 30% of the total investment in the approved
enterprise. Further, this may not be reduced, nor may dividends be declared
during the period of the guarantee, without prior government approval.
The minimum investment in fixed assets is $330,000 for Region C ($250,000
for Regions A and B).
The request for a guarantee should be filed at the same time as the main
request for approved enterprise status, and the guarantee must be utilised
within three years of approval of the enterprise. The loans themselves
are given for up to ten years for financing the construction of buildings,
and five to seven years for other requirements.
The rates of interest chargeable on the loans are regulated by the Ministry
of Finance. Security requirements consist of a fixed first charge on fixed
assets acquired by the company as part of he enterprise, including know-how,
patents and licences, and a floating charge at the most preferential level
possible at the time on all of the company’s current assets (though
the company may be permitted to create preferential floating charges in
favour of banking institutions). In addition, the personal guarantee of
the owners of the company or of the company owning the company is also
required, for up to 15% of the total loan. The risk premium is currently
1.5% per annum.
It is important to note is that where guarantees are taken without grants,
the company may still select the tax benefits which they prefer under
either b) or c) above.
The provisions in the Law relating to government loan guarantees were
repealed as of 31 December 1996. Accordingly, while it would appear that
guarantees already given will not be affected, new government loan guarantees,
both with and without grants, are no longer available.
g) Premises and infrastructure
Industrial premises at reduced rents may be available in development
areas and industrial parks. In addition, subsidies are available to approved
enterprises for the costs involved in providing essential infrastructure.
Both these matters are separate from the incentives offered under the
Law.
Obtaining Approved Enterprise status
Application, in the form of an investment plan, is made simultaneously
to the Investment Centre and to the Industrial Development Bank of Israel
Ltd (“the Bank”). The Bank and the appropriate division of the
Ministry of Industry and Trade will assess the application based on the
current national priorities and the level of local manufacture of similar
products.
The application must contain such matters as the purpose of the investment,
description of the product and the manufacturing process, list of buildings,
machinery and equipment required, details of financing and personnel,
sales projections, details of export potential or import substitution,
and timetable. At lease 30% of the cost of the fixed assets in the enterprise
must be financed by paid-up share capital.
Approval of the enterprise is in writing from the Investment Centre,
setting out its requirements and conditions of the approval, which may
include such matters as period of implementation, share capital requirements
and export requirements. Investors will be required to provide collateral
for the fulfillment of the conditions, and also to submit periodic audited
progress reports.
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