Israel: To Flip Or Not to Flip – The Israeli Tax Authority And The New Green Track

Last Updated: 4 January 2019
Article by Oz Halabi

On October 3, 2018, the Israeli Tax Authority ("ITA") issued another "green track" ruling ("GTR") process for taxpayers by submitting a ruling request with pre-determined conditions, requirements, and decisions. This is now the 22nd GTR in the last few years. When compared to U.S. Treasury practice, the GTR can be described as the Israeli version of the letter of ruling, as opposed to private letter ruling.

This latest GTR came in time for the recent changes made to the United States Tax Code as part of the Tax Cuts and Job Act and were made effective as of January 1, 2018. The TCJA imposes significant restrictions on U.S. holders of foreign corporations and foreign businesses while simultaneously creating disadvantages to US investors seeking to invest in the booming Israeli start-up scene. Many Israeli start-ups are facing growing requests (or demands) from potential U.S. investors, to provide them with extensive tax representations (and covenants) regarding the existing (and future) owners of the company, the current (and future) activities of the company, as well as current and future income projections. In some cases, the covenants are so aggressive that should the company agree, it will no longer have the ability to raise money from US taxpayers. But this topic is a whole issue to be discussed separately. We are now trying to have some fun.

The ITA in its recent GTR simplifies the process for shareholders of an Israeli corporation ("Israeli Corporation") to "flip" the holding structure tax-free, and to have a foreign company ("Foreign Corporation") hold the Israeli Corporation while becoming the new parent of the Israeli Corporation (the "Flip"). In many cases, this Flip will make it easier for Israeli start-up founders when trying to raise money in the United States. What may have been considered an inversion transaction under the U.S. Code which is now being aggressively legislated in the U.S., has been approved and acceptable by the ITA for many years, and now is also approved in GTR. Of course, the law in Israel, and the tax consequences the taxpayer agrees to in the GRT, prevent the tax benefits associated with an inversion transaction. Additionally, the GTR provides for several limitations and requirements that the ITA keeps its taxing rights as they were pre-Flip, and then some.


The GTR is applicable to owners of an Israeli Corporation (the "Holders") that wish to transfer their entire interest in an Israeli Corporation to a newly formed Foreign Corporation (formed after 01.01.2018) solely in exchange for stock of the Foreign Corporation. The GTR is only applicable when the Foreign Corporation is a resident of a country with which Israel has an income tax treaty in effect and it must be filed three months prior to the date of the Flip.

The GTR deals with many provisions including; the tax consequences of the Flip, the sale of the Israeli Corporation (now the subsidiary) stock, and the sale of the Foreign Corporation stock. The GTR further deals with the tax consequences associated with the exchange of employee stock options – both those issued under section 102 of the Israeli Tax Ordinance ("102 Options") and those under section 3(i) of the Israeli Tax Ordinance ("3i Options").

As a condition for issuing GTR, Holders of the Israeli Corporation must provide certain documents to the ITA. Holders of the Israeli Corporation must acknowledge that they will not receive, directly or indirectly, any boot in the transaction, and further, that in the two years following the Flip, the Israeli Corporation will retain all the activity and assets, including intangible property that existed prior to the Flip.

Supplemental requirements provide that, the Israeli Corporation cannot be a company the majority of the value of which constitutes interest in Israeli real estate, the Foreign Corporation cannot be a "pass-through" entity in its country of residence, and the Israeli Corporation must not transfer in the Flip, any asset outside of Israel.

It is important to note, Holders are required to represent that (i) the statutory tax rate in the Foreign Corporation's country of residence is not less than 15%, (ii) the tax laws in the Foreign Corporation's country of residence include rules which imposes taxation of passive income earned by a controlled foreign corporation and (iii) the withholding tax rate on dividends, pursuant to the applicable tax treaty, is at least 10%.1

The Tax Treatment

1.     Liable Holders and New Shares– The shares of the Foreign Corporation ("New Shares") received by holders that are defined as "liable holders" will be deposited with a trustee within 15 days following the Flip. Liable Holders are defined as Israeli resident taxpayers or foreign taxpayers not entitled to an exemption on capital gains tax in Israel, or a person whose residency status in Israel is being determined or examined by the ITA ("Liable Holder"). The trustee is required to hold the New Shares until they are sold and is required to withhold tax upon such a sale. It is clarified in the GTR that the Liable Holders will be subject to tax upon the sale of the New Stock and will be required to file tax returns in Israel, regardless of their residency on the date of sale. The GTR requires that for the two years following the Flip, Holders of the New Stock who participated in the Flip, will not be diluted below 25%. 

2.     Distribution of Dividends – The Israeli Corporation is required to report any distributed dividend distributed it made to the Foreign Corporation within seven days following such distribution. Notwithstanding anything to the contrary in an applicable tax treaty, the Foreign Corporation will be subject to tax in Israel with respect to dividends distributed to it by the Israeli Corporation. The GTR provides for two different tax treatments with regards to dividends paid by the Israeli Corporation to the Foreign Corporation. The Foreign Corporation will be taxed in Israel at a rate of 25% (30% in the case in which the Foreign Corporation holds, or held, 10% or more at any date within 12 months prior to the distribution) with respect to earnings and profits accumulated in the Israeli Corporation prior to and until the end of the second tax year following the year of the Flip ("Old E&P"). Any dividends paid out of earnings and profits that are not Old E&P will be subject to tax in accordance with the applicable treaty. 

3.     Taxation of Dividends - The GTR, in imposing high tax rates and preventing tax credits to the Foreign Corporation, requires that any dividend income of the Foreign Corporation taxed in Israel pursuant to the GTR will not be entitled to any credit or offset. However, the GTR does allow for credit of a limited amount of tax withheld by the Israeli Corporation upon distribution. The tax credit to the Foreign Corporation against its Israeli tax liability will be allowed, only with respect to the amount of dividend received by the Foreign Corporation and distributed to the Holders. If the dividend received by the Foreign Corporation was not distributed to the Holders, the Foreign Corporation will not be entitled to any credit for foreign taxes paid and it will not be able to carry the withholding amount forward. On one hand, this limitation creates a significant tax toll, but in doing so, the ITA is making sure that either the Israeli Corporation keeps its earnings and profits in Israel or its earnings and profits are being distributed to the Holders thereby insuring said earnings and profits are not parked at the Foreign Corporation, and further generate income, not subject to tax, in Israel. Any distribution of earnings and profits not allocated to the Old E&P by the Foreign Corporation to the Holders, will be taxed at the rate that is the lesser of the rate stated under the Israeli domestic law and the applicable tax treaty. This essentially is subjecting the foreign source dividends to Israeli tax law. The GTR defines the term dividend to include any payment of any kind, other than return of principal of a loan made by the Israeli Corporation to the Foreign Corporation or arm's length payments made in the ordinary course of business. 

4.     Sale of Stock of the Israeli Corporation by the Foreign Corporation - The Foreign Corporation will further be taxed in Israel upon the sale of the shares of the Israeli Corporation, despite any exemption or limitation provided in an applicable treaty. The income to be taxed in Israel will be a percentage of the capital gains, which is proportionate to the allocation of the Liable Holder and all Holders, without any right of credit or offset for any foreign tax paid on such sale. The basis that the Foreign Corporation has in the stock of the Israeli Corporation will be the same as the basis the Holders had in the stock of the Israeli Corporation, which was exchanged. Furthermore, tax will be calculated at a rate that is proportionate to the percentage of the Liable Holders income.   

5.     Sale of Stock of the Foreign corporation by Holders – Upon the sale of Foreign Corporation stock, the Liable Holders will be taxed in Israel, regardless of their residency status on the date of sale. None of the Liable Holders will be eligible for any reduction, exemption, deduction or tax credit against the capital gain, unless such holder was eligible to such prior to the Flip. 

6.     Treatment of 102 Options - The swap of the 102 Options, from options of the Israeli Corporation to those of the Foreign Corporation as part of the Flip, shall not create a taxable event to Holders of such options. The grant of any 102 Options in the Foreign Corporation, ("New Options") will arise under the same plan as the old 102 Options and the New Options will be considered to be issued on the date of the swap. This essentially starts the two-year holding period under section 102 of the Ordinance again. An employee will be taxed in Israel with respect to the exercise2 of the 102 Options in accordance with the Ordinance, irrespective of such employee's residency on the date of exercise. The GTR provides that the ITA will consider granting foreign tax credit to the employee with respect to the taxation of the 102 Options. 

7.     3i Options – The change of the 3i Options, from options of the Israeli Corporation to those of the Foreign Corporation as part of the Flip, shall not create a taxable event to Holders of such options. The 3i Options will be deposited with the trustee, as is similarly required of all other Holders with regards their shares. Holders of 3i Options will be taxed in Israel, with respect to the exercise3 or sale of their 3i Options, as income from employment on the date which is the earlier of either the exercise date or the date the optionee sold the 3i Option. The grant of the new 3i Options will be under the plan of the old 3i Options and the new 3i Options shall be considered as issued on the date of the swap. Holders of 3i Options will be taxed in Israel in accordance with the Ordinance, notwithstanding such holder's residency on the date of exercise (or sale). The GTR provides that the ITA will consider granting foreign tax credit, to Holders of 3i Options, with respect to the taxation of the 3i Options.

This article was written by Oz Halabi with contributions made by Hannah Lapuck. 


1 Out of 54 tax treaties, 29 have a withholding rate that is lower than 10%. Some examples include the Netherlands, Estonia, Singapore, Luxembourger, Malta and Japan.

2 Exercise, under section 102 of the Ordinance, is not when the employee converts his or her options to shares, but rather when the shares are sold or when the employee withdraws the stock from the trustee.

3 Exercise, under section 3(i) of the Ordinance, is when the employee converts his or her options to shares.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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