Your taxes: Structuring your investment in the start-up nation

Before you can make money (hopefully), you must invest money; How do you do this?

By LEON HARRIS
November 19, 2013 22:05
3 minute read.
Ramat Gan's Diamond Exchange district

Diamond Exchange 311. (photo credit: Wikimedia Commons)

In a recent article we discussed some of the things to check out before investing in a venture in the start-up nation. But before you can make money (hopefully), you must invest money. How do you do this?

Private companies in any sector

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In Israeli private companies, shareholders often provide interest-free loans, as these are repayable without tax consequences. A private company can have a minimal issued share capital (say NIS 100), with the rest as interest-free shareholders loans.

Another possibility is to fix the loan from a major shareholder (10 percent holding or more) in shekels rather than foreign currency, with the loan being linked to the consumer price index (CPI) inflation rate. For example, if annual inflation is 2%, the shareholder can receive 2% free of Israeli tax, and the company can claim the 2% as an expense.

Various conditions apply, and the shareholder can only receive his indexation after the year-end. The loan principal can be repaid free of Israeli tax whenever agreed. There is no upper limit on the loan amount for tax purposes, but a loan agreement is advisable.

In theory, 18% VAT applies to interest and indexation, but this is rarely enforced. But to be on the safe side, the company can apply a “reverse charge” self-assessment VAT procedure, whereby it collects the lender’s “output” VAT and reclaims the VAT as its own “input” VAT on its indexation expense. The net result is no VAT but a lot of bureaucracy.

Start-up tech companies

Foreign and Israeli resident individuals may deduct from total taxable income a “qualifying investment” of up to NIS 5 million in shares of “target companies” over a “benefit period” of three tax years commencing with the tax year in which the investment is made. The investment must be made in the years 2011-15. The individual must hold the shares allocated to him throughout the three-year benefit period. In addition, tax avoidance or improper tax reduction must not be one of the main aims for the investment.

A “qualifying investment” is an investment by an individual in a tax year in consideration for shares allocated to him in that year.

This rules out buying shares from another shareholder. A “target company” is a company incorporated in Israel whose business is controlled and managed in Israel, which meets the following conditions with regard to the qualifying investment: • No securities are listed on any stock exchange in the benefit period; • At least 75% of the amount invested by the individual, in consideration for the shares allocated, is used for R&D expenditure approved by the Chief Scientist’s Office by the end of the benefit period; • Until the preceding condition is met, in each year of the benefit period and in the tax year that condition is met, such R&D must represent at least 70% of the expenses of the company (the term “expenses” is not defined); • At least 75% of the R&D expenditure of the company in the benefit period is incurred in Israel; • In the year in which the qualifying investment is paid and the following year, revenues of the company do not exceed 50% of R&D expenditure; Throughout the benefit period, R&D expenditure is spent on promoting or development an enterprise owned by the company.

It is interesting to note that foreign-resident investors apparently can enjoy a double whammy. It seems they can claim the investment deduction against other Israeli-source income (e.g., dividends) AND an exemption from Israeli capital-gains tax when they sell their shares (assuming they are not doing business in Israel). Nevertheless, the tax position in the investor’s country of residence must also be considered.

In addition, if any angel, foreign or Israeli, invests under these rules at the end of the tax year (December 31), it seems they can still deduct one-third of their investment in that year against other Israeli-source income. It remains to be seen whether the Israel Tax Authority will issue any guidance or interpretation regarding these aspects.

As always, consult experienced tax advisers in each country at an early stage in specific cases.

leon@hcat.co

Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.


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