Israel Tax Authority Updates Guidelines on SAFE Instruments: Enhanced Clarity for High-Tech Companies and Investors

On January 29, 2025, after consulting with leading tax advisors, including from our firm, the Israel Tax Authority (“ITA”) published updated guidelines regarding the tax classification of Simple Agreement for Future Equity (“SAFE”) instruments. The guidelines aim to provide enhanced clarity and certainty for high-tech companies and investors operating within Israel’s dynamic high-tech ecosystem. The new guidelines build on the ITA’s original framework issued on May 16, 2023, which will remain in effect from January 1, 2025, through December 31, 2026.

A SAFE is a widely used investment tool in the startup sector, enabling investors to provide capital upfront in exchange for the right to receive equity in the future, typically triggered by a specific event. Unlike convertible notes, SAFEs do not accrue interest or have a maturity date, offering a more flexible and founder-friendly funding option. However, their tax classification has long been a point of uncertainty in Israel, an issue the ITA’s updated guidelines aim to address in a comprehensive manner.

The updated guidelines introduce a safe harbor under which a SAFE instrument will be classified as an equity instrument for Israeli tax purposes, provided that certain conditions are met. SAFEs that do not meet these conditions will not automatically be classified as debt instruments, instead they will be assessed based on their specific circumstances.

Below is a general summary of the main conditions (additional conditions may also apply):

• The SAFE must not grant the investor the right to demand a refund of their investment, except in extreme circumstances, such as liquidation.
• No interest, royalties, or other forms of financial compensation are permitted.
• SAFE cannot provide any non-equity returns to investors before they are converted into shares.
• The “discount rate” applied upon conversion must remain within predefined limits. While the ITA’s original guidelines prohibited time-based or milestone-based discount rates, the updated guidelines permit up to three discount rate tiers, provided the final tier occurs no later than three years from the signing of the SAFE.
• The SAFE must be automatically converted upon the earlier of: (i) a “qualified funding round” (as defined in the guidelines); (ii) an IPO; (iii) an “exit” transaction; (iv) a transaction involving the sale of the majority of the company’s assets; or (v) a pre-determined date which is set in the SAFE.
• In the event of liquidation, the rights under the SAFE take precedence over the rights of ordinary shareholders but remain subordinate to the rights of creditors.
• The target company and its affiliates are prohibited from pledging assets or providing guarantees to the investor in connection with the SAFE.
• The target company cannot deduct financing expenses or any other expenses from its taxable income, directly or indirectly, related to the SAFE.

In addition, as part of the conditions detailed in the guidelines, investors must hold the shares received upon the conversion of the SAFE for a minimum period of either (a) 12 months from the date of signing the SAFE, or (b) 9 months from the date of conversion of the SAFE. This requirement does not apply if the realization event is part of a qualified exit transaction or company liquidation. While this is not a contractual obligation, the investor must comply with this condition to avoid adverse tax consequences.

If all the conditions outlined in the guidelines are met, the SAFE instrument will be classified as equity for Israeli tax purposes, with a tax event triggered upon the sale of shares acquired from the conversion of the SAFE, ensuring that no tax liabilities arise at the time of conversion itself. However, if the conditions set forth in the guidelines are not met, the SAFE may be classified as a debt instrument for Israeli tax purposes, potentially subjecting the investment and conversion to taxation on imputed interest.

Our firm played an active role in discussions with the ITA leading up to the release of these updated guidelines, and our tax department possesses extensive expertise in this area. We are well-positioned to assist in drafting SAFE agreements that ensure compliance with the updated guidelines, as well as in reviewing the tax implications of existing agreements. Companies that have previously raised funds through SAFEs or similar convertible instruments should consider the impact of the updated guidelines and explore options for addressing any non-compliant agreements. For further assistance, please do not hesitate to contact our tax department.