On January 29, 2025, the Tax Authority published clarifications regarding the taxation of investments made through a Simple Future Capital Agreement (SAFE); previous guidelines were published on May 16, 2023.
A SAFE is a financial instrument commonly used by startups and investors when raising capital. Designed to simplify the process, a SAFE allows investors to fund a company in exchange for rights to future capital, rather than immediate shares. Typically, investors will receive shares in anticipation of a valuation event such as a new round of funding, an IPO, or a sale of the company.
In the past, a dispute arose over how to classify the difference between the amount invested by a SAFE investor and the value, usually higher, of the shares allocated to that investor when the SAFE was converted into shares. The Tax Authority argued that the difference should be classified as interest representing a proper return on the use of money over time, while the tax community argued that the SAFE and the allocated shares should be classified as a capital instrument only and should be taxed accordingly upon sale. The question has practical implications for tax liability in Israel, and in particular for foreign investors. While foreign investors are exempt from tax on the sale of shares (capital gains), they are liable for withholding tax on interest accrued by an Israeli company, which is considered Israeli-sourced income. Withholding tax rates range from 15% to 25%, depending on the tax treaty, if any, between Israel and the investor’s country of residence.
The guidelines published on May 16, 2023 set out the conditions under which a SAFE investment will be considered an equity instrument only and therefore not an interest-bearing investment. These guidelines expire on December 31, 2024. The new guidelines expand the scope of the previous guidelines and clarify certain issues; the most important points are presented below. Unless the Tax Authority publishes a further announcement, the new guidelines will apply to agreements signed between January 1, 2025 and December 31, 2026.
Conditions for classifying the SAFE as share capital
1. Conditions related to the company raising the investment:
1.1 The investment is made in an Israeli company operating in the high-tech industry.
1.2 Most of the Company’s expenses in the period between its establishment and the signing of the SAFE Agreement, or in the three years preceding the signing, whichever period is shorter, were devoted to research and development or to the production or marketing of products developed by the Company as part of its research and development activities.
1.3. At the time of signing the SAFE Agreement, research and development activities are ongoing.
1.4 The Company has not made any fundraising at a known share price for at least three months prior to the closing of the SAFE Agreement.
1.5 The Company has not deducted or reduced any interest expenses directly or indirectly related to SAFE.
1.6 The Company or its affiliated companies did not provide any security for the repayment of the SAFE.
2. Conditions related to the SAFE Agreement:
2.1 The investment amount per investor does not exceed $20 million.
2.2 The right of the SAFE holder to transfer his right arising from the SAFE Agreement prior to the allocation of shares is subject to the approval of the Company.
2.3 The SAFE Agreement is not called a debt agreement or loan agreement.
2.4 The investment under the SAFE is intended for the allocation of shares (or rights to shares) only and the allocation must be made upon the earlier of the following events: (1) a qualifying round, defined, inter alia, as the raising of 40% of the company’s share capital on a fully diluted basis or in an amount exceeding 10 times the total number of SAFE instruments that have not yet been converted into share capital; (2) an offering on the stock exchange; (3) an exit event in which the majority of shareholders by number of owners (excluding shares derived from options granted to employees and consultants) sell their shares; (4) a transaction to sell all or most of the company’s assets; or (5) on a date predetermined in the SAFE agreement.
2.5 The discount rate granted on the conversion of the SAFE investment into equity will not vary as a function of the time elapsed from the date of investment and will not be dependent on the achievement of certain milestones. However, the SAFE agreement may specify up to three discount tiers, with the discount rate in each tier being conditional on the passage of time or the achievement of milestones. In the case of multiple discount tiers, the maximum discount rate will be granted no later than 3 years from the signing of the SAFE.
2.6 If the SAFE conversion date is predetermined in the agreement, the conversion will occur at a pre-agreed value. This value may be a set amount or the share value from the last or next fundraising round, without any discount or with a pre-determined discount.
2.7 Where the conversion and allocation of shares occurs as part of a capital raising for a company, it is required that at least 25% of the capital raised must be non-SAFE. If SAFE investors make direct investments in shares to meet this requirement, their contributions will be split, and only the portion representing ordinary capital investments, i.e., non-SAFE, will be taken into account in calculating the 25% requirement.
3. Conditions relating to the sale of SAFE or underlying shares
3.1 SAFE holders are not entitled to a refund of their investments, except in the circumstances detailed below.
3.1.1 An exit event in which the majority of shareholders, by number of shareholders, sell their shares and the consideration for the SAFE is paid by a third party that is not related to the company or its shareholder and provided that it does not hold more than 25% of the company’s share capital.
3.1.2 Voluntary or involuntary liquidation, receivership or appointment of a receiver or special administrator appointed by the court or at the request of the receiver/general assignment to creditors. In such a case, the SAFE instrument ranks below the creditors of the company in the order of priority, except in liquidation where the rights of SAFE investors are similar to those of preferred shareholders, i.e. subordinate to all debts and superior to the rights of ordinary shareholders.
In each of the events listed above, the investor will only be entitled to the principal amount of the investment and nothing more.
3.2 The sale of the shares allocated under the SAFE shall not take place before the expiry of 12 months from the signing of the SAFE Agreement or before the expiry of 9 months from the date of allocation of the shares. However, the sale may take place at an earlier date if it is part of a transaction in which a majority of the shareholders of the Company sell their shares on the terms specified above (where the consideration for the SAFE is paid by a third party who is not unrelated or in the event of a liquidation or in-going receivership of the Company.
3.3 In the context of the exercise of shares, the price received by a SAFE investor is the same as the price received by holders of the same class of shares.
The benefits of compliant SAFE agreements
If the SAFE agreement fully complies with the above conditions, no taxable event will occur upon the conversion of the SAFE into equity, and the company allocating the shares will not be required to withhold tax at source. Furthermore, since any consideration received upon the sale of the underlying share will be classified as a capital gain, a foreign investor who is eligible for exemptions under Israeli law or under a relevant double taxation treaty will not be liable to tax. It is important to note, however, that despite not meeting all of the established guidelines, a SAFE may still be classified as an equity investment.
Given this complexity, STL founder Anat Shavit highlights her firm’s extensive experience handling SAFE transactions. Accessible for inquiries at shavitaxlawyers.com, STL will be happy to review specific SAFE agreements to provide legal advice and opinions. Please contact us to see how we can support your goals with our expertise.
Published in Legal Channel 433 19.02.2025 Afik & Co. https://he.afiklaw.com// Authored by Anat Shavit, Attorney
