Client Update | Revisions to the Israeli Innovation Authority Rules

The Israeli National Authority for Technological Innovation (the “IIA”, formerly known as the Office of the Chief Scientist of the Israeli Ministry of Economy and Industry) has recently published an update to its Benefit Track No. 1 – R&D Fund (“Track No. 1“). Track No. 1 stipulates the general requirements and restrictions imposed on recipients of IIA grants and includes four Exhibits. Exhibit D of Track no. 1, concerning “Instructions regarding the rate of royalties and rules for their payment”, was amended as part of this update. The provisions included in Track No. 1 apply to most IIA grants (however, we note that certain IIA programs are subject to different terms).

The main issues that were amended as part of these updated rules are with respect to the consequences of transferring the manufacturing capacity of IIA funded products outside of Israel and the manner of calculating the annual interest, which is accumulative to certain payments which are required to be paid to the IIA under the provisions of Track No. 1.

Background:

In general, any income deriving from a product (including know-how) that was developed, in whole or in part, directly or indirectly, as a result of the performance of a research and development program that had benefited from IIA support, including any derivatives, and related services thereof, is subject to the payment of royalties to the IIA upon successful commercialization of such products. Royalty payments are capped at the amount of the grants received by the IIA funded company, plus Annual Interest for a File (as further described below).

Under the IIA’s rules, an IIA funded company is obligated to manufacture the IIA-funded products locally. The transfer of manufacturing capacity outside of Israel, in whole or in part, is subject to prior written approval from the IIA (except for the transfer of less than 10% of the manufacturing capacity in the aggregate, which event requires only a notice to the IIA, which shall be provided in writing prior to the transfer of such manufacturing rights abroad, while the IIA has a right to deny such transfer within 30 days following the receipt of such notice) and, in general, such transfer is subject to the increase of the royalties’ cap and payment of royalties in accelerated rate.

According to the IIA rules, applicable to grant applications submitted until October 25, 2023:

– If (a) less than 50% of the manufacturing capacity of IIA funded products is performed outside of Israel, royalties will be increased to 120% of the grants that the company received from the IIA; (b) between 50%-90% of the manufacturing capacity of IIA funded products is performed outside of Israel, the royalties will be increased to 150% of the grants which the company received from the IIA; (c) 90% or more of the manufacturing capacity of IIA funded products is performed outside of Israel, the royalties will be increased to 300% of the grants which the company received from the IIA. All such increased caps should be paid plus Annual Interest for a File.

– An IIA funded company also had the option of declaring in its original IIA grant application its intention to perform a portion of the manufacturing capacity outside of Israel, thus avoiding the need to obtain additional approval and pay the increased royalty payments cap for such portion of manufacture capacity (we note however that in such scenario the IIA funded company will be required to pay to the IIA royalties in an accelerated rate). In the event that the IIA funded company intends to manufacture its IIA funded products outside of Israel in a manner that exceeds the manufacturing capacity that was declared in its original IIA grant application, then such activity must be pre-approved by the IIA and will be subject to increased royalties cap (this applies to the manufacturing capacity performed outside of Israel, calculated after deducting the percentages of manufacturing capacity declared by the company in its original IIA grant application).

According to the IIA rules, applicable to grant applications submitted following October 25, 2023:

– If less than 25% of the manufacturing capacity of IIA funded products is performed outside of Israel, there will be no increase in the royalty payments cap (i.e., the royalty payment obligation will be capped to the grants which the company received from the IIA (plus Annual Interest for a File)).

– If: (a) between 25%-50% of the manufacturing capacity of IIA funded products is performed outside of Israel, the royalties will be increased to 120% of the grants that the company received from the IIA; and (b) 50% or more of the manufacturing capacity of IIA funded products is performed outside of Israel, the royalties will be increased to 150% of the grants which the company received from the IIA. All such increased caps should be paid plus Annual Interest for a File.

– Such an increase in the royalty cap will also apply to the portion of manufacturing capacity outside of Israel, declared by the IIA funded company in its original IIA grant application.

As mentioned above, the royalty payments are capped at the amount of the grants received by the IIA funded company, plus “Annual Interest for a File”. In addition, other payments which are required to be paid to the IIA bear “Annual Interest” (such as the redemption fees required to be paid to the IIA in case of transferring IIA-funded know-how outside of Israel).

With respect to grant applications submitted until October 25, 2023:

The Annual Interest is calculated, in general, based on the US dollar LIBOR (London Interbank Offered Rate) interest rate. The “Annual Interest for a File” with respect to a “Small Company” (as such a term is defined under the rules) refers to the Annual Interest (i.e., the LIBOR interest rate).

With respect to grant applications submitted following October 25, 2023:

As the US dollar LIBOR (London Interbank Offered Rate) interest rate concluded its publication on June 30, 2023, the IIA had to amend the definition of “Annual Interest” to an alternative interest rate. Therefore, as part of these updated rules, the IIA has determined that the Annual Interest will be calculated, in general, based on the SOFR interest (Secured Overnight Financing Rate). In addition, the term “Annual Interest for a File” was updated to refer to the SOFR interest plus 1% or a 4% interest, whichever is higher.

The rules also provide certain Transitional Instructions, under which, inter alia, for IIA grant applications that the IIA approved between July 1, 2017, and December 31, 2023, the definition of “Annual Interest for a File” will be (a) for the period which ends on December 31, 2023 – in general, the LIBOR interest rate will apply; and (b) for the period commencing on January 1, 2024 – in general, the SOFR interest rate will apply plus 0.71513%.

Please note that different terms are or may be applicable to Large Companies (as such term is defined in the rules).