To Clients and Friends:

Wishing you and your family a Safe, Healthy and Prosperous Jewish New Year, with all the hostages back with us…..

Article: Should We Be Moody About Moody’s?

On September 27, 2024, the credit rating agency Moody’s announced it has  downgraded Government of Israel’s long-term local and foreign-currency issuer ratings to Baa1 from A2. And the outlook remains negative (See https://www.jpost.com/breaking-news/article-822128).

Given that Israel is at war, is this any surprise? Yes it is, because some of Israel’s borrowings are backed by the US government. According to Moody’s, these borrowings are supported by an irrevocable, on-demand guarantee on principal and interest payments provided by the US government. The USA may be obligated to pay within three business days if the guarantee is called upon.

What else do Moody’s say and what can we expect, especially on the economic/tax front?

More from Moody’s:

In Moody’s view, the significant escalation in geopolitical risk points to diminished quality of Israel’s institutions and governance. Also, the risk of a broader escalation involving Iran remains, even though it continues to be low. However, Israel is cushioned by the Bank of Israel’s very large foreign currency buffers of close to 40% of GDP as well as Moody’s assessment of good policy effectiveness.

In addition, Moody’s says the conflict and absence of a clear route to its resolution contribute to high social tensions and rising risks to Israel’s trade given transport and shipping restrictions, concerns around Israeli suppliers being able to meet schedules, risks of formal or informal trade restrictions and, more generally, rising risks of undermining Israel’s relations with key allies.

Consequently, Moody’s expects Israeli economic growth to remain weak in the remainder of this year and in 2025. In the second quarter of 2024, real GDP growth was just 0.2% compared to the previous quarter and 1.5% below the level of a year ago.

In addition, Moody’s think a clearer picture of the longer-term damage of the conflict to the Israeli economy is starting to emerge. First, supply constraints on the labour market remain stronger than expected for longer with the government likely to extend military service for men to 36 months from the current 32 months, negatively affecting labour supply by removing one of the most productive parts of society for longer than currently. Also, Palestinian workers remain unable to work in Israel. This is particularly relevant in the construction sector.

Therefore, Moody’s foresees GDP growth will be lower due to a higher tax burden, with taxes being raised to finance higher defense spending.

The Finance Minister has recently presented the outlines for the 2025 budget, targeting a deficit of 3.8-4% of GDP and savings measures amounting to NIS39 billion.

But Moody’s expect this year’s deficit to be wider than the government target of 6.6% of GDP at around 7.5% of GDP, given lower GDP growth and additional spending on reservists and evacuees from the North.

Legal reform?

Although civil society and the judiciary have proven to be relative strengths in Israel’s institutional structure, Moody’s now consider their ability to provide strong checks and balances to be weaker than before. The justice minister has been delaying important judicial appointments including to the position of President of the Supreme Court, despite a recent Supreme Court ruling requiring him to convene the relevant judicial appointments committee.

Implications?

The announcement from Moody’s is preceptive and clear. The legal reform is considered unhelpful. It especially deters hitech investors who want strong legal protection for Israeli technology. Otherwise, the technology tends to get registered in the US instead.

As for the government’s finances, it is clear that Israeli taxes will soon be going up. The standard rate of VAT is expected to rise from 17% to 18% next January. Don’t be surprised if it leaps to 20%, as in the UK.

As for income tax, the Finance Ministry apparently wants to collect more tax without raising tax rates.

Tax brackets and limits may not be inflation adjusted. In any event, it is proposed to tax small and medium size companies on profits retained to finance investment and employment. Also proposed is tax of up to 15% on previously exempt withdrawals from study funds (Kranot Hishtalmut). In practice, these are general funds which hold large amounts of savings.

The OECD’s Pillar 2 plan for 15% minimum corporate tax is being adopted now in many countries – but only in 2026 in Israel.

The Israeli Tax Authority has opened more tax audits. These tax audits tend to be fishing expeditions backed up by an ability to go to court. This is best dealt with by good preparation, to encourage the ITA to look for easier pickings elsewhere….

It remains to be seen whether/when Israeli income tax rates will rise.

Our take: we are not as moody as Moody’s.

Israelis are good at getting things done at the last minute. Right now, the war is keeping the Israeli government busy, working hard to a list of priorities. On the Israeli economic front reservists have been called up, but it’s largely business as usual. The Israeli tech sector continues to shown its merit. Foreign currency reserves and gas reserves are high.

So let’s hope we have a happy new year, better than the old one….

Next Steps:

Please contact us to discuss any of the above matters further, or any other matter.

As always, consult experienced legal and tax advisors in each country at an early stage in specific cases.

[email protected]

(c) Leon Harris 1.10.24