Israel Tax Authority updates its guidelines on investments through SAFEs
The Israel Tax Authority (ITA) recently published updated guidelines, regarding tax aspects applying to investments in companies through SAFEs. Such guidelines were published following the previous guidelines published by the ITA during May 2023, and which expired at the end of 2024.
SAFE transactions offer a quick and efficient solution to private companies for fundraising, which transactions are characterized, inter alia, by no agreed company valuation.
SAFE transactions are by and large common, constituting a contract between an investor and a company, pursuant to which the investor immediately provides funding for the company even though the shares are issued in the future. Under SAFE transactions, companies do not deal with valuation questions; the period between the funding and issuing the shares (upon the conversion) does not bear interest; and upon the conversion into shares, the SAFE holder is entitled to a discount compared to other investors in regular (not through SAFE) funding rounds.
Similarly to the previous guidelines, the new guidelines regulate the conditions pursuant to which the conversion of the SAFE will not be considered a taxable event in respect of interest income but rather will be classified as a transaction at the capital gain level only, to be taxed in the future, upon a sale of the shares.
These updated guidelines eliminate the tax uncertainty that has prevailed over the years in relation to such transactions. In addition, the guidelines exempt companies from the withholding tax obligation upon issuing the shares to the SAFE holders, an obligation that does exist upon issuing shares against an ordinary investment round in the company.
The updated guidelines’ main updates and innovations
- Increased investment cap per single investor: the new guidelines set the maximum investment amount per investor at USD 20 million, while the previous guidelines allowed an investment of up to ILS 40 million.
- Expanded conversion flexibility of the mandatory conversion: according to the previous guidelines, a SAFE was converted into shares solely according to the triggering mechanism pre-defined in the agreement, upon an investment round, an IPO, an exit event or a sale of most or all the company’s assets.
Similar to the previous guidelines, the SAFE will be converted into shares solely according to the triggering mechanism pre-defined in the agreement, however the updated guidelines clarify that the conversion of the SAFE becomes mandatory upon the earliest of the following events:
-
- when a funding round exceeds 40% of the company’s fully diluted share capital (before the funding round and before the share allotment) or exceeds 10 times the cumulative sums of the company’s current SAFEs;
- an IPO on the stock exchange;
- an exit event, during which most of the company’s shareholders sold their shares;
- a transaction for selling of most or all the company’s assets; or
- a date predefined in the SAFE.
Please note that not converting the SAFE following one or more of the above events will disqualify the SAFE agreement from being covered by such guidelines. The guidelines also do not prevent conversion during a funding round that does not obligate conversion.
- Entitlement to return of the SAFE funds: according to the previous guidelines, the SAFE holder is not entitled to the return of its investment, except by way of converting the SAFE into shares of the company or by receiving a consideration equal to the amount for which the shares would have been sold during a sale of all of the company’s shares, but excluding events of dissolution and liquidation of the company.
The new guidelines, in addition to the events described in the previous guidelines, entitle investors to the repayment of their investment (principal amounts solely) without converting the SAFE into shares, if most of the company’s shareholders sell their shares to a third-party purchaser. It should be noted that SAFEs do not allow for the inclusion of the company’s undertaking that the investor will receive remuneration in cash or cash equivalent by way of nominal interest, royalties or any instrument dissimilar to standard shareholder remuneration during the period between the investment date and the issuance of the shares. - Variable discount caps: according to the previous guidelines, the discount rate must be fixed and does not vary as a function of time. However, the new guidelines allow up to 3 discount caps that may vary subject to a function of time or milestones without violating the guidelines, provided that the maximum discount rate will be granted 3 years at most following the signing of the SAFE.
- Expanded the conversions on a pre-defined date: the previous guidelines allowed conversion at a pre-agreed value, but only according to the value of the last funding round and without any discount component. The new guidelines stipulate that a pre-defined conversion is permitted at a pre-agreed value or at the value of shares on the last or next funding round, without a discount or with a pre-defined discount.
The ITA’s updated guidelines apply to transactions signed or to be signed between January 1, 2025, and December 31, 2026, unless the ITA determines otherwise.
The importance of the new guidelines
The updated guidelines allow significant flexibility in formulating SAFEs and determining their terms and accordingly spread light on the uncertainties and the unpredictability of the ITA’s position with respect to SAFE terms.
Similarly to the previous guidelines, the ITA’s updated guidelines also state that if the SAFE does not fulfill the conditions specified in the guidelines, this does not necessarily mean that the SAFE will not be classified as an equity investment, but rather, that it will be examined according to all circumstances and will not be allowed into the green track (guidelines).
***
Barnea Jaffa Lande’s Tax Department and Corporate Department are at your service to answer questions about drafting SAFEs, to assist with such investments and to handle the tax issues deriving from SAFEs.
Adv. Hanna Daher is a partner and Adv. Fadi Atallah is an associate in our firm’s Tax Department.