Israel is likely make amendments to its tax regime to counter the effect of the US tax reform initiated by US President Donald Trump, which has the potential to spur an outflow of Israeli firms to US shores, experts say.

Prime Minister Benjamin Netanyahu earlier this month set up a panel to study the implications of the recently passed US tax reform on Israeli and US firms operating in Israel. He instructed the head of Israel’s National Economic Council, Avi Simhon, to have the team come up with recommendations within 30 days.

Trump’s Tax Cuts and Jobs Act, which passed last month, aims to overhaul the US tax code by cutting the number of personal income brackets and limiting or doing away with a selection of popular tax breaks. It caps the mortgage-interest deduction on new home sales and allows for capital expenditures to be deducted in year one.

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The legislation, which was touted by Trump as a “big and beautiful Christmas present in the form of a tremendous tax cut, it will be the biggest cut in the history of our country,” slashes the corporate tax rate to 21 percent from the previous 35%, effective the beginning of this year.

The tax reform will make it more attractive for Israeli firms to set up businesses or acquire companies in the US market, international tax attorneys have said. The lower US tax rate could also spur an outflow of Israeli startups to US shores, impacting Israeli tax revenues, tax attorneys have warned.

Until now, the US tax rate was higher than Israel’s — an average of 35% compared to the Israeli rate of up to 25%. But with the US rate dropping to 21%, the incentives for setting up a business in the US have grown.

“For the year ended December 31, 2017, the US had the highest corporate tax rate in the world at 35%,” said Douglas Stransky, a tax attorney at Boston-based Sullivan & Worcester LLP. “This corporate tax rate, when combined with state income tax rates, meant that US corporations, whether based in the US or subsidiaries of Israeli parents, paid corporate tax at approximately 40%.”

Now, Stransky explained, after the reform, the US corporate tax rate has decreased to 21%, “which makes it one of the lowest corporate tax rates in the world.”

In comparison, the Israeli corporate tax rate dropped to 23% in 2018 from 24% in 2017. In addition, the Encouragement of Capital Investments Law offers added tax incentives to companies with the aim of attracting capital to Israel and encourage economic initiatives and investments by foreign and local investors. Companies that benefit from the capital investments law — many of them high-tech companies or companies that export their products — are called preferred enterprises, and they pay a corporate tax rate of 5% to 16%.

“The corporate tax reduction in the US from 35% to 21% has created a situation in which the total taxes on operations in Israel – corporate taxes and dividend taxes – is significantly higher than the US corporate tax,” the Israel Advanced Technology Industries (IATI) said in a paper it presented to Finance Minister Moshe Kahlon and Simhon. This situation could encourage companies to set up their businesses in the US instead of in Israel, the paper said.

The organization is an umbrella organization of high-tech firms, VCs and startups that is active in promoting the high-tech industry and boosting its startup ecosystem,

The IATI calls for a cut in dividend taxes and withholding taxes on interest payments in Israel, as a start, to counter the effect of the US tax drop.

“The dramatic change in the US federal income tax rate for corporations may have adverse consequences on the attractiveness of establishing startups as Israeli companies,” said Elad Brauner, a tax partner at GKH Law Offices in Tel Aviv. The tax incentives for setting up a firm in Israel are no longer sufficient, he said.

Brauner said, however, that it is “unlikely” that Israel will reduce the general corporate tax rate to below 23%. What is more likely, he said, is that Israel will decide that any change to the tax rate “will be limited only to companies which are currently entitled to tax benefits under the Law for Encouragement of Capital Investments, which are entitled to reduced tax rates of up to 16%. ”

It could be that this rate will need to be lowered to 12%, he said.

In addition, he said, there is a chance that Israel will reduce the withholding tax rate for the distribution of dividends from Israeli subsidiaries to their US parent companies, so that the total tax burden for multinationals that have R&D centers in Israel “will be lower, or at least similar, to the US corporate tax rates,” he said. This will ensure that multinationals operating R&D centers in Israel will still find it attractive to do so, from a tax point of view.

Companies such Google, Apple, Deutsche Telecom and Bosch have set up research and development centers in Israel, with some 284 multinational companies operating a total of 366 R&D centers around the country today, compared with about 250 such centers in 2013, IVC Research Center and Startup Nation Central data shows.

Binyamin Tovi, International Tax Partner at Shekel & Co., a law firm in Tel Aviv, concurs that there is a greater likelihood of a change to the Law for Encouragement of Capital Investments than to the general corporate tax rate.

“I don’t think an additional general rate cut is warranted,” Tovi said. “What should be done is soften the terms set out by the Law for Encouragement of Capital Investments, so that a greater number of companies can be eligible for the rebates, under the law.”

The terms of the law today stipulate, among other things, that companies need to export at least 25 percent of their products; their research and development expenditure needs to be 7% of their total revenues within a three-year period, and 20% of their employees must work in R&D. “These terms can be softened to allow other firms to benefit from the incentives provided by the law,” he said.

Meanwhile, some in the Israeli tech industry are still assessing the impact of the reform.

“We still don’t understand the full impact of the reform on our business, as many of the details have not yet been released, but it could potentially be very damaging to Israel’s tech ecosystem,” said Kerem Nevo, the head of government relations at Wix.com, a Tel Aviv-based do-it-yourself website development company, who also heads the Israel Growth Forum, a group of some 20 mid-size Israeli startups that lobbies the government on issues that concern the tech community.

“It may be that a solution to the US tax cut does not necessarily have to come from changing Israel’s tax regime,” she said. “Maybe you can incentivize companies to incorporate in Israel by improving the business environment for them, making the regulatory environment more transparent, and making Israel a great business ecosystem for tech companies. That may be a compensation for the higher taxation rates.”