On July 12, 2016, the professional division of the Israeli Tax
Authority ("ITA") published a draft of a
new income tax circular, entitled "Employees' Preservation
Mechanism and Restrictions on Founders and Key Employees"
("the Circular"). The Circular wishes to
provide special and lenient treatment and taxation in connection
with Reverse Vesting and Holdback Payments, which are usually
provided to key employees and founders of start-ups or
corporations, by their employers, investors or co-founders.
Before we further review the Circular, we would like to bring to
your attention that this Circular was published only a few months
after the publishing of a tax decision concerning the taxation of
Holdback Payments which were paid by the purchaser of an Israeli
company to the founder of the said company ("the Tax
Decision"). The Tax Decision, which was reviewed by
us previously (in our article dated January 8, 20151),
demonstrated a surprising turnabout in the approach of the ITA, by
determining that, under the circumstances of the Tax Decision, the
Holdback Payments would be considered capital payments that are
taxed as capital gain (25-30%), and not as an employment income
that would be liable to marginal tax (up to 50%).
The Circular separately reviews the different characteristics of
the Reverse Vesting mechanism and the Holdback Payments mechanism,
on which the Circular provisions will apply. The Circular specified
that the Reverse Vesting mechanism that was determined as part of
the purchase agreement or the establishment agreement of a company,
in order to insure that the founders and employees of the company
will continue to develop and promote the company and preserve its
attractiveness by imposing restrictions on the shareholders'
control of the shares, and which fulfills after the conditions of
the Circular, will not, by itself, affect the classification of the
income derived out of the sale of the shares, as capital
As to the Holdback Payments, the Circular reflects an approach
that is similar to the approach applied in the Tax Decision. The
Circular provides that Holdback Payments, up to the price of the
sold shares, which fulfill a number of conditions, will be subject
to capital gain tax. The conditions detailed in the Circular
include, inter alia, holding the shares by the seller at
least six months before the transaction date, and receiving an
appropriate employment salary in consideration of services
rendered. It should be noted that any payment received by the
shareholders, that is above the share price, will be classified as
employment income and subject to marginal tax.
Although the final version of the Circular has not yet been
published, it is obvious that the ITA is keen to specify clear and
specific instructions, in order to enhance the certainty of the
taxation of complex mechanisms that are usually included in M&A
agreements. The current draft of the Circular sheds enough light on
the position of the ITA in this regard, and we recommend consider
carefully and accurately reviewing the provisions of the Circular,
in order to optimize the M&A agreements and transactions, by
reducing the tax amplifications.
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Israeli tax law is changing regularly. There were various amendments to the Israeli Tax Code, including the reduction of tax rates. The following summarizes Israeli tax rates and other tax information for 2016.
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