Member Article

The Israeli Tax Authority (the "ITA") has recently published a draft circular ("Draft Circular") on the tax treatment of holdback payments and reverse vesting mechanism in the context of merger and acquisition transactions.

According to the Draft Circular, subject to certain conditions as will detail below, the sale of shares to which holdback payments and reverse vesting mechanisms apply would be subject to a capital gains tax rate of 25% (30% in case of controlling shareholders). This is in contrast to the ITA's previous position which attributed consideration for continued employment of founders and key employees as employment income taxable at a marginal rate (up to 50%).

The following is a summary of the conditions set out in the Draft Circular:

Reverse Vesting
In general, the mechanism aims to ensure that founders and key employees of a company will continue to work for the company and act for its benefit by imposing restrictions on their shares for a certain period of time, which restrictions shall be removed (in stages or at one time), subject to their continued employment with the company. The following summarizes the conditions that were set out in the Draft Circular which, if fulfilled, will result in the classification of the sale of the shares under the reverse vesting mechanism as a capital gain and not as employment income:

1.The mechanism was established in advance and in writing at the time of incorporation of the Company (or near such date) and/or as a result of a substantial investment in the company (an investment of at least 5% of the company's issued shares following the investment).

2.In the event of exercise of the mechanism, the agreement provides that only the company and/or the other shareholders of the company are entitled to purchase the shares from the selling founder/key employee for no consideration or for their par value, all as agreed in advance and in writing on the date of the signing of the agreement.

3.The shares of the founders/key employees are classified as equity and are ordinary shares which entitle the holders to the same rights as the other holders of the company's ordinary shares, and the gain from the sale of which would be classified as a capital gain.

To read more, click on the PDF. Please contact Fischer Behar Chen Well Orion & Co. with any questions regarding the foregoing:

Adv. Anat Shavit [email protected] +972.3.6944162

Adv. Keren Alon [email protected] +972.3.6944203