Chipmaking Amid War in Israel
Chipmaking Amid War in Israel
What happens when innovation comes under fire
Arrian Ebrahimi of Chip Capitols returns with a timely analysis of Israeli semiconductor policy.
Amid a bloody war with Israel, the terrorist group Hamas attacked cities in Israel’s Ashkelon region, raising concerns for American semiconductor giant Intel’s fabrication facility (fab) in Kiryat Gat. Intel notes that it is “closely monitoring the situation in Israel” — but these comments call to mind memories of 2011: at the time, Hamas missiles hit Kiryat Gat just as Intel was planning a $4.8 billion expansion of its facility, with $500 million in support from the Israeli government. Beyond potential threats to facilities, Israel has called up hundreds of thousands of reservists to serve the war effort, and these individuals leave behind day jobs that often involved critical roles in global semiconductor giants.
Turning a desert-covered country in a conflict-ridden area of the world into a semiconductor powerhouse was neither easy nor accidental. Through a panoply of subsidy regimes, the Israeli government has successfully attracted foreign chipmakers and designers, while also propping up its vibrant domestic start-up ecosystem. In addition to the support Israel already counts on from foreign democracies, this long-standing industrial policy has developed what some Israeli strategists call a “silicon dome.” As in the case of Taiwan, a globally critical chip industry incentivizes the world’s economic superpowers to protect Israel from neighboring national security threats.
Although Israel’s semiconductor industry provides it a degree of protection, chipmaking also positions it in the middle of a geopolitical tug-of-war between the US and China. Israel has served as a source of cutting-edge chip design talent for semiconductor companies in both countries — but US officials have applied heavy pressure to align Israel more closely to American national security policy vis-à-vis China. As the war between Israel and Hamas rages on and China refuses to condemn Hamas’s terrorist attack on Israeli civilians, Israel’s continued investment in its chip industry after the war may play a more American-aligned position.
An Israel Chip Industry Primer
In a pre-war state, Israel plays an outsized role in the global semiconductor value chain. At its core is Intel, which employs 12,000 employees at chip design facilities in Haifa, Jerusalem, and Petah Tikva, as well as at its fab in Kiryat Gat. The US firm’s $8.7 billion in exports from Israel in 2022 alone account for 1.75% of Israel’s national GDP, leading some to acclaim, “Intel is Israel, and Israel is Intel.”
But Israel’s semiconductor industry stretches beyond Intel and further back than the past two decades. In 1964, Motorola took the chip industry’s first step into Israel with a research center, which Intel followed a decade later with its own research center in Haifa. In the years since, global chipmakers and fabless design firms — including Apple, Broadcom, Qualcomm, Samsung, Huawei, and Texas Instruments — have established design footprints in Israel, employing the country’s over 30,000 chip engineers. Intel and Israeli Tower Semiconductor own the country’s only manufacturing fabs, with Intel’s attempted purchase of the latter blocked by Chinese regulators in light of growing geopolitical tensions.
Israel’s abundance of Western chip design and manufacturing expertise makes it a linchpin in the transfer of US semiconductor technology to China. Though the small country is not the world’s largest chipmaker, over half ($2.8 billion) of Israel’s $4.5 billion in 2022 exports to China were “computer, electronic and optical products.” A more detailed 2018 report from the Israel Export Institute specifically broke down the country’s semiconductor exports to China as valued at $2.6 billion in 2018, when its overall exports to China then stood at $4.7 billion. The Israel Export Association also noted in 2018 that these semiconductor exports to China included $450 million in semiconductor manufacturing equipment (SMEs), which have since become a target of US export controls against the PRC chip industry.
Beyond viewing China as an export market, Israel has welcomed PRC firms seeking to tap into its prime chip design talent pool, just as it has with companies from the US and its allies. For example, since purchasing the Israeli IT research company Toga Networks in 2016, Huawei has employed about 500 researchers in the country. This Israeli research arm proved crucial to the Chinese IT giant when Toga stood alone among Huawei’s subsidiaries from August 2019 to August 2020 as the sole entity US authorities did not subject to export blacklisting on the Commerce Department’s “Entity List.” Huawei seized on that one-year window to stockpile semiconductor manufacturing equipment that the US Bureau of Industry and Security (BIS) otherwise barred it from purchasing. Whether avoiding blacklisting was a mistake by US authorities or part of a diplomatic compromise with Israel, Toga underscores Israel’s role as a limited but still viable avenue for sensitive US technology to reach China.
Subsidizing Miracles in the Desert
Since enacting the Encouragement of Capital Investments Law of 1959, Israel has offered tax incentives and direct grants to attract foreign investment in a range of industries. The Ministry of Economy and Industry’s Authority for Investments and Development of the Industry and Economy administers the law by evaluating the extent prospective to which foreign investors’ proposals would benefit the Israeli economy; ministers often directly negotiate with companies to determine the most competitive rates of public support.
Semiconductor manufacturers and designers have repeatedly leveraged the law to support expansions in Israel. Specifically, the Israeli government uses different parts of the law to attract different types of chip industry investment: one set of policy tools subsidizes investments in manufacturing to bolster Israel’s position in global supply chains, while the other incentivizes R&D and start-up activities to solidify Israel’s innovativeness.
Strengthening Israel’s Foothold in the Global Chip Supply Chain
In June 2023, Intel announced its latest expansion in Kiryat Gat with a fab valued at $25 billion. This massive expansion of Israel’s chipmaking capacity was made possible by a 12.8% grant from the Ministry of Economy and Industry, and Prime Minister Benjamin Netanyahu praised the investment as proof of international confidence in the Israeli economy, despite concerns over the country’s tumultuous domestic politics. Two regimes govern subsidies like the one Intel received:
The first is the Preferred Enterprise (PFE) regime, which reduces corporate income taxes for revenue stemming from investments which increase Israel’s “productive capacity.” It lowers rates from 23% to 16% for operations in central Israel, as well as to 7.5% for operations in “development area A.” (The latter refers to Israel’s priority areas for economic development, including the country’s south and north.) Intel’s facilities in Kiryat Gat, for example, are in development area A, bordering northern Gaza, and therefore likely qualify for prioritized rates.
The regime goes on to specify what types of income are eligible for the reduced tax rate. Its deduction of income from manufacturing is common in countries with subsidies for chipmaking, but Israel demonstrates its emphasis on semiconductor design work by also allowing key sources of income for fabless chip firms to qualify — specifically:
revenue from chips designed in Israel but fabricated abroad at foundries like TSMC,
royalties from software licenses (which are key for chip design toolmakers like Synopsys),
income from services for customers who buy outsourced chips or software licenses,
and outsourced R&D for foreign companies.
Alongside PFE is the Special Preferred Enterprise (SPFE) regime. This subsidy operates identically to the PFE, except that it offers significantly greater tax cuts for conglomerates with annual revenue of at least ₪1 billion ($270 million). Operations outside priority development areas are subject only to an 8% corporate income tax rate, while operations in “development area A” face just a 5% obligation. All global semiconductor companies are eligible for SPFE on the basis of income, but Israeli government officials must nonetheless approve candidates on a case-by-case basis.
Beyond those schema, companies building physical facilities in priority development areas are also eligible under the Approved Enterprise (AE) regime for direct grants typically targeting 20% of private investment. Perhaps informing the decision of companies like Intel to build in Kiryat Gat is a provision of the AE regime that offers an additional grant of 10% for investments in subregions of northern Israel, Gaza, and Negev.
Planting the Seeds for Israel’s Future Chip Technological Leadership
Though Israel seeks to grow its role in global advanced manufacturing supply chains, the country’s core value-add lies in technology development and entrepreneurship. To that end, non-manufacturing “fabless” semiconductor design firms and chip start-ups benefit from two R&D tax credits in Israel:
To start, almost any firm engaging in research and development qualifies for Israel’s base R&D tax credit. Such companies can deduct R&D expenses from their taxable income over two tax years, up to a maximum of 40% of their total taxable income in a single year.
Not only does this internationally competitive R&D tax credit encourage technology firms to invest in Israel, but a sub-provision for qualifying research conducted for foreign developers further bolsters Israel’s role as a hub for outsourced R&D.
Harking to the central role start-ups play in its economy, Israel boasts a Preferred Technology Enterprise (PTE) regime that confers three tax benefits to start-ups:
It targets “start-ups” by requiring PTE firms to have annual revenues of under ₪11 billion ($3 billion) and at least one of the following conditions:
20% or more of its employees conducting R&D,
at least 200 employees conducting R&D,
at least ₪8 million ($2 million) in venture capital investment,
at least 25% average annual revenue growth over the past three years,
or at least 25% average annual headcount growth over the past three years.
Firms that qualify under the PTE conditions enjoy reduced tax rates on intellectual property (IP) licensing income — from 23% to 12% for operations in central Israel, and to 7.5% for operations in priority development areas. Additionally, when such companies sell their IP rights, the Israeli Innovation Authority may reduce their capital gains tax liability from the typical rate of 25-33% to 12%. Lastly, to encourage foreign companies to maintain financial stakes in Israeli PTE start-ups, the dividends paid to stakeholders are subject to a sharply reduced 4% withholding tax rate. (Standard withholding rates differ by bilateral tax treaties, but US stakeholders, for example, would have to pay up to 25% tax on their Israeli dividends.)
Lastly, if a PTE company enters a consortium of other start-ups to conduct joint research, it faces a corporate tax rate reduced even further to 6% on R&D-related income. The members of consortia qualifying under this Special Preferred Technology Enterprise (SPTE) regime must have a combined revenue of at least ₪10 billion ($2.7 billion).
The subsidies described above attract investment from technology giants the world over. In doing so, however, they also intertwine the Israeli economy into the geopolitical competition between the two largest countries from which its foreign investment derives: the United States and the People’s Republic of China.
A Special Relationship That Gets Complicated on China
Israel’s close research cooperation with US entities means that Israeli semiconductor companies are often subject to American export controls. The small Mediterranean country annually exports hundreds of millions of dollars in chips to the PRC under American export licenses, but US policymakers have increased pressure on their ally to more closely adhere to both the letter and spirit of US national security policies regarding China.
In 2021, BIS reviewed 1,174 applicants from Israeli companies seeking to export sensitive technology to China and other countries of concern. These applications for exports were worth $3.5 billion and accounted for 2.9% of the total number of global applications to BIS for export licenses.
81 of these 1,174 applications were for the 3A001 category of US export licenses, which covers “electronics components.” To greatly simplify the terminological minefield that is the Export Commodity Classification Number (ECCN) system of the Export Administration Regulations (EAR) — the 3A001 category includes semiconductors as well as the tools, materials, and software used to design and manufacture them. It is not clear what dollar value these 81 applications comprised, but this category ranked as the third-largest type of license application from Israel in 2021. Ultimately, BIS approved 88.3% of Israeli firms’ license applications in 2021, but US policymakers have increasingly signaled they want Israel to curb its ties with China.
The Trump Administration lobbied Israel to adopt a more cautious approach to economic cooperation with China. A revolving door of US officials have urged their Israeli counterparts to adopt an inbound investment review mechanism akin to the US’s own Committee on Foreign Investment in the United States (CFIUS). Most notably, then–Secretary of State Mike Pompeo said in 2020 on a visit to Jerusalem, “We do not want the Chinese Communist Party to have access to Israeli infrastructure, Israeli communication systems, all of the things that put Israeli citizens at risk and in turn put the capacity for America to work alongside Israel on important projects at risk as well.”
As a result of unyielding pressure from an otherwise amicable Trump administration and continued messaging along these lines from the Biden administration, the Israeli Cabinet’s National Security Affairs Committee on October 12 of this year adopted a resolution entitled “Formulating a Process and Mechanism for Evaluating National Security Aspects of Foreign Investments.” The policy established a CFIUS-style oversight mechanism to review Chinese and Russian investment into Israel. The mechanism’s threshold for review starts at proposed ownership stakes of 20% in critical sectors, going as low as 5% stakes in especially sensitive sectors. (Previous Israeli inbound investment review systems had much looser standards for review, not requiring notification for anything under 50% stakes.) The new oversight committee also upgrades the Ministry of Foreign Affairs to a full member, raising the influence of diplomatic concerns on the investment screening process.
China does not lack the tools to counter US efforts to more closely align Israeli national security policy with its own. When US chipmaking champion Intel offered $5.4 billion to purchase Tower Semiconductor — Israel’s only domestic firm with a fab — Chinese regulators denied regulatory approval. PRC authorities were able to exercise jurisdiction over the deal because of Intel’s presence in China. Denying Intel approval to buy Tower may have been an effort to prevent an Israeli fab from falling under the control of an American company, which is in turn directly subject to US regulators. It remains to be seen, however, whether the PRC undermined its economic and diplomatic leverage with Israel as a result of its most recent decision not to condemn Hamas’s terrorist attacks.
When the Dust Settles
To understand the horrors wrought by war in the Levant, it helps to understand what this land is home to in the best of times. Tens of thousands of civilians conduct research on one of the most advanced technologies in the world, one whose manufacturing processes require the utmost cleanliness and stability. The Israeli government has encouraged semiconductor companies to overcome the country’s harsh environment and geopolitical uncertainty through massive subsidies, and such efforts combined with exceptional homegrown talent have afforded the country a unique position in the middle of US-China technological competition. After its war with Hamas, Israeli policymakers may need to reconsider what role their country’s chip industry plays in both global supply chains and geopolitics.