Israel reduces limitations on tax free reorganizations

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1 24 August 2017 Global Tax Alert Israel reduces limitations on tax free reorganizations EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: Executive summary On 6 August 2017, Amendment 242 to the Israeli Income Tax Ordinance (the amendment) was introduced in order to allow tax free reorganizations with fewer constraints. This change follows other Israeli tax amendments recently introduced in order to accommodate the dynamic transaction environment in Israel, especially in the tech industry. The current amendment is the first significant revision ever made to the Israeli tax-free reorganization regime. The amendment consists of various changes, most notably: Relaxing constraints on post-reorganization changes to the capital structure of the companies involved (including fund raising and disposal of shares by existing shareholders) Providing the ability to include cash as part of the consideration in a tax-free merger (up to 40%) The amendment is effective 6 August 2017, although it may impact reorganizations performed prior to that date. Companies with Israeli operations should examine the potential benefits available relevant to their legal entity structures, as well as to past and future transactions in Israel.

2 2 Global Tax Alert Detailed discussion Background Part E2 of the Israeli Income Tax Ordinance generally covers certain legal entity reorganizations and transfers of assets, with specific provisions to allow the execution of such transactions without being subject to tax in Israel. Such tax-free treatment is generally allowed in cases where the economic ownership is preserved, and in essence, there is no asset realization requiring taxation. The recent amendment aims to align the provisions of Part E2 with the current Israeli business environment, which often requires rapid structural changes for fast growing companies. Accordingly, the law was amended to: Relax requirements for reorganizations to be tax free Simplify the provisions of Part E2 to reduce uncertainties that often required a pre-ruling from the tax authorities Make adjustments specifically relevant to the tech industry, to make it easier to raise funds, make acquisitions, and carry out other transactions that may enhance Israeli tech companies The main changes Below are the general descriptions of some of the main changes introduced, compared to the corresponding provisions that were in force up to the effective date of the amendment (6 August 2017). Issue 1. Reducing post-reorg restrictions on transferors 2. Reducing restrictions in a share-forshare merger Provisions that were in force prior to the amendment The tax free nature of the reorganization is generally conditioned, among other things, on a requirement of the transferor(s) to hold the shares in the receiving company for a certain period following the transfer (two years in most cases). Notwithstanding this condition, the provisions of Part E2 allowed certain changes during the restrictions period, such as: Voluntary sale of up to 10% of the shares Private issuance of shares up to 25% for each investor, and up to 49% in public issuance The provisions allowed the above changes to apply for up to 49% or 50% of the company s shares, depending on the reorganization type. The tax free nature of a share-for-share merger was generally conditioned, among others, on a requirement of the receiving company to hold 100% of the shares in the transferee during the restrictions period. Provisions in force following the amendment Post-reorganization sale of shares and/or issuance of shares will be allowed during the restrictions period, as long as all or part of the original shareholders maintain a minimum ownership of 25% in the receiving company. The receiving company will be required to hold at least 51% in the transferee during the restrictions period.

3 Global Tax Alert 3 3. Reducing limitations related to a merger between a parent company and its subsidiary No special relief from limitations generally applied to this type of merger. 4. Cash consideration A cash component as part of the reorganization consideration generally violated the tax-free treatment of the transaction. 5. Tax-free transfer of assets by partners in a partnership or by common owners of the asset 6. Reducing restrictions based on the value proportions among the shareholders and the companies participating in a merger 7. Reducing restrictions on postmerger utilization of losses 8. Reducing requirements for a pre-ruling The tax-free nature of the transfer was generally conditioned, among others, on a transfer to a newly formed company. Shareholders of the companies participating in a merger were required to meet a maximum 1:9 value ratio during the restrictions period. The companies themselves were required to meet a 1:4 value ratio, which can be extended to 1:9 in certain cases. Limitations on utilization of losses of the companies participating in a merger or demerger: up to 20% of the carryover losses may be used each year, not to exceed a maximum of 50% of the company s annual taxable income. A pre-ruling is generally required for tax-free share-for-share mergers and demergers. Removal of the restrictions regarding the post-merger sale of shares and/or issuance of shares in the parent company. Also, see (7) below regarding utilization of losses. Cash consideration of up to 40% will not violate the tax-free nature of the reorganization, subject to certain conditions, including approval of the tax authorities. The cash component itself will be fully taxable. Transfer of the asset to an existing company will be allowed. Shareholders will be required to meet the value ratio at the time of the merger only. The companies value ratio is extended to 1:9. between a parent company and a wholly owned subsidiary (with a value ratio of over 1:9), the utilization limitation will not apply to losses of the surviving company. The loss utilization limitations are cancelled with respect to demergers. The pre-ruling requirement is cancelled for most cases and replaced with a reporting requirement within 30 days of the reorganization. In certain cases, for example, in reorganizations involving non-israeli companies, the pre-ruling requirements will not change. In addition, a pre-ruling is required for undertaking additional reorganizations during the restrictions period. Impact The amendment introduced various significant changes (not limited to the ones described above) and may allow companies to set up efficient holding structures with less restrictions. Companies with Israeli operations should carefully examine the impact of the amendment to their structures as well as to past and future transactions in Israel.

4 4 Global Tax Alert For additional information with respect to this Alert, please contact the following: EY Israel, Kost Forer Gabbay & Kasierer, Tel Aviv Sharon Shulman sharon.shulman@il.ey.com Ziv Manor ziv.manor@il.ey.com Hagai Oppenheim hagai.oppenheim@il.ey.com Tali Ben-zadok tali.ben-zadok@il.ey.com Ernst & Young LLP, Israel Tax Desk, New York Rani Gilady rani.gilady1@ey.com

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