On May 16, 2023, the Israel Tax Authority (ITA) published its view on the tax implications of investing through a Simple Agreement for Future Equity (SAFE). (Hereinafter referred to as: “the ITA position”).
A SAFE Agreement is an agreement between the company and an investor which is designed to protect the investor from uncertainty regarding the value of an entrepreneurial company. However, on the other hand, it enables newly formed companies to raise capital immediately.
In SAFE transactions, capital is immediately injected into the company by the investor. However, the allocation of shares for the capital injection will be performed later when the value of the company’s shares will be agreed upon, as part of a more significant and extensive capital raise in the future. The capital does not bear interest during the period between the capital injection and its conversion into shares. During the conversion stage, the investor receives a discount on the conversion ratio compared to other investors in raising capital. The ITA in several discussions have classified the aforesaid discount, from time to time, as interest income generated by the investor.
Within the framework of the ITA position, ITA determined that SAFE transactions will be considered, subject to the conditions and restrictions listed below, as an advance payment towards shares and not a loan, therefore:
(a) At the date of conversion by investor – no tax event shall apply to the benefit component, the benefit component shall not be considered as interest, hence the company is not required to withhold tax.
(b) At the date of the sale of the shares – any consideration shall be received from the realization of shares shall be considered as consideration for the sale of the shares.
Following are the characteristics of the companies that conduct SAFE transactions and to which the ITA’s position relates:
- A private Israeli resident companies engaging in the area of knowhow intensive industry (Hi-Tech);
2. The majority of the companies’ expenses are in the field of research and development, production or marketing of products it developed, as part of research and development activity;
3. The majority of the companies’ assets are not considered rights in real estate or rights to exploit natural resources in Israel, etc.;
4. The companies did not raise capital at a known valuation in the three months prior to the signing of the SAFE Agreement.
Following are the main terms and conditions of a SAFE type investment contract pursuant to the ITA’S positon :
- The amount of investment for a single investor shall not exceed NIS 40 million;
- The investor’s right to transfer his right until the conversion event, is conditional upon the approval of the company;
- The contract between the parties is not referred to as a loan/debt agreement;.
- Conversion to company shares will be solely in accordance with predetermined mechanisms;
- The investor has no right to repayment of his investment amount other than conversion into shares or receiving an expected return as part of the sale of all the shares in the company;
- If the investment funds are returned to the investor, he will be entitled to the investment fund only;
- The SAFE agreement, does not obligate the Company to grant compensation or money equivalent to the investor;
- The discount provided to the investor upon conversion does not vary linearly with time.
- No liens or seizures were imposed on the company’s assets or guarantees in favor of the investor;
- The company shall not demand financing expenses for tax purposes, whether as financing costs, capitalization of financing expenses, or as a result of the underwriting of the obligation or in any other way.
The conversion of the SAFE-type investment agreement into shares (conversion event) and the realization of the shares by the investor are as follows;
1. The conversion of the SAFE into shares (“conversion event“) will be carried out as part of a capital raising event for a company wherein at least 25% of the amount of capital raised is not
derived from SAFE investors
2. The sale of the shares issued under the SAFE agreement and in relation to SAFE transactions signed up to 30 days from the date of publication of the guidelines, will be at least (a) 12 months after the date of signing the agreement or (b) 9 months from the date of the conversion event into shares;
3. Notwithstanding clause 2 above, the date of realization of the shares can be after a shorter period, as long as all of the following are met in the transaction:
3.1. A sale of the shares by the majority of the company’s shareholders (according to the calculation of the number of shareholders, disregarding optiona holders and the sale of options or shares that originate from the exercise of options by employees or consultants of the company);
3.2. The consideration in the transaction will be paid by the purchaser of the shares and not the company (a third party not associated with the company or a shareholder who does not own more than 25% of the company’s shares);
4. As part of the realization of the shares, the price received by the investor is identical to the price received by shareholders of the same type (excluding the predetermined benefit in the framework of the SAFE agreement);
Considering ITA’s position, it is recommended to review SAFE agreements signed in the past, in order to verify compliance with ITA’s conditions as detailed above, as well as to include the relevant conditions in a SAFE agreement that will be signed after the date of publication of the ITA’s position.
If the conditions specified in ITA’s position are not met at the time of the conversion, this does not necessarily classify the transaction as debt repayment and the benefit as interest, but each case will be examined according to to the facts of the particular situation.
On the other hand, even if all of the conditions of the ITA’s position are met, there is no guarantee that the ITA will view the SAFE as a capital investment, and the ITA will still be entitled to examine the specific circumstances of the specific case and the investor. For example, in case the investor is a director or employee of the company, the transaction will be classified as a random transaction with a commercial nature, etc.
This position will apply to all transactions signed or to be signed until December 31, 2024 or until another directive is published by the ITA, whichever comes first.
This memorandum includes general information only and does not constitute legal advice or a substitute for legal advice. This memorandum is provided as a service to our clients, while clarifying that in each specific case a separate discussion must be held on a case-by-case basis. The tax department staff will be happy to assist you with any further questions at 03-3075000.
