Background and Legal Context

The Israel Tax Authority recently published a new tax ruling (No. 24/1175) providing significant clarification regarding the definition of a "foreign financial entity" in the context of tax benefits for Israeli technology companies. This ruling refers to Section 6(a) of the Law for the Encouragement of Knowledge-Intensive Industry (Temporary Order), 2023, and represents an important step in expanding financing options for Israeli high-tech companies.

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Definition of "Foreign Financial Entity"

Section 6(a) of the law defines a "foreign financial entity" as including banking corporations outside Israel, foreign financial institutions, foreign investment funds or venture capital funds, as well as other entities whose activities are similar to these. The new tax ruling broadens the interpretation of this definition.

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The Case at Hand

In the case at hand, an Israeli software development company sought to obtain a loan from a foreign company. The foreign lender is a company incorporated outside Israel, listed on a stock exchange, and holds a license to provide credit. The lender's main business is providing credit and financing, rather than equity investments.

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Tax Authority's Decision

The Tax Authority determined that the foreign lender indeed meets the definition of a "foreign financial entity" for the purpose of Section 6(a) of the law. This decision is based on the interpretation that the lender's activities are similar to those of the entities listed in the original definition in the law.

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Conditions and Limitations

It is important to note that the ruling includes several conditions and limitations. First, it is valid only for the specific loan in question. Second, in accordance with the requirements of Section 6(a), the loan amount must be at least $10 million. Additionally, the ruling does not constitute approval regarding the borrowing company's compliance with other conditions of the law, such as being a "beneficiary company" or having an "industrial enterprise".

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Practical Implications

The practical significance of this ruling is the expansion of financing options for Israeli technology companies under Section 6(a) of the law. It allows them to enjoy tax benefits even when receiving financing from foreign financial entities that are not traditional banks. This provides a significant incentive for foreign investors in the form of tax exemption on interest income from these loans.

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Tax Authority's Approach

This tax ruling emphasizes the Tax Authority's approach to examining the substance of the financing entity's activity, not just its formal definition, in line with the spirit of Section 6(a) of the law. It also underscores the importance of advance planning and thorough examination of the structure of international financing transactions.

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Conclusion

In conclusion, the new tax ruling represents a positive development in the implementation of Section 6(a) of the Law for the Encouragement of Knowledge-Intensive Industry, expanding potential funding sources for Israeli technology companies and encouraging foreign investment. However, companies interested in taking advantage of this benefit should ensure strict compliance with all conditions set out in Section 6(a) and the law in general, and consider obtaining appropriate professional advice in the field of international taxation.

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