SAFE agreements are a financial tool becoming more and more popular among startups and tech companies. The agreements allow investors to invest in these types of companies in their initial stages, in exchange for the guarantee of receiving shares at a discount in future funding rounds.
In May of 2023, the Israeli Tax Authority published guidelines that regulate their approach to these agreements. The guidelines include profiles of various companies using SAFE agreements, showcasing that when complying with all the conditions outlined in the guidelines, investors are provided with more tax certainty. Any exception to the detailed conditions may result in different taxation.
Key Points of the Guidelines
In the case that all conditions in the guidelines are met, investments in companies through the SAFE agreement will be seen as an advance payment towards shares. Meaning, that the transaction will not be taxed at the time that the agreement takes place, and the company will not be required to withhold tax from the payment. Additionally, any future profits from the shares under the agreement will be treated as gains from the sale of shares.
If all conditions are not met at the time of the conversion, the case will then be reviewed by the tax accessor, in order to determine the classification of the transaction (advance payment for shares, debt repayment, etc.) and the tax liability.
The guidelines outline the essential conditions that must be included in a SAFE agreement between a company and an investor at the time of a conversion event.
Conditions the Company Must Meet for the Guidelines to Apply
- The company must be a private Israeli tax resident, operating in the high-tech industry.
- Most of the company’s expenses from its establishment to the signing of the SAFE agreement, or in the three years prior to the signing (where there are audited financial statements), must be research and development expenses or production and marketing expenses for R&D related activities.
- R&D activities in the company must continue at the time the agreement is signed.
- The main source of the company’s assets cannot be; property holding rights, natural resource exploitation holding rights, or rights to income from Israeli real estate.
- In the three months prior to the signing, the company cannot raise its capital based on a predetermined share value.
Conditions the SAFE Agreement Must Meet
- The total value of the agreement per each investor, directly or indirectly, cannot exceed 40 million NIS.
- The investor is entitled to transfer their rights under the agreement to a third party up until the conversion event however this excludes a who was designated prior to the agreement.
- The agreement between the investor and company isn’t labeled as a loan or debt.
- Conversion of the SAFE agreement to shares is according to a procedure established in advance.
- The investor is not entitled to a refund of their investments except through conversion into shares or receiving compensation equivalent to what they would receive for the shares they are entitled to under the SAFE agreement. This does not apply to cases of voluntary or involuntary liquidation, appointing of a liquidator, court proceedings, enforcement proceedings, or a general cheque to creditors.
- If the investment funds are returned to the investor in one of the situations stated above, they will be entitled to the original investment funds only.
- The company does not promise to the investor that they will receive compensation in money or a money equivalent through a fixed interest rate, royalties, or any instrument of a compensatory nature that is not characteristic of a shareholder, during the time period between the investment and the conversion.
- The discount rate the investor will receive at the conversion does not increase as a linear function with time.
- There are no guarantees, liens, or claims on the company’s assets or related companies in favor of the investor.
- The company cannot recognize financing expenses related to the agreement, whether in the form of financing expenses, capitalization of financing costs, revaluation of liabilities, or in any other manner.
Conditions which the Conversion Must Meet
- The conversion to shares must be carried out in a funding round where at least 25% of the money comes from investors who are not SAFE investors.
- When the investor exercises his shares, the price will be the same as that for regular shareholders (excluding the benefit under the agreement).
As can be seen, SAFE agreements have various tax implications, and it’s important to consult with an expert in the field before preparing and signing these agreements. Our firm specializes in international taxation and provides a full range of services to entrepreneurs and investors concerning taxation.
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