In short
A "flip" is the transfer of an Israeli company's shares to a foreign company, usually a US one. The Israel Tax Authority allows it to be done tax-free under a "green track" ruling, on condition that a future gain on the sale of the shares will be taxed in Israel. But it is precisely after the flip that things get more complicated: US tax rules (CFC, NCTI and PFIC), exposure to US estate tax, the need for real control and management in the US company, forms and a trustee deposit of shares, and the employee option plan.
A flip is the transfer of an Israeli company's shares to a foreign company, usually a US one. It arose, among other things, from the demands of US investors, who are entitled to tax benefits only when they invest in a US company, and who also want to shift the bureaucratic burden of various reporting obligations from themselves to the company.
On the Israeli side, the Israel Tax Authority allows the move to be made tax-free under a "green track" ruling, whose key condition is an undertaking that a future gain on the sale of the shares will be taxed in Israel.
In recent years flips have also become more common because of global public opinion towards Israel and the domestic political situation. Founders who choose this route think it will make life easier, but it is precisely once a US company is in the picture that the headaches grow, for reasons including the following:
1. US tax rules
A number of US tax provisions apply to the US company and make day-to-day operations more cumbersome:
- CFC – after the flip, the Israeli company becomes a US-controlled subsidiary. Its passive income, such as interest on funds raised, may be taxed in the US right away, even without a dividend being distributed.
- NCTI (formerly GILTI) – a mechanism that taxes the profits of the foreign subsidiary in the US on a current basis, even if they have not been distributed, in some cases even if the subsidiary is loss-making for Israeli tax purposes. This is highly relevant to profits under the Israeli Encouragement of Capital Investments Law.
- PFIC – a corporation most of whose assets or income are passive. A startup with a lot of cash in the bank may fall within the definition. This is relevant to US shareholders in the Israeli company, including Israelis with US citizenship, and the PFIC tax regime is particularly harsh.
2. US estate tax
Holding shares of significant value in a US company may expose a foreign investor to heavy US estate tax. The possible solutions are tax planning, life insurance... or simply staying alive 🙂
3. Control and management
The US company needs to be genuine, with managers and activity, and not an "empty shell". Otherwise, on a future sale, it may be argued that part of the value is taxable in Israel, and from there the road to double taxation is short.
4. Forms for Israeli shareholders
The flip ruling requires forms to be completed for the Israeli shareholders. A cumbersome task when there are many investors.
5. Deposit with a trustee
Despite the wording of the green track, in practice the Israel Tax Authority requires all shareholders to deposit shares with a trustee, including foreign shareholders and tax-exempt institutional investors. A release for foreign shareholders can be requested in a separate process.
6. Employee options
Make sure the foreign company properly adopts an option plan and that grants are made at the relevant dates, so that employees' options do not end up taxed as ordinary income instead of capital gains.
The Bottom Line
Planning a flip, or already in the middle of one? It is important to involve a US tax adviser to review the relevant US issues. For the other issues, send me a message and we'll go through these points together before they become a problem.