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Guidelines regarding tax aspects applying to an investment in a company through a SAFE

The Israeli Tax Authority position regarding tax aspects applying to an investment in a company through a SAFE (Simple Agreement for Future Equity) Following to the Israel Advanced Technology Industries question about the tax aspects of the SAFE investments

Following to the IATI ("Israel Advanced Technology Industries") question about the tax aspects of SAFE investments ("Simple Agreement for Future Equity"), the Israeli Tax Authority (“ITA”) clarified its position regarding the tax treatment that applies to an investment in a company through a SAFE. The ITA response arrived after a long period of uncertainty regarding its position of SAFE investments tax implication, which made it difficult for companies to recruit investors and find funding sources.

  1. Factual Background SAFE transactions provide a quick and efficient fundraising solution for private companies that their valuation not agreed. Under this arrangement, a contract is signed between the investor and the company, according to which funds will be directly transferred to the company by the investor. However, the allocation of shares will be delayed avoiding dealing with the valuation question until the company raises significant funding, at which point a credible valuation will be agreed upon with the investors. Thus, during the period between the fundraising and the conversion to shares, no interest is charged, and during the conversion, the investor receives a discount compared to the investors in the broader fundraising. Since the difference between the actual number of shares received by the investor in the company through a SAFE transaction and the number of shares that could be purchased at market value, is derived from fluctuations in the company's market value between the time of investment and the time of actual share issuance. The question arises whether the difference constitutes interest income for the SAFE investor or whether the transaction constitutes an investment in the company's shares from start to finish.

  2. Key conditions for SAFE transactions It should be clarified that this list does not contain all the terms and conditions. For the complete list, see Appendix 1.

    1. The amount of the SAFE investment for a single investor shall not exceed 40 million NIS.

    2. The ability to transfer the SAFE to a third party is subject to obtaining the consent of the company except in the case of a permitted transferee as determined in the SAFE agreement.

    3. The SAFE Agreement does not include interest, royalties, or any other return from the date of the investment and up until the date of the conversion of the SAFE into shares of the company.

    4. The amount of the discount inherent in the exercise of the SAFE into shares does not vary in accordance with the passing of time.

    5. Investors have no right to the reimbursement of the funds of the SAFE investment which is not by way of exercising the SAFE into shares, or, in a transaction in which all of the outstanding shares of the company are being sold, by receiving an amount that would have been received by the SAFE investor had the SAFE investment been exercised, except in certain cases, such as the liquidation of the company, process of receivership, or by court ruling.

    6. The exercise of the SAFE into shares of the company will be performed in accordance with a mechanism determined in advance, at the time of a fundraising, an offering on the stock exchange, or an exit-type event.

    7. The company’s assets were not pledged, no liens were placed on such assets, and no guarantees were given (including by entities related to the company), in favor of the SAFE investor.

    8. The Company will not claim any deduction for tax purposes with respect to any financing expenses related to the SAFE.

    9. In a fundraising round that constitutes a trigger for the exercise of the SAFE, at least 25% of the amount raised is from investors that are not the SAFE investors.

    10. Other than in exceptional cases, the date of the sale of the shares allocated from the exercise of the SAFE shall be at the expiration of at least (a) 12 months from the date of the signing of the SAFE Agreement; or (b) 9 months from the exercise date.

  3. The ITA position’s regarding the classification for tax purposes of the investment in the SAFE

    1. If the conditions for SAFE investment are met, the investment in the company through the SAFE transaction, will be treated as an advance payment for shares. Therefore:

      1. No tax event will occur upon conversion by the investor and the company will not be required to withhold tax at source (even if the conditions set out in Sections 4.3.2 to 4.3.4 below have not been met at the time of conversion).

      2. any consideration received by the investor upon the sale of shares will be considered as consideration for the sale of shares upon exercise of the options.

    2. If at the time of the conversion event, all the facts and conditions for SAFE investment are not met (except the conditions in Section 4.3.2 to 4.3.4 below have not been met at the time of conversion), the transaction shall be examined based on the circumstances, in order to determine whether the classification of the transaction should be treated as an advance on shares, a debt settlement that includes interest income to the investor, or another type of transaction, and accordingly, the tax liability shall be determined by the tax authority.

    3. The SAFE classification as an advance on shares, shall not limit the ITA discretion to examine the classification of the income from the exercise of the shares by the investor due to his specific circumstances, such as being a director or an employee of the company, classification of the transaction as a random transaction due to its commercial nature, etc.

    4. The position of the ITA shall apply to all SAFE transactions that meet the facts and conditions and were or will be signed between companies and investors until December 31, 2024, or until another directive is published by the ITA, whichever comes first.

  4. Appendix 1 - The investment framework in the SAFE transaction. 4.1 Company profile that uses the SAFE investment includes the following points:

    1. The company is a private Israeli corporation ("the Company").

    2. The Company operates in the high-tech industry.

    3. Most of the Company's expenses, from its inception until the date of signing the SAFE agreement or within three years prior to the signing date, are classified as controlled financial expenses, mainly for research and development activities or production or marketing of products developed through its R&D activities.

    4. The Company continues its research and development activities at the time of signing the SAFE agreement.

    5. The source of most of the assets the company owns, directly or indirectly, is not in the rights listed in section 97 (b3) (2) of the tax order.

    6. The Company did not raise capital through a known stock value within three months before the closing date of the SAFE agreement.

4.2 Specifies terms of the SAFE investment contract between the investor and the Company:

  1. The amount of the SAFE investment for a single investor shall not exceed 40 million NIS.

  2. The SAFE agreement entitles the investor to transfer the rights arising from the agreement to a third party until the conversion event, except for transfer to a competitor, which is prohibited by the SAFE agreement.

  3. The agreement between the parties is not considered a loan or debt agreement.

  4. The conversion of the SAFE contract to company stocks will only occur according to a pre-determined mechanism, during a fundraising event as detailed in Section 4.3.1 or an issuance on the stock exchange, or an "exit" event where a majority of the company's stockholders, as detailed in Section below, sell their stocks or at the latest valuation of the company (without any discount), or as a result of a transaction to sell the majority of the company's assets.

  5. An investor has no right to a refund of their investment by the company, except through conversion to shares of the company or receiving compensation for the amount they were entitled to for the shares from the SAFE. In the event of conversion through the sale of all the company's shares, and no predetermined agreed-upon date has been set for the refund, the investor is not entitled to a refund unless it is one of the following events: voluntary liquidation, involuntary liquidation, appointment of a receiver by the property trustee, court, or general strike for creditors. In such an event, the SAFE instrument ranks junior to debt holders in the company, except in the case of liquidation, where SAFE investor rights are treated as first in line, meaning they have priority over regular shareholders.

  6. The SAFE agreement stipulates that if the investor's investment funds are returned, as stated in section 2.2.5 above, their entitlement is only to the investment fund and nothing beyond that.

  7. of the SAFE agreement does not obligate the company to pay the investor any compensation in the form of fixed interest, dividends, or any other instrument with a non-equity reward character, during the period between the investment in the SAFE and the conversion event.

  8. The discount rate for the investor at the conversion event, as defined below, is not a linear function of time.

  9. There are no lines or guarantees on the company's assets, including those of subsidiaries or related entities, for the benefit of the investor.

  10. The company will not seek funding expenses tax deductions for the SAFE, whether in the form of funding expenses, capitalization costs, or due to valuation of liabilities or any other means.

4.3 The conversion of the SAFE to shares and the exercise of shares by the investor in SAFE transactions shall be as follows:

  1. The conversion of the SAFE to shares ("the conversion event") will occur as part of a financing round for the company, in which at least 25% of the total funds raised are not from SAFE investors.

  2. The sale of the shares issued in the SAFE transaction, as described in section 2.2.5 above, will take place within 30 days from the publication date of this document (May 16, 2023). The conversion of the SAFE itself to cash or cash equivalents ("the share exercise") will occur at least: (a) 12 months from the date of signing the SAFE agreement, or (b) 9 months from the date of the conversion event to shares (hereinafter "the share exercise date").

  3. Despite what was stated in section 2.3.2 above, the stock implementation date may be subject to a shorter period of time. This is dependent on the occurrence of all the following within the transaction:

    1. The sale of stocks is done by most of the shareholders in the company (according to the number of shareholders and not to the number of stocks), without regard to option holders or the sale of options or stocks originating from the exercise of options by employees or consultants of the company.

    2. Payment for the transaction is made by the purchaser of the shares (a third party unrelated to the company or a shareholder who holds no more than 25% of the company's shares), and not by the company.

  4. As part of the stock implementation, the price received by the SAFE investor is the same as the price received by the owners of the same type of shares, subject to the predetermined benefit in the SAFE agreement.


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