Insights

New tax exemption for global banks lending to Israeli technology companies

Meir Linzen 08 Sep 2023

An overview by Herzog Fox & Neeman, Taxand Israel 

Israel has recently introduced an extensive tax benefits package to boost the growth of Israeli technology companies.

One of the key components of this package is a tax exemption for non-Israeli financial institutions on their interest income from loans extended to certain Israeli private and public technology companies. This move aims to encourage Israeli entities to choose debt financing as an alternative to equity fundraising.

Meir Linzen, Chairman and Head of the Tax Department and Yuval Navot, Tax Partner, of our Israeli firm, Herzog Fox & Neeman, provide a detailed analysis of this new tax exemption below…

Background

To boost growth of Israeli technology companies, Israel has recently introduced an extensive tax benefits package. One of the key components of this package is a tax exemption to non-Israeli financial institutions on their interest income from loans extended to certain Israeli private and public technology companies.

The primary objective of this exemption is to encourage Israeli entities to opt for debt financing as an alternative to equity fund raising. Equity fund raising often results in dilution of Israeli ownership since most of the investment in Israeli technology companies at mature growth stages comes from non-Israeli venture capital funds and strategic investors. The non-Israeli investments often results in some level of shift of the operations from Israel to non-Israeli jurisdictions, particularly with respect to future growth efforts. Furthermore, dilution of Israeli ownership reduces the capital gain tax paid when the company is sold in an exit transaction, since non-Israeli investors are exempt from Israeli capital gains tax.

Most Israeli financial institutions lack the requisite knowledge and experience to structure debt in substantial amounts to technology companies, leading to challenges for Israeli companies in securing domestic financing. Consequently, these companies often turn to non-Israeli lenders. These lenders are subject to tax on their interest income generated from the loans and it is market standards for the Israeli borrowers to assume this liability via gross up provisions in the loan agreements. The result is that these loans are very costly and unattractive. The new legislation aims at reducing the cost of accessing credit from foreign lenders.

Key Summary of The Applicable Requirements for The Benefit Eligibility

1. Lender Specifics:

• Non-Israeli financial institution (bank, insurance company, etc.) resident of a country with which Israel has signed a tax treaty.
• Neither the lender nor its affiliates have an Israeli permanent establishment or an Israeli subsidiary that extends loans within Israel.

2. Borrower’s Eligibility:

• An Israeli company that qualifies as a “Preferred Company” which has a “Preferred Technological Enterprise” (as such terms are defined under Israeli tax legislation).
• One of three alternatives is satisfied: (i) for private companies – Israeli residents own at least 5% of the shares during the year that preceded the loan grant date, (ii) for companies listed on a non-Israeli stock exchange, 5% of the unlisted shares are Israeli-owned at the end of the quarter that preceded the loan grant date, or (iii) companies that are listed on the Tel Aviv stock exchange.
• Its technological income in the tax year preceding the loan receipt is more than NIS 30 million.
• The Israel Tax Authority must be notified of the borrower’s election to utilize this exemption in the tax return submitted for the first tax year in which interest on the loan was paid.
• During the term of the loan, no significant decrease in either the Israeli employee headcount or wages paid to its Israeli employees occurs within the borrower’s “Preferred Technological Enterprise”.

3. Relationship Context:

• The borrower and lender are not related parties (generally, no 10% affiliation) beginning four years prior to the tax year in which the loan was granted and throughout its term.

4. About the Loan:

• The principal amount should be at least USD 10 million (or the equivalent in other currencies).
• Loan terms are agreed upon, and funds are transferred between July 31, 2023, and December 31, 2026.
• Loan proceeds must be used for operational activities (which include, for this purpose, acquisitions of other companies).

5. Documentation:

• The borrower’s annual tax returns during each year within the loan term must be accompanied by an accountant’s approval, confirming that all conditions for said tax exemptions were met.
• Non-compliance with certain requirements could result in the borrower being retrospectively billed for the tax it failed to withhold from interest payments.

Final Note

Undoubtedly, this is a significant game-changer that opens ample opportunities for international lenders, especially considering the fall out of Silicon Valley Bank, which was very active in the Israeli credit market to technology companies.

Should you have any questions or would like to further explore the issues discussed above, our team is ready to provide its insights and support.

Article tags

Digital Economy | Israel | Tax | Tax Exempt