“Exit Price”
In order to encourage companies and investors to keep their operation in the State of Israel, few months ago, the Encouragement of Industrial Research & Development Law was amended in the frame of the Economic Policy for years 2011 and 2012 Law (Settlements Law). Most of the amendment referred to payments that the companies supported by the Chief Scientist ought to pay in the event of transfer of their intellectual property outside of Israel, or in other words in the event of an “Exit”.
Due to the above amendment, there is no limit of the amount of payments due to the Scientist, which left investors in lack of certainty. The Finance Committee of the Knesset has resolved the uncertainty and on 14.5.2012 set maximal amounts due to the Scientist. That contributed to the certainty and stability to the companies supported by the Chief Scientist and also to foreign investors operating in the local market.
Background
In order to encourage industrial and hi-tech companies keeping their operation in Israel’s turfs, it was resolved to amend the Encouragement of Industrial Research & Development Law, 5744-1984 (hereinafter: “R&D Law”).
One of the measures chosen by the regulator to accomplish this goal is creating negative incentives to companies on the event of transfer of information and production to foreign entities and terminating the company’s operation in Israel.
Thus, Amendment no 5 of the R&D Law which came into force at the beginning of the year 2011 set significant law amendments considering the amount of payments due to the Chief Scientist in the event of information transfer (intellectual property) of the company outside Israel, or in other words in case of an “Exit”.
It is important to point that prior to the enactment of Amendment 5, the R&D Law determined that companies supported by the Scientist shall pay to the Scientist sums set in the R&D Law in the event of information transfer outside of Israel and in the event of termination of operation in Israel (the sums are defined in the R&P Law as the “Basic Sum”). However, the Amendment 5 significantly increased the Basic Sum due to the Scientist on these circumstances and did not place any limitation on the Basic Sum.
The difficulty caused by Amendment 5
The Israeli Hi-Tech industry concerts a lot of interest among international investors, thus it is not surprising that Amendment 5 of the R&D Law received harsh criticisms among seniors of the Hi-Tech industry, due to uncertainty allegedly created by the amendment and the unlimited amount of payments due to the Scientist under the relevant circumstances.
For convenience sake, hereinafter the relevant provisions in the R&D Law in case of information transfer outside Israel and termination of operation in Israel:
| Prior to Amendment | After Amendment | |
| The “Basic Sum” | The sum equal to the relation between the sum of grants the company received, and between the sum of financial investments received by the company multiplied by the sale price, provided that it shall not be lessen than the aforesaid amounts sum, in addition to an annual interest | The sum equal to the relation between the sum of grants received by the company, and between the sum of Company’s R&D expenses (approved by the Scientist), multiplied by sale price, provided it shall not be lessen than aforesaid amounts sum, in addition to an annual interest |
| The “Depreciation Rate” | The Basic Sum shall be entirely lessen (deducted of royalties paid) up to grants sum, over 10 years from plans execution expiration | The amount which shall be decreased is the deference between the Basic Sum (deducted of royalties paid) and between the grant’s amount, over 10 years from expiration of plans execution |
| The Maximum Sum | There is no reference to any maximum amount | Finance Committee shall set the maximum amount due to Scientist in events of the company’s sale |
Hereinafter is an example which demonstrates the affects of Amendment 5 of the R&D Law: a company received from the Chief Scientist a grant in the sum of 2 million NIS; the company raise additional investments in the sum of 8 million NIS; the Company’s R&D expenses summed up in 4 million NIS; two years later, the company terminated its operation in Israel and was sold for a sum of 80 million NIS.
The basic sum due to the Scientist prior to the Amendment of the law (in millions NIS): 16 = 80* (2/10)
The basic sum due to the Scientist after the Amendment of law (in millions NIS): 40 = 90* (2/4)
Since in many companies supported by the Chief Scientist, the sum of expenses is significantly lower than the sum of investments, it turns out that by using the new formula for the basic sum, the amount due to the Scientist not only increases significantly but also seams un-proportional to the sum of the Scientist’s investment.
In addition, and until setting of the aforesaid maximum amount by the Finance Committee, the above amendment created uncertainty for companies seeking to receive grants from the Scientist, regarding payments they shall be required to pay in the event of the company’s sale. Such uncertainty intensified the “numbness” the Hi-Tech industry fell into due to the severe blow it already received following the economic crisis inflicted on the world during the past previous years.
Therefore, in order to create certainty in the industry and keeping the balance between the State’s interest in encouraging R&D in the State of Israel on one hand and the company’s interest in operating in a global and competitive market on the other, it was determined that a maximum amount of payments due to the Scientist should be set on events of information transfer outside of Israel and on events of Israeli operation termination.
On May 14th, 2012 the Finance Committee of the Knesset approved the maximum amounts payable to the Scientist, and it was determined that: (1) in the event of information transfer outside of Israel but keeping the R&D operation in Israel the company shall be required to pay an amount of up to 3 times the amount granted by the Scientist; (2) On the event of termination of all Israeli operation, the company shall be required to pay a sum of up to 6 times the amount granted by the Scientist.
Getting back to the aforesaid example, the sum due to the Scientist after the amendment and after setting of the maximum amount is up to 12 million NIS (6*2=12) instead of 40 million NIS.
Conclusion
We are of the opinion that the new amendment of the law, along with setting the limitations by the Finance Committee presents a significant step in the development of the Israeli Hi-Tech industry and successfully dealing with the global economic crisis. We further assume that the amendments of law can be considered as a calculated balance between the interests of the State in keeping R&D in Israel and those of companies and investors interested in breaking into the international market.
Before concluding, it shall be clarified, since the regulations are naturally new, they are still open to different interpretations, and therefore it is required to wait and see how the calculation of the maximum amount shall be carried out by the Chief Scientist in practice.