The OECD issued its 2025 review of research and development (R&D) tax incentives across its member countries earlier this year. How does Israel as the Start-Up Nation compare?
Background
According to the OECD, tax incentives are a widely used and economically significant policy instrument to support innovation in most OECD member countries and several other major economies.
Thirty-four out of 38 OECD countries granted tax relief for R&D expenditures in 2024. Israel is one of the four countries that don’t. Why is that?
Tax credits for R&D
The United Kingdom is keen to catch up with Silicon Valley and the Start-Up Nation. It currently allows an R&D credit of 20% of approved R&D expenditure. So, if a UK company pays 25% corporation tax, but claims a 20% tax credit, that leaves only 5% corporation tax on profits up to the amount of approved R&D expenditure.
According to the OECD, small and medium-sized enterprises (SMEs) receive a more favorable tax treatment for R&D expenditure in several OECD countries. For example, Australia and Iceland provide enhanced tax-credit rates, while Canada and the United States restrict refund provisions to eligible SMEs.
In 2024, profitable SMEs in the OECD area could, on average, expect to receive a 19% tax subsidy on R&D expenditures, which was more than large profitable firms (16%).
Israel, Costa Rica, Latvia, and Luxembourg were the four OECD countries that did not provide expenditure-based R&D tax incentives in 2024, the OECD reported.
The problem
The problem is that start-ups don’t need R&D tax breaks. In the first few years, Israeli start-ups use investors’ money mainly to pay salaries to R&D techies.
Unfortunately, about 80% of start-ups fail to get their technology to the sales stage. The other 20% or so do start selling and can set off initial losses against any resulting profits for the next few years.
So, the real challenge is to get a start-up to the selling stage.
The Israeli approach
Israel supports start-ups by providing R&D cash grants through the Israel Innovation Authority (IIA) that supplement investors’ money regardless of profitability.
The grants are repayable by way of a royalty out of sales if sales materialize. Repayment of three to six times is required if the technology is transferred out of Israel.
The Israeli R&D grant rate is typically 50% of approved R&D expenditure. There also are special R&D support programs. By contrast, the average subsidy for SMEs with no profits is 16% on average and 13% for large firms, according to the OECD.
The Israel Startup Fund Program
More recently, the IIA has introduced the Israel Startup Fund Program.
The fund provides non-dilutive investment and requires matching funds from private investors. By investing in companies selected to receive funding from the IIA, the fund aims to mitigate the private investors’ inherent risk.
Which Israeli companies?
The incentive program assists Israeli start-up companies in their pre-seed, seed, and Round A stages.
Companies that submit their applications to one of the fund’s three programs undergo a due diligence process conducted by the IIA’s team of technology experts. This process aims to provide private investors considering investing matching funds with both risk mitigation for their investment and assurance of the selected companies’ technology quality and leadership team’s capability to successfully execute their proposed ventures.
How big are the grants?
• Pre-seed companies: The IAA may participate in the pre-seed investment round with a grant covering 60% of the investment round amount up to a total grant of NIS 1.5 million.
• Seed companies: The IIA may participate in the seed investment round with a grant covering 50% of the investment round amount up to a total grant of NIS 5m.
• Round A companies: The IIA may participate in the Round A investment round with a grant covering 30% of the investment round amount up to a total grant of NIS 15m.
Companies meeting the conditions of a preferred company – in which at least one of the main entrepreneurs is from an underrepresented population in hi-tech, such as Arabs, haredim (ultra-Orthodox), and women, or whose main activity is based in Israel’s periphery – will receive an additional 10% on the grant, raising the maximum grant amount to NIS 1.65m., NIS 5.5m., or NIS 16.5m., respectively, in the periphery.
Concluding remarks
The October 7 massacre is stimulating the Israeli hi-tech sector to innovate even more. Techies are called up to reserve duty, but many still work part of each day or night.
As always, consult professional advisers in each country at an early stage in specific cases.
For more information on criteria and conditions of the IIA Startup Fund Program go to innovationisrael.org.il/en/programs/startup-fund.
leon@hcat.co
The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.