Israel has seen a wave of exit deals. Exits can be paid for with cash or shares of the acquirer, especially if the acquirer’s shares are publicly traded on a stock exchange – that is as good as cash isn’t it? Not if there is immediate tax to pay and no cash yet to pay it.
This can be a problem for Israeli resident shareholders. Fortunately, there are tax deferral possibilities if certain conditions are met.
Moreover, on August 6, 2017 these rules were revamped (Amendment 242 to the Income tax Ordinance, ITO). The old rules originally passed in 1993 contained numerous bugs.
Share Swap Mergers (ITO Section 103 Chaf):
This refers to a transfer of “at least 80%” of the rights of a company or companies (the transferor company, i.e. the acquired) to another company in return for shares issued by the other company (referred to as the “transferee”, i.e. the acquirer), provided the holders of those rights and their related parties (as defined) transferred all such rights to the transferee. The deemed merger date is the end of the year, but not before each company involved has passed a merger resolution pursuant to Section 320(a) of the Company Law in a general meeting. An advance tax ruling may optionally be requested.
A share swap merger should not be taxed in Israel (and real estate may be subject to only 0.5 purchase tax), if a number of conditions are met
In particular, the transferee (i.e. the acquirer) company must acquire 100% (not 80%) of all the rights of the transferor (i.e. acquired) company and retain at least 51% throughout the requisite period.
The requisite period for a share swap is two years from the start of the process.
Other conditions for a share swap merger include:
Other conditions include: substantive post-merger business; the main objective is unified management and operations; no tax avoidance motive; most assets other than publicly traded securities are used and not sold until two years after the end of the relevant tax year; the transferee company continues with the main economic activity of the transferor companies for the requisite period (two years from the start of the merger – see above) which may optionally be confirmed by the ITA; the transferee company confers the same pro rata rights and value to shareholders as before the merger; the value of each transferor company is at least 10% of the transferee company’s value; the value of any one transferor company may not be more than nine times the value of any other; the transferee company must be an Israeli incorporated and resident company or an Israeli cooperative society OR a foreign resident company approved by the ITA.
The amendment allows shareholders to receive mixed share/cash consideration if: (1) the sellers sold all their shares in the transferor company and received none in the transferee company, or (2) the Tax Director allows the under-10% shareholders to receive up to 40% of their consideration in cash, Tax only applies to the cash consideration if the conditions are met.
If new shares are sold there is a two-step tax calculation of the indexation, and tax breaks for Olim and foreign investors are preserved at the first (swap) stage.
A gain or loss generated when the transferee (acquirer) company sells shares in the transferor (acquired) company may not be used in a loss offset by the transferee (acquirer) in the year of the share swap merger in the two subsequent tax years. In the following three years, no such offset is possible against assets acquired before the merger date.
The ITA can deny loss utilization in cases of improper tax reductions.
Swaps Into Publicly Traded Shares (ITO Sec 104Chet):
An alternative regime is available in the case of a transfer of shares and share options of a transferee (i.e. acquired) company to another receiving company (i.e. acquirer) in return for publicly traded shares of that other company with or without further consideration.
In this case, ITA approval is mandatory and tax deadlines are stipulated, but fewer other conditions apply than above.
Publicly traded shares are assumed to be liquid. To avoid the market being flooded with sales, lock-up provisions may be stipulated. A taxable sale is deemed to occur upon an actual sale or after the end of a prescribed deferral period (deemed sale), whichever is earlier
In the case of shares free of any lock-up, half are deemed to be sold within 24 months after the share swap, half after 48 months.
In the case of shares subject to a lock-up, half are deemed to be sold within 24 months after the share swap or 6 months after the lock-up ends, whichever is later. The other half are deemed to be sold within 48 months after the share swap or 6 months after the lock-up ends, whichever is later. A 0.5% purchase tax applies to any Israeli real estate entity.
Additional detailed conditions apply.
To sum up:
The amendment may make share swap mergers and acquisitions easier, but not easy. Other deals should also be considered such as asset-for share reorganizations.
As always, consult experienced tax advisors in each country at an early stage in specific cases.
The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd