New Ruling on Taxation of M&A Holdback Amounts

April 19th 2016

Dear colleagues and friends,

Yesterday (18 April 2016) the Israeli Tax Authority (the “ITA”) issued a precedential tax ruling regarding taxation of “holdback” amounts.

In the context of M&A transactions, a “holdback” is an amount that is “held back” from the consideration payable by the acquiror to certain key selling shareholders. This amount is not paid to these shareholders at the closing, but rather gradually over time, provided that they continue to provide services to the acquiror (or its affiliate).

The recent tax ruling addressed a sale of the shares of an Israeli private company to a US public company. The transaction included a provision, according to which 50% of the consideration payable to certain selling shareholders would be “held back” and released over a period of time, provided that such selling shareholders continue providing services to the company (subject to certain customary exclusions, including death or disability, termination without “cause” or resignation for “good reason”).

The target company declared in its application to the ITA that the holdback amount is an integral part of the transaction consideration payable for the company’s shares (and not in addition to such consideration); that the price per share payable to the “holdback shareholders” is identical to the price per share payable to the other company shareholders; that the “holdback shareholders” intend to enter into new employment agreements that will provide them with ample compensation (not less than their pre-acquisition compensation); and that the company would not deduct the holdback amount as an expense in its Israeli tax filings. In addition, the “holdback shareholders” intend to declare and pay tax on the entire portion of their transaction consideration (including the holdback amount).

Based on the above, the ITA issued a decision whereby the entire consideration payable to the “holdback shareholders”, including the holdback amount, is subject to capital gains tax (which is generally at a rate of 25%, rather than marginal income tax, the rate of which generally can reach 48%).

The ITA’s recent ruling is interesting in light of the Tel Aviv District Court’s ruling in Helman v. Tel Aviv Tax Assessment Officer No. 4 handed down just six months ago (in connection with a different transaction), stating that “holdback amounts” are subject to marginal income tax. The court’s general position in Helman was that due to the fact that the release of the “holdback amount” is conditioned upon continued service, such amounts should be deemed as payment for services and not as a capital gain.

In its recent decision, the ITA emphasised that the underlying facts of the current matter are different from those in Helman, which is still subject to appeal before the Supreme Court (which is scheduled to be heard in mid-June).

This publication provides general information and should not be used or taken as legal advice for specific situations, which depend on the evaluation of precise factual circumstances.

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