An opinion article by Mattan Lass on how Israeli hi-tech companies, with their sights on the US, should go through Ireland first
The US market has traditionally been the ultimate goal of the vast majority of Israeli hi-tech companies. This is little wonder particularly since Israel, a country with a population barely 2.7% of the United States, offers a tiny domestic market for hi-tech innovation. The US is the largest consumer market for Israeli hi-tech and penetration of the American market has always been considered a benchmark of success in and of itself.
For Israelis, the desire to physically set up in the USA has always been about wanting to be at the ‘heart of the action’ – most entrepreneurs have shared the common belief that their company should be as close as possible to their largest projected customer base and to the American sources of capital funding. However, new trends in the global economy are suggesting that setting up in the USA directly from Israel would not add any value to the company and, at worst, fatally harm its competitiveness.
The problem: Going directly to the USA is very expensive
The US federal corporate income tax rate is 35%, which includes both US and non-US sources of income. Companies operating in the US are also subject to state statutory corporate tax rates. In 2014, the OECD estimated that the combined federal and state statutory corporate tax rate for the country is a staggering 39.1% (at best), which easily places the United States among the most expensive corporate tax locations in the developed world.
In the hope of avoiding such a huge tax burden (and in the hope of appearing more attractive to US investors) it is estimated that over 5,000 Israeli companies have incorporated in Delaware. However, it did not take long for the Israeli tax authorities to clock on to the fact that Israeli companies were avoiding Israeli taxes by effectively incorporating shell companies in Delaware. The Israeli Tax Authority now views Delaware companies as liable to Israeli tax if the corporation is effectively run from Israel, meaning that the company’s intellectual property in Israel could be liable for Israeli capital gains taxes in an exit or IPO event. If your company is nominally incorporated in the US, but all the business operations are run and controlled out of Israel, the American and Israeli tax authorities will likely realize it too – so if you ever strike success, there is a good chance they will come looking for their slice of your cake. Therefore, while you might think that a Delaware ‘shell’ protects you from the worst excesses of Israeli and US taxation, in reality, it might actually expose you to both.
So why Ireland?
Ireland, like Israel, is a small country with an innovative, export-driven economy. Since it too has a tiny domestic market, over recent decades the country’s economy has specialized in providing a launch pad from which multinational corporations can penetrate the far larger consumer markets in Europe and North America. Therefore, it is little surprise that the same multinational companies – such as IBM, Intel, Microsoft, Salesforce, Teva and Amdocs – maintain significant operations in both countries.
By taking advantage of the country’s young, well-educated workforce, optimal geographic location between the European and American continents, cheaper operational overheads and low corporate tax rates (a flat rate corporate tax of 12.5%, with a 6.25% rate available under the Knowledge Development Box scheme), world famous tech companies such as Google, Facebook and Airbnb have helped make Dublin into a tech powerhouse. Their presence and continual expansion have pushed the Irish economy to grow by 7.8% in 2015 (the fastest pace since 2000), with expected growth of about 6.5% in 2016.
However, it would be a mistake to see Ireland as only providing a solution for the tech giants of this world. The country’s wealth of high-tech clusters and emerging start-up scene have nurtured a host of homegrown talent. Recent high profile successes have seen Cork-based cybersecurity company Trustev sold to American credit reporting company TransUnion for and Dublin-based music discovery start-up Soundwave acquired by music streaming site Spotify.
There is also mounting evidence to show that it is easier for Irish companies to raise VC funding relative to companies in the UK. In 2014, UK tech companies managed to raise €2 billion, while Irish-based companies raised a combined €401 million – not bad for a country whose total population is less than half the population of London!
Why, then, are Irish-based companies relatively far more likely to receive significant funding than their British counterparts? Well, it could be the world-famous “Luck of the Irish”. However, it is probably more because of the abundance of US money on this island. Incredibly, Ireland is the single largest beneficiary of American foreign direct investment.
A recent study has revealed that US firms have invested more than $277 billion in Ireland since 1990 and that the 750 or so American corporations operating in Ireland now employ around 130,000 people. Incredibly, this means that over the last two decades Ireland has gained more from American firms than Brazil, Russia, India and China combined.
For tax reasons, much of the money made by these US-owned companies is ‘warehoused’ in Ireland – potentially meaning that it is much easier to secure funding for your company from a US company looking to recycle its European profits in Ireland.
How can Ireland be a springboard into the USA?
Even though your sights may well be set for the US, it is important to plan for US international tax consequences early in a company’s life due to the restrictive ‘lock-in’ effect of certain US tax rules. Remember, once IP is created in the USA, it is very complicated (read ‘expensive’) to move it to a lower tax jurisdiction. Therefore, instead of heading to the USA directly, an Israeli entrepreneur could add significant value to their company by using Ireland as a stepping-stone into the US market.
It would be important to note this would be part of an overall structure and one issue that always has to be considered is the “limitation of benefit” clause in most US tax treaties, including the treaty with Ireland but this is something that it should be possible to manage.
Step 1 – The Israeli company sets up an Irish subsidiary
The Israeli company benefits from 12.5% corporate tax rate (6.25% if it transfers R&D operations to Ireland) provided it is in receipt of trading income and not just be a “brass plate”.
Step 2 – New Irish company internationalizes
The new company uses low taxes to sell its products more cheaply throughout Europe and North America. On the basis of current rules and taking into account Ireland’s membership of the EU and the double taxation treaties it has signed with Israel and the USA this means the Irish trading company should only have to account for tax in Ireland provided it does not establish a presence in these other jurisdictions.
Step 3 – The Company’s growing European and American operations raise its value
The company’s proven multinational revenues make it far more attractive to international investors, thereby increasing its ability to raise capital.
Step 4 – Exit or IPO in the USA
No 50% tax liability. Where an Irish holding company structure is used also it should result in no tax in Ireland, provided the value of the company does not arise from Irish land or buildings.
This article was originally posted on Matan Lass’ Linkedin profile
webbyness