The cars and trucks we drive around in today owe their power to the the four-stroke cycle developed from 1854-1876 by Eugenio Barsanti and Felice Matteucci, Alphonse Beau de Rochas and Nicolaus Otto. The four strokes refer to intake, compression, combustion and exhaust. Serial investors in private businesses know there is another well established four-stroke cycle. The four strokes are: Start-up, operations, IPO (initial public offering) on a stock exchange and exit (share sale). So when you invest in a Israeli start-up operation, what are the Israeli tax considerations at each stage? At the start-up stage, the first question is usually whether to have an Israeli parent corporation or a foreign parent corporation (in the US, UK, Netherlands, offshore, etc.) with an Israeli operational subsidiary? This question arises because prior to 2003, foreign and Israeli investors objected to paying up to 50 percent Israeli tax when they sold their shares in an Israeli parent corporation, so they preferred to invest in a non-Israeli corporation. But times change, and foreign investors are now mostly exempt from Israeli capital gains tax when they sell shares in an Israeli company - this applies in the following cases: * Investments in Israeli securities made between July 2005 and December 2008 if the investors reside in a country that had a tax treaty with Israel during the 10 years before their investment and report it within 30 days to the Israeli Tax Authority. * Shares in a research-intensive company that were issued to the foreign resident investor on or after January 1, 2003. * Venture capital funds that obtained an advance tax ruling from the Israeli tax authorities. * Securities traded on the Tel Aviv Stock Exchange. * Securities of Israeli companies traded on a recognized foreign stock exchange. * Exemption under any applicable tax treaty (restricted to under-10% shareholders in the US-Israel tax treaty). In other cases, the rate of Israeli capital gains tax is now only 20%, or 25% for investments made since January 1, 2003 (up to 48% for pre-2003 gains). The 20% capital gains tax rate applies to individual investors who held under 10% of all means of control of the investee company throughout the 12 months before selling its shares. The 25% rate applies to other post 2002 investments. For US investors, these taxes are expressly creditable against US federal taxes according to the US-Israel tax treaty. So there is no longer a tax impediment to investing directly in an Israeli corporation. Furthermore, there may be other advantages compared with a US parent corporation: less layers of tax on dividends repatriated from Israel and lower exposure to US anti-tax haven rules in Subpart F of the US Internal Revenue Code. At the operational stage, there are two tax regimes for companies in Israel - regular and preferential (See Israeli tax breaks for business get even better, The Jerusalem Post May 30, 2007). Under the regular tax regime in the Income Tax Ordinance, companies and their shareholders pay taxes on their profits at the following rates: * Company tax: 29% (which will drop to 25% by 2010). * Dividends paid to shareholders: 20% tax for an individual shareholder holding under 10%, otherwise 25% tax. (Separate rules apply to Israeli intercompany dividends). * Resulting total Israeli taxes on companies and their shareholders: 43.2%-46.75%. Under the preferential tax regime, in the Law for the Encouragement of Capital Investments, tax breaks are available automatically in qualifying cases for "Privileged Enterprises:" * They are in the industrial, technology or hotel sectors. * Possible exemption on undistributed profits for two to 15 years, depending on the location and foreign ownership. * Low company tax rates of 10% to 25% apply to distributed and subsequent profits. * Dividends are taxed at a rate of 4% or 15%, depending on the package selected. * Consequently, combined Israeli taxes for a Privileged Enterprise may range from 0% to 36.25%. * An "Approved Enterprise" in a development area will enjoy the same low taxes but no exemption. Instead it may receive fixed asset grants of 20%-32%. * A "minimum qualifying investment" must be made in productive fixed assets - only NIS 300,000 over three years for new start-ups. For existing companies, the new investment must also exceed 5%-12% of the tax-depreciated value of fixed assets other than buildings at the end of the preceding tax year. * Privileged Enterprises and Approved Enterprises must be competitive and not overly dependent on the market of any one country - this translates into a 25% export requirement except for biotechnology and nanotechnology. Research and development grants of 20%-85% are also available from the Office of the Chief Scientist or from various binational funds. They are generally repaid by way of a sales royalty if there are sales. A business needs to sell. One of the main markets for many Israeli start-ups is the US due to its size and sophistication. There are a number of tax issues to address in conjunction with US and Israeli tax advisers. * A subsidiary company in the US is often considered preferable to a branch or permanent establishment (fixed place of business, PE) of an Israeli corporation having regard to the foreign tax credit rules in Israel. But that check the Israeli corporation does not also do business in the US via an executive or sales person with powers to bind the Israeli corporation. * Check that the US corporation pays promptly for supplies to it by the Israeli corporation, to avoid negative US tax consequences - for example, 17.5% interest withholding tax, or deemed dividend taxation, especially if there is a US parent corporation. * Check the exposure to royalty withholding tax on technology software licenses - at rates of 10% to 15% under the US-Israel tax treaty. * Check that the ownership and development of intellectual property (technology, goodwill, brand name, etc.) is clearly defined. * Check that there is "contemporaneous" documentation in place that validates the existence of arm's length market-based intercompany transfer pricing policies for intercompany transactions. * Check out US sales and usage taxes (corresponding to VAT in Israel) and state and local taxes. Similar considerations apply in principle when transacting with/in other countries. Over time, as groups grow, they will want to develop tax-efficient supply chains - further advice should be sought on this and all other aspects. At the IPO stage, Israeli corporations often choose to go public on the Tel-Aviv Stock Exchange or NASDAQ in the US or AIM market in London. Each have advantages and disadvantages. Other exchanges should also be considered, including the Toronto Stock Exchange, which is keen to attract Israeli companies. Sometimes, the underwriters or other advisers insist on a "flip" (reorganization) to turn an Israeli group into a foreign group with an Israeli subsidiary ahead of the IPO. Note that the paper gain on such a "flip" is reportable and taxable within 30 days for Israeli tax purposes - at least for Israeli investors. To avoid this, it will be necessary to obtain an advance ruling is obtained from the Israeli Tax Authority allowing deferral of the taxable event until the shareholders sell their holdings for cash if certain conditions are met. At the exit stage: In nature, the whales swallow the minnows. Many Israel-based groups have been acquired by larger multi-national groups in recent years, sometimes at a substantial gain to their shareholders - usually for their technology or market share. Such exits are subject to Israeli capital gains tax of 20%-25% (up to 48% for pre-2003 investments) but an exemption may apply to foreign investors, as discussed above. If the acquirer purchases the assets of the Israeli target corporation rather than its shares, additional considerations apply and specialist advice is essential. If the acquirer pays using its own shares (stock) rather than cash, the paper gain is again immediately taxable unless an advance deferral ruling is obtained from the Israeli Tax Authority. If the Israeli target company previously received R&D grants from the Office of The Chief Scientist (OCS) the purchaser will need to check whether any limitations apply to the use or export of the target's technology, among other things. The purchaser will need to conduct commercial, legal, tax and accounting due diligence procedures. The above discussion is very brief and general, and does not address real estate investments. As always, consult experienced tax and legal advisers in each country at an early stage in specific cases. firstname.lastname@example.org The writer is an International Tax Partner at Ernst & Young Israel.