Overview Of Israel's R&D Law And Funding By The Office Of The Chief Scientist

Introduction

This memorandum describes the major provisions under Israel's Encouragement of Research and Development Law, 1984 (the "R&D Law"), with respect to grants provided by the Office of the Chief Scientist of the Ministry of Industry and Trade (the "OCS"), and certain obligations and restrictions imposed by the R&D Law. These restrictions have important implications for technology-related transactions between Israeli and non-Israeli entities as detailed further below. A fifth amendment to the R&D Law was recently enacted under the Economic Arrangement Law, 2011-2012 (the "Recent Amendment"), and this memo takes into account the material provisions thereof.

Grants and Royalties

Purpose. Among the R&D Law's stated objectives is the creation of new employment opportunities in the technology industry through the encouragement of domestic research and development projects.

Grant application. A grant application must describe the research plan, the applicant company's business, and particularly the technology intended to be developed in the context of the research plan. Significantly, the application must indicate the portion of manufacturing of products developed with OCS assistance to be performed in Israel. Under the Recent Amendment, a grant applicant is required to undertake to ensure that all know-how derived from the research and development performed under an OCS-approved program, and all rights deriving therefrom, will be owned by the applicant from the time of the creation of such know-how.

Grant amount. Grants are available in amounts ranging from 20% to 50% of the approved budget. In practice, grants at the maximum rate of 50% are not awarded to companies reporting that more than half of the relevant manufacturing will be conducted outside Israel. Grants at a rate of 66% of the approved budget are available through the "Magnet/Magneton" program (a special program intended to encourage cooperation between industry and academia).

Reporting. Periodic reports must be submitted by the company to the OCS with respect to royalty accrual and application of grant monies to the approved budget. This often requires employees to itemize their time spent on particular research projects.

Royalty obligations. Royalties are payable on sales1 of (i) products developed in the context of the research plan, (ii) associated services, and (iii) products developed with company (non-OCS) financing but based on core technology developed in the approved research plan ("Supported Products"). Royalties are paid at rates beginning at 3% of sales, depending on various criteria (see below). Royalties are payable until 100% of the amount of the grant has been repaid with interest as provided in the applicable regulations (or a higher percentage, if some of the manufacturing is transferred overseas – see below). Of particular importance to note is that restrictions on overseas transfer and manufacturing, discussed in detail below, continue to apply despite full payment of the grant. "Magnet/Magneton" grants are royalty-free.

Calculation of royalties on sales to affiliates. In case of sale by the applicant company to an affiliated company, followed by resale by the affiliated company to a third party customer, the "sale price" is deemed the consideration received upon such resale to a customer. An "affiliated entity" in this respect means (i) a directly or indirectly controlled or controlling entity, or an entity under common control; or (ii) an entity which was granted manufacturing rights in the Supported Products.

Regarding sales to an affiliate which are not for resale, the law states that "in special cases of sale for non-monetary consideration or a price affected by a proximate relationship, the [Research] Committee may determine the sale value...