By Simon Weintraub and Adrian Daniels
Establishing a business in Israel is a relatively simple and straightforward process. When setting up a business, there are generally three types of legal structures to consider, namely a company (subsidiary), a foreign branch or a partnership. There are no residency or nationality requirements to establish or even maintain any of the above legal structures. Moreover, with the exception of a limited number of strategic industries (such as banking, insurance, and defense), there is little government intervention or limits on foreign control and investment.
The structures and mechanisms of Israeli business entities will be familiar to anyone with experience in other Common Law based systems in North America or in Europe. Israeli corporate law has it origins from the English Companies Act and over time, has been modified to take into account modern corporate law developments, principally in the United States. Israeli corporate law is strongly supported by a robust and specialised court system which routinely adjudicates complicated points of law and also enforces foreign judgments as a matter of routine.
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- Company (subsidiary):
An Israeli company, like many of its international counterparts is a separate and distinct legal entity from its shareholders. Companies in Israel are overseen by a board of directors who have certain duties of care and loyalty to the Company, and are managed by their executive officers who are subordinate to the board of directors. The shareholders of an Israeli company, who have limited liability limited solely to their shares, elect the members of the board. The corporate veil between the company and its shareholder may only be pierced in extreme situations such as fraud. A company is subject to taxation for both earnings on the corporate level and for any dividends or other distributions on the shareholder level.
From a practical perspective, setting up a company is relatively simple. The Israeli Registrar of Companies (the “Registrar”), the government body responsible for the incorporation of corporate entities, allows a company’s local legal counsel to electronically file incorporation documents, along with satisfying ongoing reporting obligations.
The incorporation of a company requires the filing of the company’s initial articles of association and other incorporation documents with the Registrar. This process can be completed digitally by the company’s counsel and typically is completed within a few days. Once incorporated, companies are subject to various corporate governance requirements. These include the appointment of auditors, ongoing Registrar reporting obligations and minimum shareholder and board meetings (unanimous written consents in lieu of meetings are permitted).
- Foreign Branch:
A foreign corporation that seeks to conduct business in Israel must register with the Registrar as a Foreign Company. A Foreign Company does not constitute a separate legal entity distinct from the overseas entity. The registration process typically can be completed within a couple of weeks and consists of submitting various corporate documents of the original entity to the Registrar and executing a power of attorney in favour of a person regularly residing in Israel, authorising him or her to act in its name and accept judicial documents and notices on its behalf.
It should be noted that since a Foreign Branch is considered part of the same legal entity as the overseas entity which set it up, there often are bureaucratic hoops through which the overseas entity must jump upon incorporation and even in its on-going business. Examples of this may include the provision of board resolutions (and sometimes shareholder resolutions) of the overseas entity authorising actions that need to be taken, as well as delivery of other corporate documents and certifications of the overseas entity. By way of example, Israeli banks often require original or certified original copies of resolutions approving the setting up of a bank account. Furthermore, local lawyers are often required to certify such requirements and are unable to do so for foreign entities which require further complications and costs.
Israeli law provides for only two types of partnerships: (i) general partnerships and (ii) limited partnerships. In a general partnership, each partner is jointly and severally liable for the acts of his or her partner, while a limited partnership consists of at least one general partner with unlimited liability and limited partners with limited liability restricted to their capital contributions to the partnership. Partnerships are separate and distinct legal entities, which are regarded as pass-through entities for tax purposes.
Both general and limited partnerships must register with the Israeli Registrar of Partnerships (“Registrar of Partnerships”), a process which can take several days. The registration process requires, inter alia, the filing of the identity of the partners and, in the case of a limited partnership, the partnership agreement and the partners’ capital contributions.
It is important to be aware that filings with the Registrar and Registrar of Partnerships are publically disclosed. Consequently, information such as the identity of directors and shareholders, or the identity of partners, is publically available. It should be noted that most such public filings are declarative in nature and therefore the public database cannot be relied upon for example to prove the legal shareholders of a company as many companies are not up to date in their filings.
Among recent regulatory developments, two new legislative reforms are likely to have a significant impact on foreign businesses operating in Israel in 2018:
- Restrictive Trade Practices Law, 5748-1988 (the “Restrictive Trade Practices Law”): A recently proposed amendment to the Restrictive Trade Practices Law contains far reaching reforms in Israeli antitrust and competition law, which while extending the reach of the law, are also intended to streamline the current processes.
The amendment contains three central reforms. Firstly, while currently for a foreign corporation or partnership to fall within the merger control regime, the foreign entity must satisfy a jurisdictional nexus requirement (such as holding a significant position in an Israeli company), the proposed legislation abolishes this requirement. Under the proposed amendment, foreign entities are subjected to the merger control regime solely based on the same market share and turnover thresholds applicable to Israeli entities. Secondly, the proposed amendment would replace the current NIS 150 million combined turnover threshold for being subject to the provisions of the Law with an increased NIS 360 million threshold. Lastly, the amendment seeks to streamline the review process of restrictive arrangements. Presently, the Israel Antitrust Authority has 90 days to review an application for an exemption of a restrictive arrangement. The proposed amendment would expedite this process by reducing the review period to 30 days, with a total cap of 120 days on any additional extensions.
- Financial Services Supervision (Regulated Financial Services) Law, 5776-2016 (the “Financial Services Law”): This newly enacted law imposes a mandatory licensing requirement and regulatory regime on various non-institutional financial services providers such as lending institutions which are not banks. The Financial Services Law applies to two classes of financial services: financial asset services and the extension of credit. Financial asset services include the exchange and management of cash, checks, promissory notes and virtual currency. While the extension of credit includes the provision of loans, guarantees and other credit facilities. In addition to licensing requirements, financial service providers are subject to ongoing regulation including corporate governance requirements and restrictions on corporate control and dispositions of equity. The Financial Services Law exempts many types of financial institutions such as banks and insurance companies but unfortunately did not provide exemptions for foreign entities. There are draft regulations currently proposed to extend this law to foreign entities, however such draft regulations have not yet been formally adopted. The ramifications of this law currently impact on the ability of foreign financial institutions to loan money to projects in Israel without obtaining a license.
Investment Issues and Pitfalls:
A foreign entity or individual investing in Israel for the first time is likely to find the transaction documentation familiar and readily comprehensible. Investment documents are frequently drafted in English and follow international trends and practices, and in some sectors, particularly the technology sector, companies are run with a view to foreign investment and, therefore, most if not all corporate and commercial documents from inception are drafted in the English language. Further, Israeli law provides for favorable tax treatment of foreign investors.
Typically, the more sophisticated venture capital type investments involve three principal documents, a share purchase agreement, articles of association, and an investor rights agreement. The Share Purchase agreement will include the commercial terms of the investment, the representations and warranties of the parties, and any post closing covenants. The articles of association, which are the central organisational document of a company, will contain the various shareholder rights and preferences and include a description of the rights of the shares as well as the relationship between the shareholders. Typical provisions include dividend and liquidation preferences, anti-dilution protection, board composition provisions, and veto rights. The Investor Rights Agreement typically includes financial and information rights, as well as United States style share registration rights.
Two potential pitfalls are of particular importance when investing in an Israeli business. The first relates to the Israel Innovation Authority (formerly the Office of the Chief Scientist) (the “IIA”). The IIA is a governmental body charged with providing financial support to private sector entrepreneurs for research and development activities. Many Israeli companies take advantage of this source of funding.
The IIA generally finances the recipient company’s activities through the providing of government-grants, which become repayable by way of royalty payments from future sales, if any, using the funded technology. These grants are attractive to companies since they are only repaid through future sales, if any, and the investment does not dilute the shareholdings of the company. While the receipt of such funding does not limit the amount of foreign investment a company can raise, it does, however, subject it to certain sale or technology transfer restrictions which have important implications for technology related transactions between Israeli and non-Israeli entities. Know-how developed under research and development programs funded by the IIA, as well as manufacturing activities, are subject to certain restrictions on their export outside of Israel including the ability to manufacture outside of Israel. Overseas transfers of know-how, which include both outright transfers of ownership and out-licensing arrangements, are subject to IIA approval and payment of a “transfer fee.” which in some cases can be up to six time the amount of the original grant. Similarly, the export of manufacturing activities requires IIA approval and payment of increased royalties. Accordingly, part of any due diligence process conducted by a potential foreign investor, should include questions regarding possible IIA funding and a thorough review of such funding where it exists.
A second potential pitfall foreign investors should be cognizant of is their tax liability when selling stock in Israeli companies. The Israeli Income Tax Ordinance grants non-Israeli resident individuals and entities a broad exemption from capital gains tax upon the sale of securities in Israeli and Israeli-related companies. Unless an investor formally applies for this exemption from the Israeli Tax Authority, there is an obligation to withhold tax even for a foreign entity upon the sale of securities. While obtaining the exemption is relatively straightforward, the process can be lengthy and costly.
Israel has a strong corporate governance regime along with well-established rule of law and an independent and effective court system. Israeli companies are, therefore, well respected internationally, with many listed on leading foreign exchanges. Israeli companies are also subject to favourable tax rates and although tax rates may soon fall in the US, Israel may follow suit. Further, Israeli investment transactions follow international trends and practices, allowing for relatively seamless transitions into the Israeli market. While setting up an Israeli business is rather familiar for investors coming from most Western countries, there are certainly issues that arise which are unique to Israel and it is, therefore, important to seek competent local legal, tax and accounting advisors when commencing operations in Israel.
The authors of this article, Simon Weintraub and Adrian Daniels, are partners in the International Department of the Israeli law firm Yigal Arnon & Co. Simon and Adrian specialise in representing interests of foreign companies in Israel foreign funds and individuals who invest in Israeli companies.