In 2011, Israel passed a law allowing angel investors to claim a deduction for Israeli tax purposes for investments in certain Israeli hi-tech startups.
However, the conditions are so onerous that this incentive has not proved successful. Consequently, modifications are now proposed.
The present law According to the Economic Policy Law for 2011- 2012 (“the Angel Law”), Israeli- and foreign-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.
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 the 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 is spent on promoting or development an enterprise owned by the company, What is now proposed As part of the 2015 draft budget law, it is proposed to leave the “target company” definition unchanged but to add a second category – the “startup company.”
The definition of a startup company for these purposes includes the following: (1) Incorporated within 48 months before the qualifying investment, or received support from the Chief Scientist’s Office within the last 12 months; (2) Sales prior to the qualifying investment of no more than NIS 1.5m. per year or NIS 4.5m. in total; (3) Expenses prior to the qualifying investment of no more than NIS 3m. per year or NIS 10m. in total; (4) Total cash deposited in the company prior to the qualifying investment of no more than NIS 12m.; (5) A CPA confirms these numbers are met; (6) The Chief Scientist’s Office confirms annually that the company’s activity stems mainly from its R&D and that it has owned all rights arising from it since they were generated, or acquired them from a “knowledge trading company” using knowledge generated in an academic institution or hospital; (7) The Chief Scientist’s Office will prescribe annually the required expenditure on the company’s products; (8) Most expenditure to be incurred in Israel.
Any shortfall in such expenditure will be treated as income and taxed to the company but taxed at personal tax rates (up to 48% or 50%).
It is proposed to extend the period for making investments until the end of 2019. Partnerships of individuals would also be allowed.
Foreign investors It is interesting to note that foreign-resident investors might 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. Nevertheless, the tax position in the investor’s country of residence must also be considered.
Closing remarks It remains to be seen what will finally be legislated and when it would commence. But the new proposals seem almost as bureaucratic as before. Out of the frying pan and into the fire? As always, consult experienced tax advisers in each country at an early stage in specific cases.
Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.