Tax Aspects of SAFE (Simple Agreement for Future Equity) Investments

Tax Aspects of SAFE (Simple Agreement for Future Equity) Investments

On January 29, 2025, the Israeli Tax Authority issued clarifications on the taxation of investments made through a Simple Agreement for Future Equity (SAFE); previous guidelines had been issued on May 16, 2023.  

A SAFE is a financial instrument that is commonly used by startups and investors when raising capital. Designed to simplify the process, the SAFE allows investors to fund a company in exchange for rights to future equity, rather than immediate shares. Investors typically receive equity upon a valuation event such as a further financing round, IPO, or sale of the company.

Disagreement arose in the past about how to classify the difference between the amount invested by a SAFE investor and the generally higher value of the shares allocated to that investor upon the conversion of the SAFE to equity. The Tax Authority argued that the difference should be classified as interest representing proper consideration for the use of money over time, while tax practitioners contended that the SAFE and the allocated shares should be classified solely as a capital instrument and be taxed accordingly upon sale. The question has practical implications for tax liability in Israel, especially for foreign investors. While foreign investors are exempt from tax on the sale of shares (capital gains), they are subject to withholding tax on interest accrued by an Israeli company, which is considered income from an Israeli source. Withholding tax rates vary from 15% to 25%, depending on the treaty, if any, between Israel and the investor’s country of residence.

The guidelines that were issued on May 16, 2023, set the terms under which a SAFE investment is considered a capital instrument only and therefore not an interest-earning investment. Those guidelines expired on December 31, 2024. The new guidelines extend the application of the earlier ones and clarify certain issues; the most important points are presented below. Unless the Tax Authority provides further notice, the new guidelines apply to agreements that are signed between January 1, 2025, and December 31, 2026.

Conditions for the SAFE to Be Classified as Equity

1. Conditions related to the company raising the investment:
   • The investment is made in an Israeli company acting in the high-tech industry.
   • Most of the company’s expenses between its establishment and the signing of the SAFE agreement, or in the three years before the signing, whichever period is shorter, have been dedicated to research and development or to the manufacture or marketing of products that the company developed as part of its R&D activities.
   • At the signing of the SAFE agreement, the R&D activity is ongoing.
   • The company did not conduct any fundraising at a known share price for at least three months prior to the closing of the SAFE agreement.
   • The company did not deduct or amortize any interest expenses connected directly or indirectly with the SAFE.
   • The company or its affiliates did not provide any security for the repayment of the SAFE.

2. Conditions related to the SAFE agreement:
   • The investment amount per investor does not exceed USD20M.
   • The SAFE holder’s right to transfer the SAFE before the issuance of shares is subject to the company’s approval.
   • The SAFE agreement specifies that the instrument is neither a debt nor a loan.
   • The SAFE will be converted into shares only at one of the following events: (i) a qualified round, which is defined, among other things, as the raising of 40% of the company’s share capital on a fully diluted basis or of an amount exceeding 10 times the total of SAFE instruments not yet converted to equity; (ii) an IPO; (iii) an exit event in which the majority of shareholders by number (excluding shares derived from options granted to employees and consultants) sell their shares; (iv) a transaction involving the sale of all or most of the company’s assets; or (v) a date predetermined in the SAFE agreement.
   • The discount rate for the conversion of the SAFE into equity will not change as a function of time or depend on the achievement of certain milestones. However, the SAFE agreement may specify up to three discount tiers, with the discount rate at each tier being conditioned on the passage of time or the achievement of milestones. In the case of multiple discount tiers, the maximum discount rate will be granted no later than 3 years from the signing of the SAFE.
   • If the date of the SAFE’s conversion is predetermined in the agreement, the conversion will occur at a pre-agreed value. This value may be a specified amount or the share value from the last or next funding round, either without any discount or with a pre-established discount.
   • When the conversion and allocation of shares occur as part of a capital raise for the company, at least 25% of the capital raised must be unrelated to SAFE instruments. If SAFE investors make direct share investments to meet this requirement, their contributions will be divided, and only the portion representing regular equity investments will be considered in calculating the 25% requirement.

3. Conditions related to the sale of SAFE or underlying shares
   • SAFE holders are not entitled to a refund of their investments, except under the circumstances detailed below.
     • An exit event in which the majority of shareholders by number sell their shares. The consideration for the SAFE is paid by a third party that is unrelated to the company or its shareholders and that owns no more than 25% of the company’s share capital.
     • Voluntary or involuntary liquidation, receivership, or the appointment of a receiver or special administrator by the court or the petition of the receiver/general creditor. In such an event, the SAFE instrument ranks below the company’s creditors in the order of preference, except in a liquidation in which the rights of SAFE investors are similar to those of preferred shareholders, i.e., subordinate to all debts and superior to the rights of ordinary shareholders.
   • In any of the events listed above, the investor will be entitled only to the principal amount of the investment and nothing beyond that.

• The sale of shares allocated under the SAFE must not take place any earlier than 12 months from the signing of the SAFE agreement or 9 months from the date of share allocation. However, the sale may occur sooner if it is part of a transaction in which the majority of the company’s shareholders are selling their shares under the conditions specified above, with the payment for the SAFE made by an unrelated third party or in the event of company liquidation.
• In the context of realizing the shares, the price received by a SAFE investor is identical to the price received by holders of the same type of shares.

Benefits of Compliant SAFE Agreements

If the SAFE agreement is fully compliant with the above conditions, no taxable event will occur upon the conversion of the SAFE into equity, and the company issuing the shares will not be required to withhold any withholding taxes. Furthermore, since any consideration received upon the sale of the underlying share will be classified as capital gains, a foreign investor who qualifies for exemptions under Israeli law or a relevant double tax treaty will not be subject to tax. It is important to note, however, that despite non-conformity with all the prescribed guidelines, a SAFE may still be classified as a capital investment.

In light of these complexities, STL’s founder, Anat Shavit, emphasizes her firm’s substantial experience in handling SAFE transactions. Accessible at shavitaxlawyers.com, STL is happy to review specific SAFE agreements to provide legal advice and opinions. Please contact us to explore how we can support your objectives with our expertise.