Israeli small businesses doomed to failure

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Tax Man

The Israeli economy is growing at a tremendous pace, yet a recent study by BDI-Coface has shown that despite the fact that there was a 3% rise in 2007 of newly-founded businesses over previous years, most Israeli businesses are doomed to failure. According to the study, only 58% of ventures are still around after two years, and 30% are around after five.

Tehila Yanai, joint CEO of BDI-Coface, told the Jerusalem Post that founding a new business requires a delicate balancing act which can be easily upset by any number of factors:

“When entrepreneurs start new businesses, they take out bank loans for investment in their venture. They can run into difficulties if their business plan doesn’t materialize, and their income doesn’t match their prediction. When that happens, paying back the loan becomes problematic,” Yanai said.

Fluctuating market conditions, tough competition, and new overdraft laws forbidding transgressions from credit limits all play a part in making life for a new business difficult, she said, though it was too soon to measure the effects of the new overdraft laws on businesses.

I would like to add a few more factors to why Israeli businesses may fail:

  1. VAT – Businesses are tax collectors for the government. We collect VAT from our clients, and hold it until VAT payment day. This causes two problems: 1. In many cases for B2B, and in most cases for B2C, businesses give their clients an official tax receipt, even if payment hasn’t yet been received. Sometimes payment doesn’t come for months, but the government demands that money on VAT day. If payment has not yet arrived, the business is paying this VAT out of pocket, which can spell disaster for a small business with tight cash flow. 2. It is difficult to get an idea of how much cash a business actually has when the money in the bank is made up of real income and VAT. A small business owner can look at his or her account, and make financial judgements based on what appears to be a nice sum of money, only to be in trouble when VAT day comes along.
  2. Income tax – Small businesses have to pay income tax advances that are calculated according to previous income, and is not based on real income. As a result, if a small business is going through a rough period and revenues are lower than usual, they still have to pay income tax at the rate for higher income. It is true that at the end of the tax year, if it is found that the business did indeed earn less, the owner will get a tax return, but that can take months and does not help them in their current difficult situation. With lower revenues and tight cash flow, a small business may find it hard or impossible to pay these income tax rates.
  3. Bituach Leumi (National Insurance) – Bituach Leumi has no mercy. At least VAT is based on sales, and Income Tax has some logic behind it. Bituach Leumi couldn’t care if you were lying in a ditch with rags on your back. You’d still have to pay. I am not exaggerating: people with absolutely no income, like homemakers and students, have to pay Bituach Leumi. Similar to Income Tax advances, Bituach Leumi also sends business owners payment slips, but these are based on mysterious calculations that make no sense. In addition, freelancers/small business owners have to pay almost double the Bituach Leumi rate that employees do, and if they happen to grow enough that they can employ someone else, they actually get taxed on that and have to pay Bituach Leumi for the employee too!

I’m guessing that many small business owners simply get tired of working like dogs only to see their hard-earned cash sucked up by the government. I’m not saying that small businesses shouldn’t pay taxes, but a system should be designed that makes it possible for them to do so.

Small businesses are the accelerators for any economy: they employ more people than the big businesses, and generally encourage growth. It is in everyone’s interest to support small businesses, and I think that in Israel the best way to do that is to consider modifying the current disastrous tax system.

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