TAXATION OF EXEMPT PROFITS UNDER THE LAW FOR THE ENCOURAGEMENT OF CAPITAL INVESTMENTS

1. TAXATION OF EXEMPT PROFITS UNDER THE LAW FOR THE ENCOURAGEMENT OF CAPITAL INVESTMENTS June 19, 2012

2. Provisions of the Law in Its Previous Format • Under the provisions of the old law for the encouragement of capital investments, programs for investment in the setting up or the expansion of industrial plants conferred entitlement to a grant and tax benefits • Presented below are the corporate tax rates that were applicable under the Law: • Companies that waived the grant were fully exempted from corporate tax for a period of 2-10 years (“the exempt profits”) • The exemption was conditional upon the non-distribution of profits to the shareholders (dividend) so that these may be used for investments in the plant in Israel for the purpose of increasing the manufacturing capacity and expanding employment • The distribution of a dividend out of the exempt profits was subject to the payment of the corporate tax rates, as stated above, as well as tax at the rate of 15% on the dividend

3. Provisions of the Law in Its New Format • At the beginning of January 2011, the law for the encouragement of capital investments was amended • Under the new Law, an industrial company that exports more than 25% of its product is entitled to tax benefits • The Law determines that a company that is entitled to tax benefits will pay the following corporate tax rates (full maturity in 2015): • Central Israel – 12% • Periphery – 6%

4. The Situation in Practice • In view of the high tax rate, companies refrain from distributing the exempt profits that are accumulated and defer the distribution of profits to the shareholders to an unknown date or keep the surplus cash in deposits • The tax benefit has caused companies to act based on tax considerations rather than with an eye to business considerations • Some of the companies that had received the tax benefit used the accumulated exempt profits for various investments within and outside Israel that do not serve the objectives of the benefit granted • No transitional provisions have been determined regarding the taxation of the accumulated exempt profits and the refunding of corporate tax

5. The Ad Hoc Provision • In order to cause companies to act based on business rather than tax considerations and to fulfill the objective of the original legislation, it has been decided to prescribe in an ad hoc provision an incentive mechanism that would encourage companies to unfreeze the exempt profits • The ad hoc provision provides for a reduction of the corporate tax at rates that will be determined on the basis of a linear model in proportion to the rate of unfreezing of the exempt profits • The tax payment that is to result from the ad hoc provision reflects the discount of the payments that are expected to be received from the original tax benefit • The proposed model does not require the actual distribution of the dividends • No benefit is extended for the actual distribution of the dividend • The ad hoc provision will result in an immediate inflow of income that will narrow the budgetary gap created by the crisis and will prevent some of the financial sanctions that would have otherwise been imposed on the public

6. Advantages of the Model • The model is linear – the scope of the benefit is in direct proportion to the unfreezing of the exempt profits and is therefore progressive • The model creates a significant incentive to unfreeze as much exempt profits as possible • The model may be easily implemented and monitored by the system

7. Examples * Assuming a 5% discount rate