Mitigating Trump Tax Reform GILTI: Tax Related Investments in Israeli High-Tech Companies
Inversion from Israeli Company into US Corporation
The High-Tech industry in Israel attracts many US investors to invest in high-tech companies. Such investments are made directly or indirectly through venture capital funds and/or private equity funds incorporated mostly as US and/or Cayman partnerships, mainly as a vehicle to invest in an Israeli startup in areas ranging from software to biotechnology, cybersecurity and other major technology segments. Israel’s startup ecosystem is ranked among the top five in the world.
As part of the Trump Tax Reform, the new Section 951A – Global Low-Taxed Intangible Income (GILTI) – was added, effectively imposing US tax on taxpayers who own 10% or more of CFCs (Controlled Foreign Corporations). The Trump Tax Reform also extends the definition of CFC, so that the 10% threshold is examined not only on the basis of voting power of the stock, but includes also the value basis of stock of a CFC. As a result of this significant change in law, a US person who owns, directly or indirectly, less than 10% of the vote (or holds non-voting stock) but at least 10% of the value of the stock of a foreign corporation, is now considered a US shareholder under the CFC rules and therefore is subject to such rules.
An Israeli company, of which 50% or more are owned by US persons (directly or indirectly through funds), would be classified as CFC for US tax purposes, and therefore the GILTI provisions would come into play on the 10% US investor. It should be noted that the 50% threshold could be triggered by attribution rules although the holdings of US investors are less than 50%. Special pre-tax planning attention is required as such threshold could be relevant in the next investment rounds of Israeli companies or simply in the event of relocation of founders to the US in order to expand the company’s business in the US.
The GILTI provisions apply to all US taxpayers, and may impose severe tax considerations on individual US investors in an Israeli company, by inclusion of income using the existing Subpart F provisions of the Internal Revenue Code and the GILTI provisions. The GILTI provisions include certain rules of reduction, however after such reductions, the remaining earnings are considered GILTI and are subject to US tax under Subpart F. Aside for reporting obligations to the IRS for being CFC and/or triggering the GILTI, the US investors may be subject to tax in the US, up to their maximum marginal tax rates.
Corporate investors, which are US taxpayers may benefit from a 50% reduction in the GILTI inclusion which would reduce the 21% US corporate tax rate on foreign income to an effective rate of 10.5%, and can also benefit from indirect foreign tax credit. Such reductions may eliminate the US tax completely for C corporation investors, provided that the foreign companies have paid local effective income tax at a rate of at least 13.125%. As the effective rate of Israeli corporate tax is currently 23%, the GILTI provisions should not affect such US corporate investors of an Israeli company.
Pursuant to Israeli Encouragement Laws, the Israeli company tax could be reduced to a tax rate ranging from 6% to 16%, and in such case, not only would the individual investors and/or investments funds be affected by the GILTI rules, but also the US corporate investors investing in Israeli companies.
The Government of the State of Israel appointed a special committee to review the implications of the Trump Tax Reform, in particular on the high-tech industry, and to consider certain measures to take in order to continue encouraging US investors to invest in Israeli companies with no adverse tax consequences in the US.
Recently, the Israeli Tax Authority published a “Green Tax Track Inversion Private Letter Rulingˮ (“Inversion PLRˮ), which enables an inversion of an Israeli company into a foreign company without imposing Israeli capital gains tax liability on such an exchange. With regard to US investors, such Inversion PLR could be implemented to shareholders of an Israeli company that can exchange their shares into a US corporation’s stock, and as a result, after such an exchange, the Israeli company would become a wholly owned subsidiary of a US corporation to be held by the investors. To affect, Israeli companies could approach the Israeli Tax Authority for the issuance of a tax ruling based on the provisions of the Inversion PLR.
The Inversion PLR includes certain tax rules regarding dividend distributions, roll over provisions and other provisions that enable the Israeli Tax Authority to collect taxes, among others, upon exit transactions from certain investors (mainly, Israeli resident investors who become, as a result of the inversion, shareholders of a US corporation). In addition, certain limitations may apply as for percentage of dilution and/or sale of stock within a period of 2 years from the inversion. Upon sale of stock of a US corporation, a US investor should be exempt from Israeli capital gains tax, assuming such an investor would also be exempt from Israeli capital gains tax if he remained a shareholder of the Israeli company.
The inversion from an Israeli company into a US corporation may avoid the effect of the GILTI provisions, as the US shareholders do not directly hold a foreign company and the CFC rules do not apply.
Inversion of an Israeli company into a US corporation involves tax, corporate, security laws, funding and other legal and accounting issues to further review. Although following an inversion, the parent company becomes a US corporation, it should be noted that the intellectual property of the Israeli company, remains held by the Israeli company following the inversion, and the transfer pricing method following such inversion should be further analyzed.
Transferring intellectual property from the Israeli company to a US corporation, would trigger a tax event in Israel, which could be considered as jeopardizing the ruling (if such transfer is made during the two years lock-up period as of the inversion). Additionally, special attention should be paid to Israeli companies that have grants or funding from the Israel Innovation Authority, previously known as the Office of the Chief Scientist.
US investors should analyze the impact of the GILTI on their investment in Israeli companies, and the rules which govern the CFC (the 50% and 10% thresholds), and may consider this reorganization, an opportunity to invert the Israeli company into a US corporation to mitigate the Trump Tax Reform impact on their investment.
For further information, you are welcome to contact Adv. Oren Biran, Partner, and Head of the GKH Tax Department, at +972-3-607-4547 or via email: oren@gkh-law.com and/or other advocates from the GKH Tax Department.
