Sheshinski Committee Main points of the committee’s draft conclusions Click here for attached Summary of Conclusions

Background The fiscal system in the oil and gas industry was structured in the 1950s. About ten years ago, the government proposed making changes in the system, but it was never implemented. Significant gas deposits have been discovered off the coast of Israel. Decisions that will be made in the coming months will be of decisive and long-term importance for distributing the revenues in the economy.

Background The basic question facing the committee is defining the proper and fair distribution of a natural resource between the general public and the investors in a manner that will maximize the welfare of all:  It will ensure the continued development of additional oil and gas deposits while maintaining the profitability for investors.  It will enable the general public to benefit from its share of the natural resource.

The existing fiscal system Principles of the system  Royalties equivalent to 12.5% of the value of the gas, by well.  Special regulations, including corporate tax breaks:  Depletion deduction – reducing the annual tax base of 27.5% of the turnover  Depreciation – recognizing exploration expenses as revenue expenses.

The existing fiscal system The existing system is based on legislation from the 1950s. The economic and geopolitical reality has changed completely.  Significant gas deposits have been discovered of the coast of Israel.  The Israeli economy has grown tremendously.  The Israeli economy has become competitive and open.  Almost all sectors of the Israeli economy have become attractive to international investment.  Tax rates in Israel differ widely.

The existing fiscal system Ordinary industry The oil and gas industry 1Income 100 2Various expenses(20) 3Effective royalties(11) 4Depletion deduction(24.5) 5Income tax base Average tax payment(14)(25) 7Total payment to the state Total payments as a percentage of the profits 31% Let’s compare the level of taxation in the oil and gas industry to the level of taxation on business activity that does not involve the exploitation of a natural resource. Under reasonable assumptions, the rate of the government’s receipts is similar in both cases. The public does not receive remuneration for the use of the natural resource. Data from existing deposits that was submitted to the committee and analyzed by it shows a similar picture, whereby the royalties paid to the state are offset by other tax benefits.

Source: Oil & Gas Journal April 18, 2005 New ZealandArgentina Morocco GabonCambodia Pakistan Australia Pakistan, water Philippines Mongolia South AfricaUnited States PeruAzerbaijan NorwayTimorRussiaAzerbaijan Egypt Indonesia United States, weighted estimate Columbia Malaysia Congo Syria Egypt Iran LibyaVenezuela Indonesia Malaysia Nigeria Qatar Myanmar Percentage of the state’s share among the countries of the world The state’s share in the discovery profits (Government Take – GT) is an accepted index for comparing fiscal systems in different countries.

Source: Oil & Gas Journal April 18, 2005 New ZealandArgentina Morocco GabonCambodia Pakistan Australia Pakistan, water Philippines Mongolia South AfricaUnited States PeruAzerbaijan NorwayTimorRussiaAzerbaijan Egypt Indonesia United States, weighted estimate Columbia Malaysia Congo Syria Egypt Iran LibyaVenezuela Indonesia Malaysia Nigeria Qatar Myanmar Percentage of the state’s share among the countries of the world 1952: Enactment of the law. The state’s share: 58% %

Source: Oil & Gas Journal April 18, 2005 New ZealandArgentina Morocco GabonCambodia Pakistan Australia Pakistan, water Philippines Mongolia South AfricaUnited States PeruAzerbaijan NorwayTimorRussiaAzerbaijan Egypt Indonesia United States, weighted estimate Columbia Malaysia Congo Syria Egypt Iran LibyaVenezuela Indonesia Malaysia Nigeria Qatar Myanmar % % 1952: Enactment of the law. The state’s share: 58% Today, the state’s share: 30% Percentage of the state’s share among the countries of the world

1952: Enactment of the law. The state’s share: 58% Today, the state’s share: 30% 2016: Under a cabinet decision, the state’s share: 25% Percentage of the state’s share among the countries of the world New ZealandArgentina Morocco GabonCambodia Pakistan Australia Pakistan, water Philippines Mongolia South AfricaUnited States PeruAzerbaijan NorwayTimorRussiaAzerbaijan Egypt Indonesia United States, weighted estimate Columbia Malaysia Congo Syria Egypt Iran LibyaVenezuela Indonesia Malaysia Nigeria Qatar Myanmar Source: Oil & Gas Journal April 18, % % %

The principles of the proposed model The objective of the system: ensuring the continued development of the gas industry, along with receiving suitable remuneration for the public, while giving proper incentives to those working in the industry. Required features of the system.  Progressive.  Repayment of the entrepreneur’s investment prior to increasing the share of the state.  Providing exploration incentives.  Economic efficiency – preventing distortions.  Adapting to changing market conditions.

The proposed fiscal system The proposed change: instituting a new fiscal system that will be applied to all activity in the industry, beginning in Leaving the rate of the royalties as is. Canceling the depletion deduction. Instituting a gas and oil profits levy.

Gas and oil profits levy A levy collected from the project revenues less current expenses. The levy will apply only after payback of the investment plus 50%. Progressive levy – the rate increases gradually with the increase in profits. A profitable project will pay the levy. Factor for determining the levy rate: *Net cumulative revenues = R-factor Exploration and development expenses * Cumulative revenues less cumulative current expenses and payment of cumulative royalties and levy.

Gas and oil profits levy R-Factor Tax rate 60% 20% Gradual increase 0% Start of payment of the levy

Gas and oil profits levy – additional features The taxation will be imposed on each deposit separately (ring fencing). Increased return on exploration expenses (uplift) will be recognized. With regard to the levy, immediate depreciation will be determined for investments during the life of the project. The limits on the levy will not include export facilities. The levy will be recognized as an expense for the purpose of calculating income tax. Depreciation rules for tax purposes will be formulated that are specific to the industry.

The proposed system – impact on deposits The impact of the proposed model on a series of typical deposits was examined. The following results were obtained:  The levy will not be reflected in the first years of production:  In a medium to large deposit, it will come into effect only after 8 years of production.  In small deposits, it will come into effect after 15 years.  The levy will have a limited impact on the yield of a borderline project.  The proposed system will not have a significant impact on the cash flow in the first years of production.  The scope of the overall GT will be about two thirds throughout the years of a profitable project.

Continued work of the committee The committee’s recommendations were passed unanimously. The committee will submit draft recommendations for the perusal of the public. The committee will receive comments from the public. If the committee learns that the proposed system impairs the financing ability of a project under development, it will examine the required solutions. After hearing the public’s comments, the committee will submit its recommendations to the ministers by the end of the year.

Summary The proposed system is consistent with accepted systems around the world, both in the scope of the state’s receipts and in the manner in which they are collected. The proposed change was examined in depth at both the economic level and the legal level. The proposed system leaves the incentive in the hands of the entrepreneurs. The proposed system encourages exploration operations. The public will receive suitable remuneration for the natural resource.

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