US President Donald Trump’s plan for what his officials called the “biggest tax cut” in US history could spark an exit of companies and tax revenues from Israel, just at the government in Jerusalem has promised to lower taxes for its citizens.
Trump proposed dramatic cuts in the taxes paid by corporations big and small Wednesday in an overhaul his administration says will spur economic growth and bring jobs and prosperity to America’s middle class.
The plan would also reduce investment and estate taxes aimed at the wealthy. But administration officials said that action on other key tax code elements would ensure the plan would largely help the middle class instead of the affluent.
On the corporate side, the top marginal tax rate would fall from 35% to 15%. Small businesses that account for their owners’ personal incomes would see their top tax rate go from 39.6% to the proposed corporate tax rate of 15%.
“At a low tax rate of 15% in the US there is a strong likelihood we will see Israeli tech companies, whose main markets are in the US, incorporating in the US,” said Sharon Shulman, the tax managing partner of EY Israel, in a phone interview. “This represents without any doubt a significant risk to the Israeli economy in the long term.” EY Israel is a member firm of member firm of Ernst & Young Global Ltd., which is a provider of tax, transactions and advisory services,
Pressure on startups to incorporate in the US
Companies that are already incorporated in Israel will not rush to uproot themselves and relocate, Shulman said. But for new companies that are setting up, if the US tax rate drops to 15%, the decision to remain in Israel will be harder. “And that is exactly the intention of Trump,” to lure companies to the us, he said.
“If the corporate tax rate in the US will be cut to 15% as proposed by Trump, this will put a lot of pressure on Israeli startups to succumb to investors’ demands and incorporate in the US,” said Jonathan Irom, a partner at the International and High Tech Department at the GKH law firm in Tel Aviv.
Up until now the US tax rate was higher than in Israel — an average US rate of 35% compared to the Israeli rate of up to 25%. “Israeli entrepreneurs have been able to use the lower tax rate as an excuse to incorporate here in Israel,” Irom said. “But once the rate is cut in the US that excuse will no longer be valid, and this will drive a lot of startups to seriously consider incorporating in the US rather than in Israel.”
“That means less foreign investment in Israel, less companies in Israel that are paying taxes locally and lower revenues from M&A deals under certain structures,” Irom said.
Israel is expected to put into place by January 1, 2018, a new tax plan that would slash corporate taxes for multinational companies that invest in the country, in an effort to draw more firms to its shores and ensure that those already operating in Israel maintain their operations.
The legislation, called the “Innovation Box” proposal and backed by the Finance and Economy ministries, will cut corporate income tax to 6 percent for companies with consolidated revenues of over $2.6 billion and to 12 percent for smaller firms. This compares to a current corporate tax rate in the range of 16% to 25%. The withholding tax rate on dividends will be lowered to 4%, compared to a rate of around 20%-25% today.
“This plan can certainly help Israel,” said EY’s Shulman. “But if the rate in the US will indeed drop to 15%, it may not be enough. It could be we will see pressure to lower the rate to below 12%, perhaps to 10%,” Shulman said.
Earlier this month Finance Minister Moshe Kahlon announced a package of tax breaks and benefits aimed at increasing the net income of poor and middle-class working families by thousands of shekels a year. And both Kahlon and Prime Minister Benjamin Netanyahu have promised to use surplus tax revenues to cut taxes for citizens.
“Trump’s tax reform puts Israel in a bind,” said EY’s Shulman. “On one hand it will not be able to stay with a corporate tax rate of 24%, if the US will indeed reduce its rate to 15%. But if tax rates in Israel are cut further, then Israel must make tough decisions about its budget and how to finance the tax cuts.”
“The implications of President Trump’s new tax plan could be dramatic for Israel in the sense that they may lead to a shift of revenues to the US,” said Binyamin Tovi, International Tax Partner at Shekel & Co., a law firm in Tel Aviv. “The solution for preventing Israeli high-tech companies from fleeing to the US is not to lower corporate tax but rather modify the conditions for benefits in Israel.”