What is the Encouragement of Capital Investments Law and its benefits?

The Encouragement of Capital Investments Law has undergone many amendments since it was first enacted.  In its original version, The Encouragement Law was intended to attract capital investment to Israel and encourage economic initiative, foreign capital investments, and local capital investments.

In the period following the ratification of Amendment 68, the objectives of the Capital Investment Encouragement Act changed. The objectives have become: to develop the country’s production capacity, improve the business sector’s ability to cope with competitive conditions in international markets, and create infrastructure for new and sustainable jobs. An examination of a company’s compliance with the terms of the law will be made in light of the objectives of the law, as they are presented in its current wording.

The Economic Efficiency Law (legislative amendments for the implementation of economic policy for the 2017 and 2018 fiscal years), led to the addition of Amendment 73 to the Capital Investment Encouragement Law (hereinafter: “Amendment 73”). The purpose of Amendment 73 was to modify the law to encourage the establishment of suitable companies to create branches and expand their activities in Israel. The amendment also set an incentive to encourage new activity in Israel and raise the level of productivity and innovation.

The Three Main Purposes of the Capital Investment Encouragement Law:

• Develop the country’s production capacity.
• Improve the ability of the business sector to cope with competitive conditions in international markets.
• Creating infrastructure for new and sustainable jobs

Corporations must meet the conditions of the Investment Encouragement Act in order to obtain significant tax benefits and applicable grants. Companies that meet the conditions of the law will enjoy significant tax benefits.

Below is a table showing the tax benefits under the Capital Investment Encouragement Law:

Comments	Capital Gains when selling IP	Dividend	Tax		Corporate	Tax Rate	Tax Benefits
		Israeli Company	Foreign Company	Individual	Other Area Development	Area A Development
Dividend to a non-substantial shareholder (25%)	23%	0%	30%	30%	23%	23%	Without a law of encouragement
	23%	0%	20%	20%	16%	7.5%	Preferred  Enterprise
Foreign Company with full holding	23%	0%	5%	20%	8%	5%	Special Preferred  Enterprise
Foreign Company with over 90% of the shares (obtains capital gains benefits under certain conditions)	12%	0%	4%	20%	12%	7.5%	Technological Preferred  Enterprise
Obtains capital gains benefits under certain circumstances.	6%	0%	4%	20%	6%	6%	Special Preferred  Technological Enterprise

*Possibility of a grant in the case of an industrial plant – the grant rate is 20% of the total approved investments included in the business plan approved for the corporation.

The Main Conditions for the Application of the Capital Investment Encouragement Law on a Preferred Enterprise:

• The corporation must legally be a preferred company with a “preferred factory” in Israel. A preferred plant is an industrial plant that is a competitive plant as defined below.
• This is an industrial plant, i.e. most of the company’s activities should be manufacturing, production via raw material (there are some exceptions), or production from scratch.
• Regarding the existence of a factory – there is no definition of a factory in the law. This indicates that there are no specific conditions of an enterprise that must be met, especially when it comes to software development. Decisions of the Tax Authority such as 6003/19 refer to the existence of an office. For the above taxation decision read here.
  • Excluded from the definition of an “industrial plant”: a mine, a plant whose activity is the production of a natural resource, a plant for the exploration or production of oil as defined in the Oil Law, 1952. Also excluded is an approved agricultural plant as defined in the Law for Encouraging Capital Investments in Agriculture, 1980.
• The law does not require a certain number of workers to fit the definition of an industrial plant, however, at the time the law was set, the Tax Authority set a minimum number of ten workers. The IRS no longer adheres to this guideline, however, there will still be an advantage to employing a certain number of workers, even if not ten (The condition is required for an industrial plant, whereas a technological plant needs to have an intangible asset owned by the plant).
• A plant is defined as “competitive” and export if it meets the following conditions:
  1. Its main activity is in the field of biotechnology or nanotechnology, and has been approved by the National Authority for Technological Innovation prior to the approval of the program as stated in this section.
  2. Its income in the tax year from the sale of the enterprise in a particular market does not exceed 75% of its total income in that tax year.
  3. 25% or more of its total income, in the tax year from sales of the plant, are from sales in a particular market of at least 14 million inhabitants (or more – the amount increases yearly).

• Preferred Income – Income from activities carried out in Israel. This includes a number of alternatives: income from the sale of products manufactured in the same plant, including their components manufactured in another plant, income from granting the right to use knowledge or software developed in the factory (for example, income from software usage fees), income from ancillary service for sales and income from research, and industrial development for a foreign resident for whom a scientist’s approval has been obtained.
• The definition of a preferred company includes a company that was incorporated in Israel, legally manages ledgers, did not commit offenses, etc.

For the purpose of recognizing a preferred technological enterprise (as opposed to a preferred enterprise) and for its significant benefits – additional conditions are required:

• The fixed conditions regarding a preferred plant as detailed above.
• Expenditures classified as research and development expenses in accordance with accepted accounting practices (hereinafter: “R&D”) of the enterprise, in the three years preceding the tax year, were at least 7% on average per year of the company’s total revenue or exceeded NIS 75 million per year.

The Tax Authority Circular (09/2017) stipulates that they will be considered as recognized R&D expenses, including any of the following.

• Wages, direct expenses, management and general expenses that were used directly for the R&D activity, cost of materials and everything provided that the costs were used for the company’s R&D activities directly.
• The company that owns the plant must meet one or more of the following conditions:
  • 20% or more of the company’s employees are R&D employees or the company employs at least 200 R&D employees.
  • A venture capital fund has invested at least 8 million NIS in the company, and the company has not changed its line of business after the date of investment.
  • The company’s revenue turnover in the tax year and in the three tax years preceding it was NIS 10 million NIS or more, and its revenues in the three years preceding the tax year increased by an average of 25% or more compared to the tax year prior.
  • The company employed at least 50 employees in the tax year and in the three tax years that preceded it and the number of employees in the three years prior to the tax year increased by 25% or more on average compared to the tax year that preceded them.
  • Employs a person who is “not legally registered as an employee of the company but is at the disposal of the company provided that they exclusively work at the plant”. As to the conditions pertaining to the employee – in accordance with Circular 9/2017 (page 13) employee
  • The turnover of the company that owns the factory is less than 10 billion NIS.

Preferred Technological Income

Preferred technological income is income generated from an intangible asset which is wholly or partly owned by the enterprise, or which the enterprise has the right to use, including any of the following:

1. Income from the granting of a right to use a beneficiary intangible asset.
2. Revenue from a software-based service.
3. Income from a product in which the plant made use of a beneficiary intangible asset.
4. Income from an ancillary or supporting product to a computer program or product as stated in paragraph (3), provided that the product was directly related to the beneficiary intangible asset and one of the following exists for it:
   1. No other beneficiary property was used in its production.
   2. In its production, there was the use of another intangible asset not owned by the parent company or a related party, and which does not give a related party the right to use it.
5. Income from ancillary service for the grant of a right of use, service, or product as stated in paragraphs 1-3 or supports any of those as stated in paragraphs 1-3, as the case may be.
6. Income from the sale of research and development services that does not exceed 15% of the plant’s income.

*Intangible assets including copyright, software, etc.

Additional Conditions for a Technological Enterprise from Regulations to Encourage Capital Investments:

Regulation 3 of the Capital Investment Encouragement Regulations contains additional requirements for the existence of a technological enterprise:

• The number of employees in Israel in a given year is greater than 20% of the number of workers employed in Israel in the two tax years prior to the year in which the company was considered a technological enterprise.
• The cost of wages for Israel-based employees in a given tax year is greater than 20% of the average wage cost in the two tax years prior to the tax year in which the company was considered a technological enterprise.

*In some cases, instead of the additional conditions for a technological enterprise, it is possible to obtain approval from the National Authority for Technological Innovation. Technological income is part of the income derived from R&D in Israel according to the “Nexus” formula.

Nexus formula:

Total Revenue in IP x (130% x eligible expense for IP R&D/Total IP Expenses)

Total expenses, ie the denominator (including “bad” expenses):

Receipt of R&D services from related parties abroad, royalties to a foreign company, the cost of acquiring knowledge to a foreign company, purchase of an asset not made in Israel, undocumented “good” expenses, and R&D services by an unrelated party in Israel if the number of employees and their wages is reduced by 20% at least in the year the company was first considered a technological enterprise.

The formula will apply to all companies that implement the Capital Investment Encouragement Law as of 1/7/2021. In the case of an intangible asset purchased after 30/6/16, the formula will apply as early as 1/1/17.

In accordance with the Income Tax Circular 09/2017 – the software industry currently operates following the model of “software as a service” and not just in the business of licenses.

Moreover, in cases where no license is granted, access to software is provided via cloud computing or over the Internet and income will be considered technological income. Software-based services currently exist in various industries such as internet advertising, finance, and more. Revenue from such services are considered “technological revenue” provided that it is in fact derived from software. In this regard, it is important to emphasize the nature of a company’s activity as a software development company and not as a service-based company.

Additional Incentive Laws

The Angel Investment Act

The Angel Investment Act was passed as part of a temporary provision with the purpose of encouraging investors to fund business ventures in their early stages. The temporary order expired at the end of 2019, however, it is not inconceivable that the rationale underlying the temporary order will be reflected in further legislative proceedings soon.

Read here about the Law of Angels here.

Click here to read about other types of tax planning.