Merger law update

On August 6, 2017, new tax legislation passed that day by the Knesset regarding reorganizations became effective here (Amendment 242). The new legislation revamps the tax regime for reorganizations originally passed in 1993, which contained numerous bugs.

Reorganizations are possible companies, partnerships, cooperative societies and charities. Approval is generally needed from the Israel Tax Authority when a foreign entity is involved and may be advisable anyway

Mergers

Below we review the revamped Israeli tax legislation relating to corporate fusion mergers. The tax law recognizes three types of mergers:

First, a transfer of all the assets and liabilities of a company or a number of companies (transferor) to another company (transferee), and termination of the transferor without liquidation, according to a merger order under the Companies Law (i.e. a corporate fusion). This is a classic merger;

Second, a transfer of at least 80% of the rights of a company or companies (the transferred company) to another company in return for shares issued by the other company (transferee), provided the holders of those rights and their related parties (as defined) transferred all such rights to the transferee (i.e. a share-swap merger). This is typically used for acquisitions of unrelated companies.

Third, a string of mergers – these need ITA approval.

Corporate fusion merger

A corporate fusion merger should not be taxed here (and real estate may be subject to only 0.5% purchase tax), if a number of conditions are met.

These conditions include: substantive post-merger business; the main objective is united management and operations; no tax avoidance motive; most assets other than publicly traded securities are used and not sold until two years after the end of the relevant tax year; the transferee company continues with the main economic activity of the transferor companies for the requisite period (see below), which may optionally be confirmed by the ITA; the transferee company confers the same pro rata rights and value to shareholders as before the merger; the value of each transferor company is at least 10% of the transferee company’s value; the value of any one transferor company may not be more than nine times the value of any other; the transferee company must be an Israeli incorporated and resident company or an Israeli cooperative society OR a foreign resident company approved by the ITA; existing rights holders retain at least 25% of their holdings throughout the requisite period (not applicable to 100% parent companies).

Moreover, tax is due on an asset if its designation is changed e.g. stops being a fixed asset, or is used privately.

The “requisite” period for a corporate fusion merger is two years from the start of the merger or the end of the year after a merger order or confirmation, whichever is longer.

Suppose a shareholder receives both cash and shares in the fusion merger?

The amendment allows shareholders to receive mixed share/cash consideration if: (1) the sellers sold all their shares in the transferor company and received none in the transferee company, or (2) the tax director allowed all the shareholders in the transferor company to receive up to 40% of their consideration in cash, the transferee company and its shareholders/rights holders hold under 10% of the transferor company – and vice versa (i.e. the transferor company and its shareholders/rights holders also hold under 10% of the transferee company). Tax only applies to the cash consideration if the conditions are met.

Post-merger assets and shares sold:

There is no “step-up” of the cost of assets transferred – they stay at the same cost basis. If new (post-merger) shares are sold there is a two-step tax calculation.

Stage 1: Deemed sale of old shares on the merger date after adjusting the cost basis for inflation – foreign investors and olim tax breaks at Stage 1 are usable.

Stage 2: Sale of new shares as if they were purchased on the merger date at the old share cost plus inflation adjustments at Stages 1 and 2.

Loss limitations

To discourage mergers to get at tax losses, loss utilization cannot exceed 20% of all transferor companies’ business losses or 50% of the transferee company’s annual taxable income. A similar limitation applies to business capital losses but no limitation applies to other assets of the same transferor or transferee company. Un-utilized losses can be carried forward and used for five years subject to similar 50% limitations each year. The 50% limitations are lifted in year 6. No loss limitation may apply if the transferee company held 100% of the transferor company and was worth nine times as much. The ITA can deny loss utilization in cases of improper tax reductions.

Advance rulings

Requests can be made to the ITA for an advance ruling regarding a merger. Fees will be due. The ITA has 90 days to reply, extendable up to 180 days or more if the finance minister allows it.

Summary

The amendment will make corporate fusion mergers easier, but not easy. A tax ruling is usually necessary or advisable. Share swap mergers and other forms or reorganization, not discussed above, should also be considered.

As always, consult experienced tax advisers in each country at an early stage in specific cases.

leon@hcat.co

The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.