January 2, 2019
Henriette Fuchs, Adv, LLM, Senior Partner at Pearl Cohen’s Tel Aviv office and Chair of the International Tax Group.
Israel: Tax Authorities publish clarifying circular “Tax benefits for investors on Tel Aviv stock exchange in listed R&D companies and Tech Funds”
In a Circular published on December 31, 2018 (# 21/2018), the Israel Tax Authorities guide the audience through the tax reliefs granted to investors in certain qualifying research and development companies and to investors through qualifying High-Tech Venture Funds listed on the Tel Aviv stock Exchange. These reliefs as accepted in Amendment # 220 to the Income Tax Ordinance of Israel (“ITO”) and its transitional rules, passed already in 2016, are intended to encourage investment in Israel’s continuously strong high-tech industry.
The tax benefits granted to investors in publicly traded R&D companies and tech venture funds focus on the investors in such companies, both controlling shareholders / entrepreneurs (founders) behind the R & D companies as well as institutional investors.
An investor in equity of a qualifying R&D company may recognize the actual amount of his equity investment (paid on issuance) as a capital loss incurred the year of investment up to an amount of 5 million NIS, and whereupon the loss may be offset in three equal annual parts against taxable income (over a period of 3 years) similar to benefits granted under the “Angels Law” for investment in a private company. Once the shares in the R&D company are sold, the gain (loss) is calculated under neutralization of the amount of capital loss recognized as above explained in previous years.
Controlling shareholders -often the founders still functioning as employees of the company- may secure the capital gains tax rate (25%) on a gain from a sale of their shares in the R&D company shaking off the otherwise applicable progressive income tax rates (up to 47%) on benefits from employment. This arrangement is similar to the existing ‘Trustee supervised Capital Gains Route’ for employee options (Section 102 ITO) in Israel. As Section 102 ITO in fact excludes ‘controlling shareholders’ from the favorable gains track arrangement (marginal tax rate of up to 47% – plus national security and health insurance premiums) controlling shareholders employed by the R&D company can claim the flat reduced rate of gains tax to the increase in value of their options/ shares from the date of registration for trading of the R&D company until the actual sale of their shares. Note that special arrangements already apply to hold back payments for shares and ‘reverse vesting’ arrangements in relation to founders – also of non-R&D companies.
Tax incentives for registration for trade of R & D companies (temporary provision)
Investors in R & D companies are eligible for tax incentives provided the R&D company is
- incorporated in Israel; the control and management over its business are in Israel;
- listed at the Stock Exchange in Israel;
- not listed at a foreign Stock Exchange prior to its registration in Israel;
- defined as a R & D company in accordance with the Stock Exchange Regulations on the date of listing, while regarding a company listed holding an R & D company, this requirement would apply to the R & D subsidiary and not the parent;
- and its’ market value is between 200 million and 1 billion NIS (taking as the value of the number of existing shares as the value of the shares being offered/issued multiplied by the minimum price offered per share);
Until the date of public investment, each year approval from the Israel Innovation Authority was received that at least 70% of the company’s expenses qualify as R & D expenses.
Tax exemption for provident funds invested in high technology fund
Venture capital funds may also be registered for trading and invest in Israeli R & D companies, including privately held R&D companies (“Tech Fund”) under similar tax benefits. In general, provident (pension) funds are exempt from tax on capital gains from investment through the Tel Aviv Stock Exchange (TASE) on condition that the provident fund does not hold 50% (or more) of the means of control in the venture fund. In order to facilitate investment by provident funds in Tech Funds, a provident fund may claim exemption from tax on profits from investments through a dedicated Tech Fund even if it holds up to 75% control in the Tech Fund. This particular relief should allow investors to take a stake in a provident-fund-driven public Tech Fund likely leaving the ‘small investor’ less exposed to risk as the investment power and platform of such a Tech Fund would effectively offer a spread of risk by a diversified portfolio.
Do note that extensive corporate tax benefits (reduced income tax rates and other tax benefits) may apply to the R&D / IP owning company itself under Israel’s Law for Encouragement of Capital Investments 1959 and these benefits often exist for qualifying R&D companies in parallel to the tax benefits above discussed for investors in these R&D companies.
The benefits discussed above for investors to qualifying R&D companies and Tech Funds that have registered (or will register) for trade at the Tel Aviv Stock Exchange between July 1, 2016 up to June 30, 2019.