How to Catch an Angel
To sweeten the pill for angels, there are new Israeli tax breaks for Israeli and foreign investors in Israeli hi-tech firms.
Angel investors are people who are willing to invest a part of their capital in a private company with great potential, usually before it is profitable. Over the years, angels have invested large amounts in the Israeli hi-tech, clean-tech and biotech sectors, but more is always needed.
The investor takes a risk but hopes to make a good profit if the company succeeds. Angels sometimes invest directly, or sometimes via venture-capital funds, which are typically organized as limited partnerships and are fiscally transparent under Israeli tax law (the investor is taxed according to his own status on his share of partnership income and gains).
To sweeten the pill for angels, there are new Israeli tax breaks for Israeli and foreign investors in Israeli hi-tech firms in the Economic Arrangements Law for 2011 and 2012 (Legislative Amendments), 2011. These provisions allow the cost of investments to be written off for Israeli tax purposes against income, if certain conditions are met. This is better than waiting to offset the cost of a future capital gain, which may or may not materialize.
Investments by individuals in research and intensive companies
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 2011-2015. 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:
(1) No securities are listed on any stock exchange in the benefit period;
(2) At least 75 percent 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;
(3) 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 expenses of the company (the term ‘‘expenses‘‘ is not defined);
(4) At least 75% of the R&D expenditure of the company in the benefit period is incurred in Israel;
(5) 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;
(6) Throughout the benefit period, R&D expenditure spent on promoting or developing an enterprise owned by the company (this implies the resulting intellectual property should be owned by the company).
In computing the NIS 5m. maximum investment, the interests of certain relatives are taken into account.
Note that the investment amount deducted against income under these rules reduces the cost of the shares upon a future sale for capital-gains tax purposes.
What happens if a company wants to invest?
Separate detailed rules are prescribed. We will discuss these in an upcoming article.
To sum up, individual investors in hi-tech start-ups not yet making money can now write off their investments over three tax years against other income if they are Israeli taxpayers and if all the prescribed conditions are met.
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 checked out.
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 advisors in each country at an early stage in specific cases. Also carry out legal, technical, accounting and commercial due diligence checks before investing in any company.
Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.