ABOVE THE FOLD
A key driver for M&A activity will be the need of large corporate groups to find cash to service their debt mountains
What’s on Sale?
Prime Minister Netanyahu’s decision to call an election early in 2013 halted the progress of legislation that was working its way through the Knesset (Israel’s Parliament) aimed at lessening “concentration” in the Israeli marketplace. The draft legislation was based on the recommendations of a Committee appointed at the end of 2010 by the Prime Minister, amid concerns that the concentration of a large portion of the economy in the hands of a small number of investment groups endangered the long term stability of the Israeli economy.
The first main recommendation of the draft legislation was to separate the ownership of financial holdings (banks, insurance companies and investment houses) from significant “real” holdings. The second principal recommendation was to put an end to multi-tiered publicly-traded corporate groups, through which the controlling shareholders control an entire chain of public companies while holding a minor equity interest in corporations low down the corporate chain. Each of these recommendations is likely to trigger significant M&A activity.
One of the first economic measures that the new government has decided upon is to push the “concentration” legislation ahead. That being said, market forces may soon render the issue redundant. Israel’s so-called “tycoons” – entrepreneurs who have built corporate empires largely based on borrowed money – have been shown to have “feet of clay”. Corporate borrowers are straining under a mountain of debt. A number of major Israeli companies have been sold during the course of the last year in order to enable the owners to finance debt repayment (leading examples are Partner Communications, one of Israel’s leading mobile phone companies, Makhteshim Agan, a global agrochemical manufacturer, and Clal Investments, one of Israel’s major holding companies, owning among other things, Israel’s cement monopoly). Other companies are expected to follow suit.
Most of the money which fuelled the activity of corporate acquirers in recent years has come from debt raised in the capital markets. Traditionally, the level of security and protections granted to public bondholders has been significantly weaker than that demanded by banks. In light of the financial crisis at the end of 2008 onwards, the Capital Markets Division at Israel’s Ministry of Finance adopted a series of guidelines for the managers of public funds to follow when investing in corporate (non-government) debentures. More recently, the concern that the public was losing out in a number of recent debt reschedulings has led to an amendment to Israel’s Companies Law (Amendment No. 18, 2012), which provides that as soon as a company begins negotiating a debt rescheduling with public bondholders, the trustee of the bondholders (and if there is none, then the company itself) must apply to the court to appoint an expert on behalf of the court. The responsibilities of the expert include analysing the proposed arrangement, providing an expert opinion on whether the arrangement is fair for the bondholders, and reviewing whether any distributions made by the company to its shareholders prior to the application to court for approval of an “arrangement” amounted to an unlawful distribution.
Public hostility to the tycoons and to their proposals for debt rescheduling has resulted in bondholder trustees adopting a more militant stance than anything seen before. For the first time, we see bondholders attempting to gain control of a major corporate group (the IDB Group), a move without precedent in Israel.
Another and perhaps more significant amendment to the Companies Law (Amendment 19, which came into effect in January 2013) introduces a corporate rehabilitation regime into Israeli law similar to Chapter 11 of the U.S. Bankruptcy Code. If the court approves a rehabilitation process for a company, the provider of “Utilities” to the company must continue to provide the Utility, and the court can require the provider of “Vital Services” to continue to provide those services, if necessary for the rehabilitation of the company.
The court-appointed administrator in the rehabilitation process will have wide powers to adopt or reject executory contracts and to raise new money for the company, including on the security of previously pledged assets, ranking prior to existing security interests, if the court considers that existing secured creditors have “adequate protection” for return of their money.
To sum up, it seems likely that the liquidity crisis facing many of Israel’s corporate groups will generate a wave of M&A activity for the foreseeable future, encouraged by the new “Concentration Law”, as and when the legislation is finally passed by the Knesset. However, it is not only adverse market conditions that are encouraging M&A transactions. Israeli technology remains at the cutting edge, and we have recently seen a number of major technology companies, such as Apple, Cisco Systems and Facebook, making significant acquisitions in Israel. Google and Facebook are reportedly in a bidding war to acquire “Waze”, the Israeli social navigation network. This trend will no doubt continue, as Israeli technology
The article “What’s on Sale” originally appeared in the March 2013 issue of The Lawyer magazine.
Legal Developments - Critical information for new immigrants and returning residents regarding tax benefits
On April 25, 2013, a proposed amendment to the Economic Arrangements Law (the “Draft”) was published. The Draft is referred to as a “decision draft”, and at this stage in time only includes a description of the proposed changes without providing detailed language for proposed changes in the law. The Draft, which has been submitted to the Government, includes various amendments to Israeli laws, including amendments to the Israeli Income Tax Ordinance [New Version] 1961 (the “Ordinance”). One of these amendments proposes a radical change to the tax relief for New Immigrants and Long Absent Returning Residents (former Israeli residents who return to Israel after being foreign residents for a period of at least 10 years) (collectively referred to in this Note as “New Immigrants”).
We summarize below the main changes proposed with respect to the taxation of New Immigrants, as well as the main implications arising from the proposed amendments.
Under the current legislation, New Immigrants are not subject to Israeli reporting obligations with respect to their foreign source income and assets, for a period of ten years. The Draft proposes to abolish this relief and to require New Immigrants to report their foreign source income or assets regardless of any tax exemption to which they are entitled.
This change is very significant and is expected to impact many New Immigrants who are currently living in Israel and are not subject to any reporting obligations. The two main reasons noted in the Draft for abolishing the reporting exemption are that (i) due to the reporting exemption, the tax authorities cannot evaluate if a particular income item is entitled to exemption from tax; and (ii) the reporting exemption contradicts international standards of transparency and information exchange; Israel is currently subject to review by a committee of the OECD, which has informed the Israeli tax authorities that the reporting exemption must be noted in their report as reflecting a policy which is contrary to international standards.
Under current legislation, a trust which was settled by a new immigrant is entitled to the same tax benefit to which the New Immigrant is entitled (namely a 10-year exemption on foreign source income).
These benefits continue after the death of the settler of the trust, until the end of the 10-year term. The Draft proposes that upon the death of the settlor, the trust will not be entitled to the benefits which are provided to New Immigrants, and will become subject to tax in Israel on its world-wide income.
As mentioned above, New Immigrants are entitled to a 10-year exemption on their foreign source income, including foreign source dividends. According to the current law, if the dividend is distributed by a foreign company, the dividend will be classified as foreign source income, and will be tax exempt in Israel. The new Draft proposes that if the dividend has been distributed by a foreign company, but it was distributed from income which was derived in Israel, then such dividend will not be classified as foreign source income, and accordingly, the exemption will not apply. For example, in a case where a foreign company has a business in Israel and distributes its profits from the business in Israel as a dividend to a New Immigrant - the current legislation exempts such a dividend from tax (1), but the proposal in the Draft seeks to tax such a dividend in Israel.
The Israeli tax laws include two main anti-deferral regimes –
- Controlled Foreign Companies Regime (CFC). According to the Israeli CFC legislation, the passive income of a foreign company is, in certain circumstances, to be allocated to its Israeli shareholders as if this passive income had been distributed as a dividend to them.
- Foreign Occupation Companies (FOC). As a general rule, a foreign company that is used by Israeli residents in order to provide services outside of Israel is considered, under certain circumstances, to be an FOC. Part of the income of an FOC which is derived from services that are provided by Israeli residents is subject to tax in Israel. New Immigrants are not subject to the CFC and FOC regimes and the Draft does not propose to change this. However, the Draft makes a significant change regarding the way in which the New Immigrant affects his Israeli partners in the CFC and the FOC.
As a general rule, one condition that must be satisfied for a foreign company to be a CFC or FOC is that more than 50% or 75% (respectively) of the means of control of the company (2) are held by Israeli residents. According to current legislation, New Immigrants are considered as foreign residents and therefore their immigration to Israel does not affect the taxation of their Israeli partners in the foreign company.
The Draft proposes to ignore New Immigrants when calculating the percentage of Israeli means of control, and not to treat them as foreign residents. The effect of the proposal in the Draft can be illustrated in the following example. Suppose that the New Immigrant holds 65% of a foreign company and an Israeli resident holds 35%. According to current legislation, the interests of the New Immigrant are taken into account and regarded as those of a foreign resident. The foreign company is therefore not considered as a CFC, since Israeli residents hold less than 50% of the means of control, and both the Israeli resident and the New Immigrant are not subject to tax on deemed dividends from the foreign company. According to the proposal in the Draft, however, the interest of the New Immigrant is disregarded, and the foreign company is deemed to be entirely held by the Israeli minority shareholder (Israeli residents will hold 35%/35%=100% of the means of control). Such a company will become a CFC upon the immigration of the New Immigrant to Israel and the Israeli resident may be regarded as having received its share of the foreign company’s income as a deemed dividend (the New Immigrant will remain tax exempt).
This change is very important, as there are many cases in which new Immigrants hold foreign companies together with their Israeli relatives. According to the proposed change, these Israeli relatives may become subject to tax on their share in the profits of the foreign company, even if they do not receive any actual distribution from the foreign company.
Another extremely important set of proposals is intended to bring about dramatic changes to the taxation of foreign trusts, and in particular the taxation of “a Foreign Settlor Trust”, namely a trust established by a non-Israeli resident for the benefit of, among others, Israeli resident beneficiaries. For more details on the proposed changes to the taxation of Trusts, open the attached link.
FOLD OF THE MATTER
Updates and information on the developing energy sector in Israel
The year 2012 and the year 2013 to date have been a busy period in the Natural Resources sector, with particular emphasis on electricity production projects. However, 2013 will see some challenges for the sector that will need to be met in order to continue development.
Following the financing of the first major conventional IPP in 2010 (the Dorad Energy 850MW gas fired plant), additional IPP projects reached financial close in 2012, including two new cogeneration plants at Makhteshim Chemical Works facility in Ramat Hovav and the Agan Chemicals facility in Ashdod, and the Dalia project (an approximately 850MW plant to be located at Tzafit).
However, a number of problems are casting a shadow over continued development in the electricity generation sector. One key problem is that the ability of the Tamar field to ensure an uninterrupted supply of gas to additional IPP projects is doubtful due to capacity restrictions in the offshore pipeline infrastructure. In addition, the electricity regulator (the PUA: Electricity) is currently reviewing some of the financial mechanisms that encouraged the development of IPP’s (including the purchase obligation of the IEC) in order to determine whether they will continue to apply in the future.
The PUA has also recently published a position paper in which it sets out restrictions on cross holdings in multiple IPP’s. Although it is not clear if and how these restrictions will be implemented, they are certainly giving players in the industry some food for thought. When combined with the previous decisions of the PUA regarding cross holdings in different parts of the oil and gas supply chain, there remains a great deal of regulatory uncertainty.
Due to attractive feed in tariffs that were available at the time, 2011 and 2012 saw multiple solar power projects reach financial close. However, utilisation of all or almost all of the available tariff commitments from the PUA has resulted in a slowing down of the solar market, although a number of large solar projects (30-40MW) are expected to reach financial closing in late 2013 or early 2014.
The oil and gas sector had a mixed year in 2012 and thus far in 2013.
For various reasons (including a loss of confidence following dry wells in a number of fields), funding for exploration has become increasingly difficult to obtain and therefore the number of wells being drilled is expected to continue to decline.
On the production side, the Tamar field has commenced production and the partners continue to finalise supply agreements with Israeli customers, although capacity limits in the offshore pipeline network and an uncertain regulatory environment have made reaching such agreements a difficult process.
There have also been positive reports about the extent of deposits in other fields, such as the Karish field.
However, the main focus in the oil and gas sector in the next few months is expected to be on the Government decision on export policy. Although the Tsemach committee gave its recommendations in 2012, as yet the Government has not decided if and how much gas will be exported and on what terms. It is possible that the Government will reduce the amount available for export, and recent press reports indicate that additional taxes on exports are also being considered. Until these issues are resolved, further development of the Leviathan field and any other discoveries is likely to be limited.