On April 18, 2016, the Israeli Tax Authority (“ITA”) published a tax ruling (4253/16) determining the tax treatment applicable to holdback amounts payable in the context of an M&A transaction to certain major selling shareholders.

The retained amount is paid only gradually over time, after the closing, on condition that these key shareholders continue to function in the company (or an affiliate). Although entitlements to such amounts pursuant to the sale agreement are contingent on future employment of the sellers (with some exceptions), the ITA ruled that the holdback amounts will be taxed at a capital gain tax rate. The facts outlined in the ITA publication are as follows:

  1. Target is an Israeli R&D company (“Target”) held, among others, by five individuals (“Shareholders”).
  2. In 2016, the Shareholders sold their shares in Target to a publicly traded U.S. corporation.
  3. Pursuant to the sale agreement, 50% of the sale consideration is subject to a holdback provision (“Holdback Consideration”) under which most of the Holdback Consideration is held in escrow for a period of 4 years (“Vesting Period”).
  4. The price per share payable to the Holdback Shareholders is identical to the price per share payable to other selling shareholders and the Shareholders received normal compensation and employment terms for their continued engagement. 
  5. Each year, a portion of the Holdback Consideration that remained in escrow would be released to the Shareholders subject to their continued employment in Target.
  6. A Shareholder is entitled to the entire Holdback Consideration only if he or she remained an employee of Target for the entire 4 years. However, pursuant to the sale agreement, there are some exceptions under which a Shareholder would be entitled to receive the entire Holdback Consideration even if his or her employment was terminated. Therefore, the Holdback Consideration is subject to some risk of forfeiture.

The ruling:

  1. The ITA ruled that although the Shareholders are entitled to the Holdback Consideration only if they remain employed by Target (and therefore the amounts could be linked to employment (regular progressive tax rates up to 48% plus a potential 2% tax for 'high income earners'), the entire Holdback Consideration should be taxed as capital gain (flat rate of 25% or 30% for 'substantial shareholders').
  2. The ITA ruled that although the Holdback Consideration is held in escrow and it is subject to some risk of forfeiture, the Shareholders should include such amount as income in the year the actual sale occurred (2016).
  3. The ITA also ruled that if, at the end of the Vesting Period, the total consideration paid to any Shareholder is higher than what such Shareholder is entitled to pursuant to the sale agreement (excluding interest or gains accrued on the Holdback Consideration), the difference should be taxed as employment income and not as capital gain.  If, however, at the end of the Vesting Period, the total consideration paid to any Shareholder is lower than what such shareholder is entitled to pursuant to the sale agreement, the Shareholder will be entitled to the appropriate tax refund.

This decision contributes to clarity regarding exit deals which emphasized even more by Tel Aviv District Court’s recent decision (Helman v. Tel Aviv Tax Assessment Officer) in connection with another similar transaction. In the Helman case, since the release of the “holdback amount” was conditioned upon 'continued service', the Court actually deemed the release of the Holdback Consideration as 'payment for services'. The Helman case is currently pending appeal before the Supreme Court of Israel and expected to be heard in mid-June.


Although the ITA  agree that income associated with future employment as capital gains, immediate tax on the full sale proceeds, including payments that have not yet been received by the seller and still subject to economic risk or forfeiture, is payable.

As the specific facts of any Hold Back situation are determinative for classification of the income from Hold Back arrangements, when structuring exit deals, experienced tax counsel can assist in structuring the deal in a tax efficient manner to avoid costly consequences for departing key shareholders.