ITA issues guidance for SAFE investments

18 May, 2023

On May 16, 2023, the Israel Tax Authority issued guidelines governing the taxation of SAFEs (Simple Agreements for Future Equity).

If certain conditions are met: (i) the conversion of the SAFE into shares will not constitute a tax event for the investors, (ii) the company will not be required to withhold tax upon conversion, and (iii) gains received by the investors upon the subsequent sale of the conversion shares will be taxed aa capital gains from sale of shares.

The guidelines contain an extensive list of pre-conditions and qualifications to be eligible for this tax treatment, which are summarized below.  Please note that this is only a summary, and the application of this guidance to any particular SAFE investment should be checked with our Tax Department.

Conditions related to the Company

The guidance applies to Israel resident companies in the high-tech industry. 

The majority of the company’s expenses during certain specified periods including as of the date of the signing of the SAFE must be classified as research and development, or as manufacturing or marketing products that were the results of the R&D efforts.

The guidance does not apply to companies primarily engaged in real estate activities or the exploitation of natural resources, and only applies where the SAFE is signed at least three months after the most recent equity financing round with a fixed share price.

Conditions related to the provisions of the SAFE

The guidance applies to SAFEs that contain the following key provisions, among others:

  • The amount invested under the SAFE by a single investor does not exceed NIS 40 million (approximately USD 11 million, subject to exchange rate fluctuations).
  • The SAFE is not transferable other than with the approval or the company or to pre-defined permitted transferees, and the agreement is not called a loan or debt agreement.
  • The SAFE can only convert to the company’s shares according to a pre-determined discount mechanism upon an equity financing round, or an IPO or exit in which a majority of the company shareholders sell their shares or following a sale of the majority/all of the company’s assets.  The SAFE can also convert according to the valuation at the previous equity financing (without any discount).
  • There is no right for the repayment of the amount invested under the SAFE other than by conversion into the company’s shares, or in the event of the sale of all of the shares of the company, by receipt of the amount that the investor would have received upon conversion of the shares.
  • The SAFE amount can be repayable, without interest, upon liquidation, appointment of a receiver, or a general assignment to creditors.  In such cases, the amount payable to the SAFE investor ranks after third party debt, but ahead of any amounts payable to the holders of ordinary shares.
  • The SAFE investment is unsecured, and does not include any interest or royalty component or any consideration apart from the value of the shares, and the discount does not change as a function of time.

Conditions related Conversion of the SAFE and Sale of Underlying Shares

The conversion of the SAFE to shares needs to take place as part of a financing round in which at least 25% of the funds raised by the company comes from parties other than the SAFE investors.  The shares issued to the SAFE investors have to be at the same price as those issued to the other investors (apart from the agreed discount), and in general, the sale of shares can only take place upon the earlier of: (A) 12 months from the execution of the SAFE, or (B) 9 months from the date on which the SAFE was converted into shares. The guidance also contains some transition provisions with respect to SAFEs signed within 30 days of the publication of the guidance.

Notwithstanding the above time periods, the shares can also be sold at any time in connection with a share sale transaction that meets the following conditions: (A) the majority of the company’s shareholders sell their shares; and (B) the purchaser of the shares is a third party that is not related to the company, or is a shareholder who holds less than 25% of the company’s shares, and in no event is the purchaser the company itself.

If not all the above are met, the ITA will examine the SAFE investment to determine whether it should be classified as an advance on the purchase of shares or repayment of debt, or any other type of transaction, and determine that tax liability accordingly.

The classification of the SAFE as an advance on purchase of shares does not limit the ITA’s authority to examine the classification of the income from the sale of the shares by the investor according to the investor’s individual circumstances.

The guidelines apply to SAFEs signed prior to December 31, 2024 or until the publication of other guidelines by the ITA, if earlier.

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