The consistent growth in the R&D centers' activity is powered by Israel's comparative advantages. Efficient tax planning constitutes another incentive for dispersing operations in the multinational corporations' value chain between different countries. In this way, while their activity in Israel yields large-scale R&D output, the intellectual property developed within the framework of this activity has, until now, been listed in other countries in which taxation of income from intellectual property is considered more convenient.

Accordingly, the R&D centers' operations in Israel is, in most cases, taxed by the 'cost-plus' method[1] that fails to gross up the actual business profit from the company’s R&D activity. This means that tax revenue from the R&D centers in Israel does not reflect the added value of their research and development activity, i.e., the high income from the sale of products worldwide.

This status quo of dispersal of global activity based on tax planning was interrupted during 2016 with the publication by the OECD of the BEPS Regulations.[2] The objective of the regulations is to prevent the relocation of high-tech companies' profits to countries with favorable tax regulations and to tax havens worldwide. The regulations mean, among other things, that intellectual property must be registered in its country of development. The full adoption of the BEPS Regulations by the developed countries, therefore, presents multinational corporations with two alternatives: the first, to transfer their R&D operations to a country in which both the tax and business conditions are optimal for them. The second option is to leave the R&D activity in those countries possessing the comparative technological and systemic advantages for innovation, despite the change in tax payments expected with the ascription of sales income to these countries.      
At the same time, countries of the second category, including Israel, will be required to conform their tax system to prevent corporations from transferring their R&D activity to countries enjoying a comparative tax advantage. The regulations determine that only the country in which intellectual property has been developed may bestow tax benefits on income derived from it, and they therefore provide an opportunity for countries that have hitherto hosted multinational corporations' R&D activity, to create an attractive tax regime.

If so, the BEPS Regulations constitute a challenge for preserving the attractiveness of the Israeli innovation system in the eyes of multinational corporations. Primarily, the State of Israel must maintain those comparative advantages due to which multinational corporations have come here in such large numbers – skilled personnel mainly in ICT, groundbreaking high-tech companies, world-leading technology, and others. Also, the restriction on granting tax benefits on income from intellectual property creates an opportunity to incentivize multinational corporations to register here the intellectual property developed in Israel. Experience proves that the establishment of intellectual property in a particular country frequently leads to the expansion of that company's management activity there. Such a dynamic is also expected to bring about an increase in high-salaried employment of workers in supportive functions, including management. The registration of intellectual property in Israel may therefore lead in the long-term, to an expansion of the multinational high-tech corporations' economic activity in Israel.

And indeed, the government is currently engaged in adapting the tax system that applies to high-tech companies to the international tax environment in accordance with the recent changes. Following preparatory work led by the Ministry of Finance, the Knesset authorized in late 2016, Amendment No. 73 to the Encouragement of Capital Investments Law and the Finances Committee recently authorized the ordinances for its implementation. The Amendment creates a special track for high-tech companies and grants them significant tax benefits on income from technological developments. The benefits include the lowering of corporate tax from 25 percent to 6-12 percent[3] and significant benefits in the tax rates on dividends and capital gains.
Within the framework of the Amendment, the Innovation Authority received several consulting and arbitral powers the objective of which is to make the Amendment's implementation easier for technology companies, this based on its proximity to the industry and its in-depth familiarity with research and development processes. Firstly, it was determined that companies failing to conform to the special track's conditions as determined by the law, may submit a request to the Innovation Authority asking to be included in the definition of an "innovation advancing plant." This definition will allow them to receive the benefit granted in the Amendment. Secondly, the Innovation Authority has the power to adjudge whether technological knowledge developed in Israel or transferred to Israel conforms to the application of tax benefits.[4]
The described changes will allow multinational corporations to continue expanding their R&D activity while registering the resultant intellectual property in Israel, and will even make the transfer of intellectual property from other countries to Israel worthwhile. These changes are not, of course, only relevant to Israel: with the publication of the BEPS Regulations, a kind of 'arms race' of tax regime adaptation developed in the international arena. Will the changes that Israel is implementing be effective in preserving and expanding the R&D activity of multinational corporations? How will their tax revenues change? In light of the central role played by the multinational corporations in the local economy, these are indeed critical questions for the future of Israeli innovation.

The Innovation Authority – In Practice: Supporting Strategic Cooperation between Israeli Companies and Multinational Corporations

Multinational high-tech corporations can benefit the Israeli high-tech system not only by means of the activity of the R&D centers located here but also, via strategic collaborations with Israeli start-up companies. These collaborations pave Israeli companies' way to markets and avenues of operation both in Israel and around the world, and infuse Israeli industry with knowledge, experience and skills at all stages of the technological development's value chain.
A successful example of such cooperation is the connection between the Israeli company Qlight and the global chemical and pharmaceutical corporation Merck. Qlight was founded in 2009 and develops applications for LED lighting and television screens, based on a nano-technology originally developed at the Hebrew University, that enables precision color control. Merck expressed interest in Qlight's technology already at its inception, joined forces with it in joint development and invested in the start-up company at an increasing rate. The Innovation Authority's support of Qlight, within the framework of the Global Enterprise Collaboration Program, assisted in strengthening the strategic collaboration between the two companies. Merck's vast knowledge aided Qlight in understanding market needs and focusing on new directions.

In 2015, following years of joint endeavor, Merck completed acquisition of Qlight. Following the acquisition, Qlight's R&D infrastructures were significantly expanded. The company is continuing its operation in Jerusalem as a R&D center of the global Merck Corporation in the field of advanced materials.

  • 1. [1] Pricing of the added value according to the operation's cost price plus a profit constant accepted in the sector, and determined by the tax authorities. The accepted rate in multinational corporations' R&D centers is 5-12 percent.
  • 2. [2] Base Erosion and Profit Shifting
  • 3. [3] Twelve per cent for preferred technological factories, 7.5 per cent for preferred technological factories in Development Areas 'A', and 6 per cent for special preferred technological factories (giant corporations).
  • 4. [4] The full details are updated on the innovation Authority's website.