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Taxation of investment funds – Lexology

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Introduction

Israel – known as the ‘start-up nation’ – has encouraged and attracted inbound foreign investments for many years. Investors looking to invest in Israeli companies may do so by:

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  • investing directly;
  • investing in investment funds managed by others; or
  • establishing a private investment fund.

Recent years have shown an increased interest and investment activity in Israeli companies by foreign investors, several of which have formed an Israeli corporate venture capital (CVC) fund for this purpose.

Among the primary tools for encouraging inbound investments is the special tax regime for private investment funds. Over the years, the Tax Authority has issued substantial guidance and numerous private rulings under the Income Tax Ordinance, providing significant tax benefits to foreign investors and private investment funds operating in Israel.

This article outlines the income tax arrangements applicable to private investment funds operating in Israel. These arrangements are predominantly based on Income Tax Circulars 9/2018 and 10/2018, which govern the taxation of venture capital funds and private equity funds, respectively.

The special tax regime applicable to private investment funds is currently under review by the Tax Authority and the Ministry of Finance. As such, tax benefits that are available under the existing regime may be adjusted and further criteria for entitlement may be added. However, such changes are not expected to affect the existing arrangements for non-Israeli limited partners.

Criteria for beneficial tax treatment

The principal conditions for beneficial tax treatment for non-Israeli investors regarding their investments in private equity and venture capital funds are as follows:(1)

  • The fund must have at least 10 unrelated (directly or indirectly) investors.
  • Investors may not hold more than 20% of the capital of the fund, with the anchor investor able to hold up to 35% of the capital of the fund.
  • At least 30% of the investors in the fund must be non-Israeli investors.
  • Total investment commitments must be at least $10 million, of which at least $5 million must come from non-Israeli investors.
  • The fund may not invest more than 25% of its total commitments (net of management fees) in any single company.
  • The fund may not invest more than 20% of its total funds raised (after deduction of management fees) in companies whose securities are publicly traded.
  • The fund may not hold short-term cash deposits or publicly traded securities, unless they originate from:
    • monies which investors transferred in accordance with their investment commitments in the fund; or
    • the realisation of profits prior to their distribution or reinvestment.
  • The fund must invest in ‘qualifying investments’ (as defined below) in Israel in accordance with the lesser of the following alternatives:
    • at least $10 million in qualifying investments of which at least $6 million must be invested, directly or indirectly, in Israeli resident companies whose intellectual property is owned by them and/or in their non-Israeli parent companies; or
    • at least 50% of the fund’s total commitments in qualifying investments, of which at least 30% of total commitments must be invested, directly or indirectly, in Israeli resident companies whose intellectual property is owned by them and/or in their non-Israeli parent companies.
  • The fund must be managed by the general partner or by a person on its behalf. The limited partners may not take any role in identifying targets or managing the portfolio companies or in the day-to-day management of the fund and will have no voting rights in the investment committee of the fund.
  • The fund may be required to provide certain financial information to the Tax Authority.
  • Investors in the fund may be required to provide certain information to the fund or the Tax Authority in order to establish their right to enjoy the benefits of a Tax Authority ruling issued with respect to the fund.

Definitions

For purposes hereof:

  • a ‘qualifying investment’ is an investment in shares of an Israeli resident company or an Israel affiliated company whose principal activity is a qualifying activity, including venture capital investments. Investments in securities traded on the stock exchange will not be considered qualifying investments, unless the fund’s holding period of a publicly traded portfolio company is at least one year from the time of the fund’s first investment therein;
  • a ‘qualifying activity’ is the establishment or expansion of enterprises engaged in activities in Israel in the areas of industry, agriculture, tourism, transport, construction (excluding real estate), water, energy, technology, communications, computing, security, medicine, biotechnology or nanotechnology or research and development in these areas;
  • an ‘Israel affiliated company’ is a foreign company whose principal assets and/or activities, directly or indirectly, are in Israel;
  • ‘shares’ include stock options and warrants, convertible notes and convertible bridge loans which are not secured by assets other than the technology or the assets which the target company owns; and
  • ‘venture capital investments’ are qualifying investments in the high-tech sector, where at least 75% of the total investment is in consideration for the issuance of shares.

Beneficial tax arrangement

If all of the above criteria are met, the following will apply to the non-Israeli investors in the fund and in the general partner.

Tax arrangement for non-Israeli limited partners

Income derived from non-Israeli investments (ie, non-Israeli companies or non-Israeli affiliated companies) will be exempt from tax in Israel.

Income derived from venture capital investments (ie, capital gains, dividends and interest) will be exempt from tax in Israel.

Income derived from qualified investments that are not venture capital investments will be taxed as follows:

  • Income from the realisation of qualified investments will be exempt.
  • Dividend income received from the qualified investments will be taxed as follows:
    • Dividend income attributed to individual investors (including if held through a transparent entity for tax purposes in the country of residency of the individual) will be subject to tax at the rate of 15%.
    • Dividend income attributed to corporate investors will be subject to tax at the corporate income tax rate (currently 23%).
    • Notwithstanding the foregoing, foreign investors from a treaty jurisdiction may be eligible for the tax rates set out under the applicable treaty (15%),(2) subject to confirmation of tax residency and beneficial ownership by the Tax Authority
  • Interest income received from the qualified investments will be taxed as follows:
    • Interest income will be subject to tax at the regular applicable tax rates set out in the Income Tax Ordinance (individuals will be taxed at a rate of 15% to 50% depending on the nature of the interest; corporates will be taxed at 23%).
    • Notwithstanding the foregoing, non-Israeli investors from a treaty jurisdiction may be eligible for the tax rates set out under the applicable treaty (10%), subject to confirmation of tax residency and beneficial ownership by the Tax Authority.
  • Any other income (not covered above), including income from management fees received from portfolio companies, will be subject to the regular tax rates set out in the Income Tax Ordinance (up to 50% for individuals and 23% for corporates).
  • Foreign investors in the fund will not be considered tax residents of Israel and will not have filing obligations in Israel as a result of their investments in the fund.

Tax arrangement for non-Israeli fund managers

Based on the foregoing, and once the fund qualifies for tax benefits, the general partner and the managers of the fund may also be entitled to certain tax benefits. As stated above, the special tax regime applicable to private investment funds is currently under review by the Tax Authority and the Ministry of Finance. As such, tax benefits that are available under the existing regime may be adjusted and further criteria for entitlement may be added.

Taxation of carried interest

Carried interest income attributable to Israeli investments will be subject to tax at the rate of 15% in the hands of non-Israeli fund managers.

Carried interest income attributable to investments in foreign entities will not be subject to tax in Israel.

Notwithstanding the foregoing, non-Israeli general partners and fund managers from a treaty jurisdiction may be eligible for the tax rates set out under the applicable treaty, subject to confirmation of tax residency and beneficial ownership by the Tax Authority.

Taxation of management fees

Income derived from management fees will generally be subject to the regular tax rates set out in the Income Tax Ordinance (up to 50% for individuals and 23% for corporates).

Alternative tax arrangements if conditions are not met

Over the years, the Tax Authority has issued alternative tax arrangements for funds that do not meet the criteria described above, including funds:

  • that have fewer than 10 investors;
  • with commitments of less than $10 million;
  • in which the limited partners are involved in the management of the fund; and
  • in which the general partner is a substantial investor.

The following is a short description of the beneficial tax treatment available in some of these situations.

Funds that have fewer than 10 investors

Income from realisations of qualifying investments will be subject to 15% income tax in Israel.

Income from interest and dividend payments that are derived from qualifying investments will be subject to tax at the lesser of:

  • 15%; and
  • the tax rates under an applicable tax treaty.

Other income that is not derived or accrued from qualified investments will be subject to the tax rates established in the Income Tax Ordinance.

Income derived from non-Israeli companies (ie, non-Israeli or non-Israeli affiliated companies) will be exempt.

Funds with less than $10 million in commitments

A beneficial tax arrangement will be available to funds that are focused on making venture capital investments.

Income from realisations of venture capital investments will be exempt from tax in Israel.

Income from interest and dividend payments will be subject to tax at the lesser of:

  • the tax rates established in the Income Tax Ordinance; and
  • the tax rates under an applicable tax treaty.

Non-Israeli funds investing in Israel without representation in israel

Generally, such a fund will enjoy the same tax benefits as described under “Tax Arrangement for Non-Israeli Limited Partners” above.

Non-Israeli managers of the fund will be entitled to exemption from Israeli tax on their carried interest (as opposed to 15% tax on carry sourced from investments in Israel, for a fund with Israeli representation) and on their management fees.

Endnotes

(1) Limited partners holding more than 4% of the interests in a fund may not control the entities managing the fund and may not hold more than 10% of the general partner, if they wish to enjoy the tax benefits.

(2) For a percentage holding lower than 25%.

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Amazon Adds $2.75 Billion To Anthropic Investment, Sora Goes To Hollywood – Forbes

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Amazon invests $2.75 billion in Anthropic. This brings Amazon’s investment to $4 billion, as it follows its previous investment of $1.25 billion, which gave the company the option to invest the additional funds. This comes as Anthropic’s new Claude-3 chatbot outperforms ChatGPT- 4 in recent tests. Amazon has unique insight into Anthropic’s performance as it is one of the suite of AI models offered by AWS, which include most of Claude’s competitors.

Sora Goes To Hollywood. Everyone is reacting to a Bloomberg report that OpenAI will soon be meeting with studios and other Hollywood stakeholders to demonstrate the capabilities of the text-to-video generator and explore partnerships. OpenAI says unnamed “A list” directors are already using it.

Based in Toronto, shy kids are a multimedia production company who utilized Sora for the above short film about a man “who is literally filled with hot air.” His head, as you can see, is a yellow balloon. “We now have the ability to expand on stories we once thought impossible,” shares the trio made up of Walter Woodman, Sidney Leeder and Patrick Cederberg. Walter, who directed Air Head, said as great as Sora is at generating things that appear real, what excites us is its ability to make things that are totally surreal.

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Neuralink Shows Paralyzed Patient Playing Chess on a PC. Elon Musk’s brain-computer interface company shared a video of its first human patient, Noland Arbaugh, playing chess and Civilization VI using their brain implant. Arbaugh, who is paralyzed below the shoulders, described the experience as “just stare somewhere on the screen” to move the cursor. While some experts see this as a promising step, others emphasize that it’s still early days and the technology has limitations. Arbaugh acknowledged that there’s still work to be done, but the implant has already changed his life.

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Illuvium Labs Raises an additional $12 million for NFT Gaming Universe. Following an extensive three-and-a-half-year development journey and $60 million in funding, Illuvium Labs is on the cusp of unveiling its interoperable gaming universe. It will feature three interconnected titles designed to utilize the same NFTs seamlessly across all games, promising a first-of-its-kind experience. The influx of $12 million in Series A funding from esteemed firms like King River Capital, Arrington and Animoca will be allocated to developing new gaming titles within the Illuvium ecosystem.

Databricks’ DBRX claims the crown as best open-source LLM. It’s a list that includes Meta’s Llama 2 and Mistral’s Mixtral. Leading companies like OpenAI, Google, and Anthropic sell, or rent, their proprietary private models to enterprises and subscribers. DBRX was produced for just $10 million, orders of magnitude less than its competitors. On Monday, Wired reported that the company showed data proving its AI model’s reading comprehension, answers to general knowledge questions, and coding is superior to other open-source models that can be downloaded from Hugging Face and modified by users.

Shiba-Inu Metaverse leader steps down amid dispute over IP. Marcie Jastrow, the well-regarded Hollywood executive who led Technicolor’s XR efforts, has left the company. This led the company’s legions, known as the Shib Army, to speculate about malfeasance, which is easy to do, because Jastrow is the only person involved who is not anonymous, including Ship’s charismatic leader Shytoshi Kusama.

This live football experience was built by Immersiv.io to showcase how AR can transform the live sports broadcast and fan experience using the Apple Vision Pro. Immersiv.io worked with the Bundesliga (the German Football League) on the production. In a post on X, the company said. “This is a 3D reproduction of the live game integrating TRACAB Gen 6 live skeletal data of all players and the ball, complemented with real-time insights, offering the ultimate live tactical perspective of the game.”

SXSW 2024: XR That Makes You Go Wow. The XR competition was won by an AI experience, The Golden Key. This is the second year in a row that an XR experience did not take the immersive festival’s grand prize.

The second annual AI Film Festival is coming to Los Angeles on May 1, and New York May 9. Seats are limited, request to attend at http://aiff.com

This column, once called “This Week in XR,” is also a podcast hosted by author Charlie Fink, and Ted Schilowitz, former studio executive and co-founder of Red Camera, and Rony Abovitz, founder of Magic Leap. This week our guest is Liz Hyman, CEO of the XR Association. We can be found on Spotify, iTunes, and YouTube.

What We’re Reading

Where Will Virtual Reality Take Us? (Jaron Lanier/New Yorker)

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FP Answers: What is a 'behavioural edge' in investing and how does it affect returns? – Financial Post

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Temperament is the unsung hero of investing success

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By Julie Cazzin with Felix Narhi

Q: What is a “behavioural edge” in investing? How does it potentially enhance returns? How can an investor develop it? — Giovanni

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FP Answers: Giovanni, the term behavioural edge is just another way of saying “temperament,” which refers to the habitual way a person behaves in each situation. For example, one person may be easygoing and relaxed while another is more likely to be impatient and assertive.

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Temperament is the unsung hero of investing success. Gaining insight about our innate emotional temperament and learning how to work with it gives investors an edge.

The common misconception is that you need a high level of intelligence to be a successful investor. No doubt, that can be helpful, but based on many years in the industry, I’ve seen it is not always the most important differentiator.

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Once someone has at least an average level of intelligence, it is temperament that often provides the investing edge in leading to better returns over the long term. “Investing is not a business where the guy with the 160 IQ beats the guy with the 130 IQ,” famed investor Warren Buffett has pointed out.

Having the right temperament can potentially enhance investment returns in several ways. An investor who is very reactive to external events is likely to fare poorly over the long term because, quite simply, the world is full of uncertainty and always will be. Markets are highly reactive, abetted by algorithmic trading and automatic rebalancing by exchange-traded funds. Individual investors should not be.

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Research shows that investors who trade frequently or try to time the market underperform. On the other hand, those investors who can remain calm and patient throughout market cycles do better because markets historically trend upwards. Hands down, being calm, cool and collected is the right temperament for an investor to have.

The concept of “homo economicus” — or economic man — describes a hypothetical person who consistently makes rational decisions. In real life, our decisions are coloured by our formative experiences, moods, external circumstances, what we ate for lunch and a host of other factors. These influences drive our behaviours, but they often operate below conscious awareness (even artificial-intelligence apps “hallucinate”).

Given that behaviour is some combination of cognitive and emotional inputs, an investor can create an edge by developing a disciplined investment process that overrides temperament, especially during highly volatile periods.

The term “active patience” means being clear about your investment principles and what you are looking for, and practicing active patience until the right opportunity arises.

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In contrast, regular patience is making an investment decision and sticking with it no matter what, even if it was the wrong decision. The latter approach is unlikely to bring financial success, which is the major goal of investing.

Active patience is what Buffett would call the “fat pitch,” which occurs when the market (occasionally) presents a very attractive opportunity. It is easy to spot a great opportunity and take full advantage of it when an investor has clear principles on what they are looking for.

Can we change our temperament? Recent studies show that personality traits and moods are subject to change, sometimes within the hour, so temperament may not be as fixed as we’ve been led to believe.

Becoming a better investor starts with self-knowledge — and lots of practice. The behavioural traits associated with good investment outcomes are patience, discipline, emotional control and risk awareness. It so happens, these qualities lead to good life outcomes, too. A calm temperament is the bedrock of making sound investment decisions.

Every investor must determine for themselves how to achieve greater equanimity and there is no shortage of books, videos and TikTok tutorials on that evergreen topic. I would also add the importance of staying humble.

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In investing, as in life, the learning never stops. Staying open to new information and having the courage to challenge our own and others’ beliefs and habitual behaviours are the keys to future success.

Felix Narhi is chief investment officer and portfolio manager at PenderFund Capital Management Ltd.

Bookmark our website and support our journalism: Don’t miss the business news you need to know — add financialpost.com to your bookmarks and sign up for our newsletters here.

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Lenders Rally After India’s Central Bank Eases Investment Curbs – BNN Bloomberg

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(Bloomberg) — Indian banks and shadow lenders rose Thursday after the country’s central bank eased capital requirements for a unique type of investment, a move that may free up more funds for loans.

The gains came after the Reserve Bank of India issued Wednesday modified rules on lenders’ required provisions for exposure to alternative investment funds, or AIFs, that invest in the lenders’ borrowers. Under the new policy, a lender needs to set aside capital only for the amount the AIF invested in the debtor company, and not the entire investment of the lender in the AIF.

Shares of Piramal Enterprises Ltd., which reported among the biggest provisions for such investments, closed 1% higher after rising as much as 6% during the day. A gauge of financial services firms climbed 1%, the most since March 1.

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Lenders led the rally in the broader market, with the NSE Nifty 50 Index registering its best day since beginning of the month.

The RBI’s softening stance came after industry players raised concerns over clarity and uniformity after it announced in December restrictions on lenders’ exposure to AIFs that hold stakes in their borrowers. The latest move will likely help firms including Piramal, HDFC Bank Ltd. and IIFL Finance Ltd. reverse some of their relevant provisions made previously, according to analysts at Citigroup Inc. and Jefferies Financial Group Inc.

Read more: India’s Crackdown on Financial Risks Puts Industry on Watch

“Select private banks and NBFCs like Piramal had provided for their entire AIF exposure during 3Q and could see some write-backs in 4Q if they decide to reverse the excess provision,” Jefferies analyst Bhaskar Basu wrote in a note.

Regulators introduced a flurry of new rules last year to prevent a buildup of financial stress at a time when India’s economy remained resilient in the face of rising interest rates, slowing global growth and unabated geopolitical tensions.

©2024 Bloomberg L.P.

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