The entrance of foreign technology companies to Israel sometimes draws significant debate. Critics say that their research and development centers take advantage of local knowledge /rder to divert profits abroad, and that the companies are responsible for raising local high-tech salaries and thus pushing local companies to find cheaper manpower in Eastern Europe.
On the other hand, the companies are credited with training local managers with the knowhow of multinational companies, giving Israeli workers a greater variety of opportunities, creating a more diverse workforce, and their tolerance for training inexperienced workers.
Multinational companies’ research and development centers also help advance Israel as a brand; the BDS movement, the occupation and the constant security issues haven’t shaken Israel’s image as the startup nation. Thousands of Israeli startups draw investors from around the world, who inject billions into the local economy and snap up companies.
Now, GKH Law Offices and the high-tech industry umbrella group Israel Advanced Technology Industries (IATI) have a new argument in favor of international development centers: They’re the backbone of the Israeli economy, they argue. A new report found that these companies contribute some $7.75 billion in taxes, or 27 billion shekels a year – some 16% of all direct taxes paid in Israel.
In 2019, Israel’s government stands to collect an estimated $48 billion in direct taxes – taxes on employees’ income and corporate profits. As of 2018, direct taxes accounted for 54% of all taxes collected in Israel.
The calculation is based on the taxes the companies pay directly on their profits and dividends, as well as income taxes workers pay on their salaries, as well as taxes paid by service providers that work with the foreign companies.
In other words, some 360 companies and a few tens of thousands of workers are responsible for an incredibly large portion of Israel’s tax revenue, compared to the other millions of Israeli workers, the report argues.
Gross’s office represents several prominent multinational firms in their Israeli operations, including Amazon, General Electric and Autodesk. The lead authors were Dr. Ayal Shenhav, a partner at the law firm and its head of high tech and venture capital, and attorney Chen Manzur, a partner in high tech.
The calculation presumes $125,000 in tax revenues per employee, with an estimated 62,000 Israelis employed at foreign R&D firms.
While the statistics in the report may not be incorrect, it’s important to look at the complete picture, including why the tax breaks granted to many multinational companies are criticized.
Multinationals such as Google, Facebook, Amazon, Apple and Microsoft have both research and development operations in Israel as well as local sales in fields such as advertising and cloud computing services. The technology they develop in Israel brings them revenues around the world. And yet, the extent of revenues attributed to Israel for foreign R&D centers is calculated based on the cost-plus model, which is detached from their actual profits. In the cost-plus model, the Israeli R&D centers pay a tax calculated based on a fixed percentage of their expenses – such as rent, employee salaries and payments to subcontractors. The Israeli subsidiary generates profits by selling its services to the parent company – generally at a markup of between 5%-15% over costs, a percentage known as the “plus.”
Shenhav says the accepted rate is 8%. On this “plus” – the profit – the company pays taxes of 23%, although in some cases, the companies have benefits that enable them to pay a lower tax rate. This method guarantees the Israeli subsidiary a risk-free profit. That is, limited profit is attributed to Israel even if the product isn’t profitable. But if there is a large profit from the products made in the Israeli R&D center, as in many of the big tech companies, it is not attributed to Israel. This is where the big money lies.
Another issue is the fact that major multinational companies do not pay taxes on their revenue from Israeli customers. For example, Google and Facebook alone are thought to take in 900 million shekels on advertising in Israel, yet this revenue isn’t taxed in Israel, but rather in Ireland or the United States.
Shenhav says the implementation of the OECD’s BEPS plan, designed to combat tax planning measures that enable multinational corporations to redirect profits to tax shelters or other countries with low taxation, will significantly increase Israel’s tax revenues from multinationals.
BEPS states, among others, that a company’s profits will be taxable in the country where its operations are that create them. Shenhav estimates that multinationals currently pay taxes equal to 2-3% of their annual turnover, and that after the reform, that figure will increase to 6-12%. This could mean billions more in revenue for Israel, he says.
The report is based on the IVC database, which collects data on Israel’s high tech industry and tracks trends among foreign companies.
Half of the foreign R&D centers in Israel have fewer than 50 employees each. Most of the centers were formed after foreign companies bought Israeli startups, as opposed to directly launching R&D operations here.
The report found that as of the end of 2010, there were 210 multinational tech companies in Israel, a figure that grew by 50% to 354 as of 2016, and then at a more moderate rate to 362 by 2019. Between 2016 and 2019 there were fewer R&D centers opened, and a significant number shuttered.
Shenhav and Manzur believe fewer companies have been launching local operations in Israel due to the high cost of manpower in Israel, due to both the strong shekel and the high competition for Israeli tech workers, which pushes up wages.
They also note that Israel’s government isn’t encouraging multinationals to create a local representation.
GKH’s estimate is based on several assumptions. Shenav said his team arrived at this figure through discussions with companies’ financial executives.