INVESTMENT BY MEANS OF SAFE
UPDATED TAX AUTHORITY GUIDELINES
In recent years there has been an increased use of investment agreements styled as SAFE (a Simple Agreement for Future Equity) as a means for raising capital in start-ups both quickly and efficiently. Investment with the use of SAFEs facilitates an immediate flow of moneys to the capital raising company, while deferring the date for the allotment of shares to SAFE investors until a future date when a credible valuation of the company’s shares is crystallized (usually following a substantial raising of capital or upon launch of an IPO). This valuation is used in order to determine the number of shares to be allotted to SAFE investors, who, generally, enjoy a discount on the price per share when compared to other investors, at a pre-determined rate as prescribed in the SAFE.
The use of SAFE gave rise to an array of complicated tax issues requiring consideration, including qualification of the investment for Israeli tax purposes (a capital as opposed to debt investment), the tax implications stemming from the discount that is accorded to SAFE investors on the date of allotment, the question of the duty to withhold tax at source on the date of allotment of the shares to SAFE investors, and the like.
On 16 May 2023 the Israel Tax Authority (ITA) published guidelines in this regard, wherein a “green track” for the taxation of investments made by means of SAFEs was determined. It was thus established that upon the fulfilment of certain conditions as detailed in the guidelines, SAFEs will be categorized as capital instruments. As a consequence, a tax event would not apply on the date of allotment of the shares to SAFE investors, nor would the allotting company be duty-bound to withhold tax at source. Moreover, the consideration to be received by the SAFE investors would be subject to capital gains tax.
The ITA recently published updated guidelines with respect to the tax aspects applicable to investments made with the use of SAFEs. These guidelines include a series of reliefs that allow for much greater flexibility in the planning structure of the agreement and its terms. Thus, for example, the maximum possible amount to be invested by a single SAFE investor has been increased to US $20 million (as opposed to NIS 40 million in the original guidelines). Similarly, the new guidelines provide that SAFEs can include up to three different discount tiers for investors, depending on the achievement of milestones or as a function of time.
The new guidelines apply to SAFEs that will be entered into during the period 1 January 2025 until 31 December 2026 (unless further updated published guidelines on the subject provide otherwise). It should nevertheless be clarified that reliance can be made on these guidelines also for interpreting the original guidelines with respect to SAFE transactions consummated prior to 1 January 2025.
The drafting of future SAFEs therefore oblige a meticulous review of the ITA’s guidelines and conformance of the provisions of the agreement with its terms, such that SAFE investors will be conferred with certainty with respect to the tax ramifications flowing from the investment.
WITHHOLDING TAX AT SOURCE FOR THE SALE OF DIGITAL ASSETS
The Ministry of Finance recently published a draft order – Income Tax Order (Determination of Consideration Payment or Capital Gain from a Digital Asset as Income), 5785-2024, aimed at broadening the regulatory arrangement in the realm of the taxation of digital currencies in Israel and streamlining the enforcement of taxes applicable to profits generated from the sale of such currencies. According to the provisions of the draft order, any consideration or capital gain derived from the sale of digital assets will be considered as income over which a duty to withhold tax at source pursuant to the provisions of section 165 of the Income Tax Ordinance, 5721-1961 (the ITO) will apply. As a consequence, any payee or person responsible for the payment of income sourced from the sale of digital assets will be obliged to withhold tax at source in relation to such generated income.
As a complementary measure, the Ministry of Finance published draft Income Tax Regulations (Withholding From Payment or Capital Gain Upon the Sale of a Digital Asset), 5785-2024, as well as draft Income Tax Regulations (Exemption From the Submission of a Statement of Account) (Amendment-Digital Asset), 5785-2025, aimed at reducing the bureaucratic burden that today applies on holders of digital assets and perhaps to even encourage the entry of “foreign players” into the economy. Pursuant to the provisions of the proposed regulations, supervised entities (holding the appropriate license) will be required to withhold tax at source for income sourced from digital assets, while owners of digital currencies will be exempt from filing an annual report for that income, provided that the total amount of income generated from the sale of digital assets in the relevant tax year will not exceed NIS 2,810,000. On the other hand, it was proposed to establish that a taxpayer holding digital assets valued at NIS 400,000 and more will be required to submit an annual report, regardless of the sales turnover deriving from them, unless he is exempt from having to submit the aforesaid report pursuant to the provisions of applicable law as currently in effect.
RULING IN THE CASE OF THE NATIONAL INSTITUTE FOR TESTING AND
EVALUATION – THAT THE REGISTERED NON-PROFIT ASSOCIATION
IS NOT ENTITLED TO A TAX EXEMPTION ON ITS INCOME
As is known, section 9(2) of the ITO provides that the income of a public institution will purportedly be exempt from tax, unless it is generated from a business in which it is engaged. A ruling rendered by the Jerusalem District Court was recently published in the case of The National Institute for Testing and Evaluation (the Institute), clarifying the scope of application of this fundamental exemption.
The Institute was incorporated as a registered non-profit association (amuta) in 1983 by representatives of seven leading Israeli academic institutions. Until incorporation of the Institute, each of the aforementioned academic institutions prepared entrance exams and evaluated candidates independently. Due to the difficulties emanating from operating this screening mechanism and the high costs associated with such operation, it was decided to establish the Institute.
Until 2013 (i.e., for 30 years from the date of its establishment), the Institute was classified as a public institution under the auspices of the provisions of section 9(2) of the ITO, and accordingly was exempt from tax on all income generated by it. However, in income tax assessments issued by the Jerusalem 3 Assessing Officer for the Institute covering the years 2014-2016, it was determined that the provisions of section 9(2) of the ITO should be interpreted narrowly and that in light of such interpretation, income generated by the Institute should be subject to income tax. In so doing, it was determined that the Institute’s activities were not carried out for a “public purpose”. In addition, the Assessing Officer imposed high deficit fines on the Institute. The Institute’s appeal on this principled holding was recently rejected by the Jerusalem District Court.
The court accepted the Assessing Officer’s stance, whereby the latter’s narrow interpretation of section 9(2) of the ITO should be preferred, and held that the Institute’s activity cannot be viewed as that for “educational” purposes, even though this concerns a registered non-profit association (amuta) whose stated purpose is to assist academic institutions in Israel in screening candidates. The court added, that the high profitability characterizing the Institute’s activity also attest to the fact that it does not speak of a non-profit organization that is exempt from income tax.
Nevertheless, the court accepted the Institute’s argument regarding the deficit fines and ordered for their cancellation. In so doing, it was held that the reclassification carried out by the Respondent cannot be deemed as attesting to negligence on the part of the Institute in the preparation of reports submitted by it or of its intention to violate the provisions of the ITO, particularly in light of the fact that this speaks of a legal entity that has enjoyed the status of a public institution for thirty years. In this regard, it should be noted that of late the imposition of deficit fines by the Assessing Officer has become a routine occurrence. We thus believe that where a taxpayer has acted over the years in a certain way in good faith and/or where reliance is made on a legal opinion, there is no room, at the very least, for imposing deficit fines on the ground of negligent activity.
NEW REPORTING DUTIES FOR INTERNATIONAL GROUPS – CBCr
Section 85C of the ITO, which was enacted within the context of Amendment No. 261 to the ITO, establishes a reporting duty for an Israeli-resident parent company that is a member of an international group of companies. Thus, as of 2022, multinational companies whose ultimate parent company is an Israeli company and whose consolidated annual turnover exceeds NIS 3.4 billion, are subject to unique reporting obligations in Israel – Country-by-Country Reporting (CBCr).
On 11 February 2025, the ITA published Income Tax Circular 01/2025, titled: “Transfer Pricing – Amendment No. 261 to the Income Tax Ordinance – Ultimate Parent Entity Report (hereinafter: CBCr)” (the Circular). The Circular aims to specify the obligations associated with submission of the ultimate parent entity’s report, the manner for submitting same as well as the associated sanctions in the event of their breach.
The Circular clarifies that companies that are obliged to submit an ultimate parent entity’s report in Israel should do so via the “AEoI – Automatic Exchange of Information” portal, no later than 12 months from the ultimate parent entity’s tax year end. It further clarifies that the failure to submit the ultimate parent entity’s report, even partially, will be treated in the same manner as the failure to submit a report pursuant to section 131.
