By Matthew Kalman

Israeli finance officials are closely following the progress of the U.S. tax reform bill, as practitioners warn that the loss of Israel's tax advantage could reduce its attraction for high-tech startups.

The U.S. House and Senate plan votes next week on a compromise reform plan that could trigger “an economic earthquake in international trade,” according to Israel's tax chief.

“Meetings have already been convened in the treasury. We are considering alternatives. If it advances in its current form, we will respond,” Moshe Asher, director general of the Israel Tax Authority, told a conference Dec. 14 in Jerusalem of the Institute of Certified Public Accountants in Israel. Israel shares the concerns expressed by European finance ministers in a Dec. 11 letter to U.S. Treasury Secretary Steve Mnuchin that the emerging bill contradicts trade pacts and could adversely affect companies trading with the U.S., Asher said.

With a corporate tax rate of 23 percent from Jan. 1 and a range of incentives for major investors and exporters, Israel is “in a good place compared to other countries,” so the country's “response will not be dramatic,” he said. “We can make one small adjustment or another. All in all, our legislation, with an emphasis on the law of encouraging capital investment, is basically competitive and does its job.”

The price of Israeli exports would rise with the imposition of a 20 percent tax on routine cross-border transactions between business units of the same company and the proposed move to a territorial taxation under which American taxpayers will no longer be able to offset Israeli withholding taxes. That 20 percent provision exists in the House version but not the Senate version of the tax reform plan, H.R. 1; the two bills are being melded and the compromise version could be made public Dec. 15.

“The territorial regime will increase the overall tax cost for Americans” of Israeli exports, Asher said. “Any withholding tax will be money thrown in the trash for Americans.”

The huge tax cut and recall of overseas capital would drain Israel of much-needed investment, he warned. “If the legislation goes through in its current form, there will be a huge wave of activity and a massive wave of funds moving toward the U.S.,” Asher said. “All the funds will fly from outside the U.S. to inside the U.S. You'll have no reason to leave it outside the U.S. You will invest in the U.S. and not in other places.”

High-Tech Startups

Israel's burgeoning high-tech industry, with its thousands of startups, would be severely affected by the proposed new U.S. tax regime, said Harel Perlmutter, head of tax at Barnea and Co. law firm in Tel Aviv, who recently represented the Israeli GPS developer Exo Technologies in its acquisition by Lear Corp.

“One of the good reasons for those startups to be in Israel is because of the favorable tax regime compared to the U.S.,” Perlmutter said in a Dec. 14 interview. “If tomorrow the corporation tax is going to be 20 percent in the U.S., those companies will consider moving to the U.S.” where the customers, finance, investors and multinationals are located.

If Israel loses its tax advantage, “I see a lot of companies that not only will not start in Israel but entities that are already set up in Israel will emigrate to the U.S.,” he said. “Israel and all the western world is waiting to see if this reform is going to pass and, if so, it's going to be a kind of race to the bottom—who is going to take the corporate rate tax lower.”

The U.S. return to a type of territorial tax system would make Israel less attractive as a base for subsidiaries of U.S. companies, said Daniel Paserman, partner and head of tax at Gorntizky and Co. law firm in Tel Aviv.

“You won't get credit for taxes paid outside of the U.S. because the profits are not taxed in the U.S.,” Paserman said Dec. 14. “If multinationals have activities outside the U.S. and they are taxed in Israel, when you repatriate those profits you would end up paying double taxation because you would have to pay U.S. taxes and you won't get any credit for the tax paid in Israel. This will deter companies from establishing activities outside of the U.S. in jurisdictions like Israel that levy taxes. It's a problem.”

To contact the reporter on this story: Matthew Kalman in Jerusalem at correspondents@bloomberglaw.com

To contact the editor responsible for this story: Penny Sukhraj at psukhraj@bloombergtax.com