Supreme Court ruling increases tax burden on multinational R&D units in Israel

Supreme Court ruling increases tax burden on multinational R&D units in Israel

Decision seen to reduce country’s ability to attract global companies to operate locally and comes amid stiff competition for these firms

Doing taxes (Pixabay)
Doing taxes (Pixabay)

A recent Supreme Court ruling is making it less attractive for multinationals to set up R&D and tech operations in Israel, as it raises the specter of an increased tax burden.

The Supreme Court in Jerusalem last week backed the Israeli Tax Authority, which is claiming that companies that have subsidiaries in Israel and operate on a so-called “Cost Plus” basis should factor into their expenses the costs of issuing the options they give workers. Cost Plus is an accounting measure in which profit is calculated as a percentage of costs. Under the measure, the higher the costs, the higher the profit, and that means higher taxation on that profit.

“This affects high-tech companies that have R&D centers in Israel, as they mostly use the Cost Plus model,” said Binyamin Tovi, International Tax Partner at Shekel & Co., a law firm in Tel Aviv. “Many R&D companies issue options to their employees. Following this ruling, expenses incurred in issuing such options to  employees will have to be calculated into the costs. This will increase the profitability of the companies and will increase the amount of taxes they pay locally.”

In addition, the court has said that the cost of issuing options cannot be deducted as an expense, because employees who receive these options benefit from lower tax brackets under a special regime, Tovi said.

Binyamin Tovi, International Tax Partner, at Shekel & Co. law firm (Courtesy)

“All this means that tax expenses of these companies will rise and it will be more expensive for them to operate in Israel,” he said.

The ruling came in the case of Kontera Technologies Ltd. and Finisar Israel Ltd., two local subsidiaries of US technology firms.

Companies such Google, Apple, Deutsche Telecom and Bosch have set up research and development centers in Israel, and there are some 300 multinational companies operating a total of 366 R&D centers around the country today, IVC Research Center and Startup Nation Central data shows. Many of these centers were set up after the acquisition of Israeli high-tech companies. These R&D centers are a key part of Israel’s innovation scene, and account for 50 percent of  R&D investment in Israel, according the the Innovation Authority’s 2017 report.

The ruling comes at a time when US President Donald Trump’s tax reform is making it more attractive for companies to set up operations in the US, and as countries globally compete to offer attractive packages to multinationals to draw them to set up their operations locally.

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