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Government Lends High Tech a Fiscal Hand

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Tuesday, November 30th, 2010

As reported in IVC: The economic arrangements bill contains encouraging news for Israel’s high-tech industry.

The economic arrangements bill, which we take a negative view of in general, contains some important news to encourage Israel’s knowledge and high-tech industry. The bill includes focused tax breaks for three groups – investors, scientists, and experts – whose return to Israel will become more worthwhile from the beginning of next year.
To encourage investment in seed-stage high-tech companies, the bill proposes that an individual who invests in a company that is primarily engaged in R&D, will receive the cost of the investment as an expense against any future source of income (including income from a salary or business) spread over three years. In effect, this means that the state is a partner in 45% of the individual investor’s risk.

The bill also proposes that in the event of acquisition of technology start-ups by established technology companies, the buyer can amortize the cost of the purchase of shares of the target company (after deducting the target company’s shareholders’ equity) over five years, and set the amortization against taxable income from any other source.

As for the tax break of 18-25% on the cost of the investment, that is limited to cases in which the know-how developed remains under Israeli ownership.

Encouraging scientists to immigrate or return to Israel

Scientists who immigrate to Israel, and returning residents (after more than six years abroad as foreign residents), who contract with a technology transfer company for the development of a new product, will enjoy a tax exemption for five years on income from royalties and from licensing of the product to a foreign resident.

Benefits from 2011

There is no doubt that Ministry of Finance director general Haim Shani’s vast experience in the technology market and his understanding of its special needs has enabled him to lead a clear and sophisticated agenda that will make an important contribution to the fostering of this key industry for Israel.

The tax break will only apply on investments made in 2011-15, so it can be expected that eligible individuals and companies will begin to invest in or return to Israel, and in the in the case of a scientist interested in working with a technology transfer company, as early as 2011.

The severe economic crisis, which reduced investment in high tech from the standard sources, increases the importance of encouraging investment in start-ups by individuals. For this reason, it is recommended that investment should also be encouraged via “rollover” investments, meaning that someone who realizes an investment at a profit can defer the tax payment by investing the proceeds in another technology start-up.

The difficulty of an IPO by technology companies in the current market climate, combined with the need of venture capital funds to realize investments by the end of a fund’s lifespan, increase the need to encourage investment by private equity funds in acquiring mature Israeli companies. This will make it possible to bridge the gap until it is possible to float the companies in a better market climate.

Since the model of the investment funds is based on leverage, it is recommended to allow the deduction of financing expenses for acquisitions against profits by the acquired company. The non-recognition of interest expenses as a deduction in Israel, when these expenses are permitted as a deduction in many countries (such as the US and UK) effectively raises the cost of investment in Israeli companies, and helps divert investments to other markets.