Israel’s chief economist revealed Monday at a Knesset State Control Committee panel that the country was nearly sanctioned by two multinational banks three years ago for failing to uphold global anti-money laundering standards.
Israeli authorities have taken the tentative first steps toward creating a regulatory framework to encourage development and trade in virtual currency and companies dealing with blockchain technology.
Months of regulatory hostility have made it impossible for cryptocurrency companies to open accounts with Israeli banks or join the Tel Aviv Stock Market indexes. But now practitioners hope that an interim report on initial coin offerings by the Israel Securities Authority and the final version of an Israel Tax Authority circular on the tax treatment of utility tokens will signal the start of a policy pivot that will cement Israel’s position as a leader in the field.
“They definitely show that the door is open and there will be projects that will be welcomed here,” said Saul Adereth, a partner and head of blockchain and smart contracts at Shibolet and Co. law firm in Tel Aviv. “What we see in the past two weeks is a demonstration of trying to slowly open up for these companies and encourage this technology here in Israel.”
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Israeli officials “don’t want to be the territory to ban the technology and ban the advance. On the contrary, we want to be the Crypto Valley,” Aderet said.
Many countries are currently struggling with the proper tax treatment and regulation of cryptocurrency and cryptocurrency-based companies, as the industry grows and changes rapidly.
The Israel Securities Authority’s interim report emphasized how Israel’s economy could benefit from encouraging cryptocurrency-based companies. The report was issued on March 19 by a committee convened in August to study Israel’s regulatory approach to initial coin offerings (ICOs).
The authority on March 14 confirmed that cryptocurrency-based companies wouldn’t be included in the stock exchange indexes, echoing the policy of the U.S. Securities and Exchange Commission.
“The industry based on distributed registry technology is an innovative industry with the potential to transform and rationalize the financial world as we know it, in Israel and around the world. Israel’s unique characteristics and global standing in this industry can lead to this field contributing to the growth of the Israeli economy,” the authority’s report said. “The question of whether a currency will be considered a security will be decided according to the totality of the circumstances and characteristics of each case against the background of the aim of the law.”
Extending Tax Benefits
Tax Authority Circular 7/2018, extends significant tax benefits for utility token ICOs and the companies behind them. It also acknowledged that Israeli companies prefer to hold their ICOs abroad where the regulatory climate is more welcoming, and is seen as an attempt to woo them back by extending tax benefits to the proceeds of those offerings as if they had taken place in Israel.
The circular was released March 13 and is the result of a consultation on a draft issued Jan. 17.
“It’s good for the industry, definitely,” said Yitzchak Chikorel, partner and head of international taxation at Deloitte in Tel Aviv, who had criticized January’s draft as a “killer” for Israel’s nascent cryptocurrency companies.
“It acknowledges the economy. It realizes the decentralized business model of those companies and technologies. Initially they didn’t understand what the idea is behind an ICO, behind the tokenization,” Chikorel told Bloomberg Tax March 20. “They are much more clear about it. They understand the philosophy of the decentralized economics. Now they understand it.”
The circular allows deferral of the recognition of income for companies issuing both direct utility tokens and those issuing tokens not used to purchase assets or services from the company issuing them, but from other companies.
It also allows the proceeds from a utility token ICO to be recorded as a liability or pre-paid income “that will be released to the profit and loss report of the company according to the pace of use of the token,” Chikorel said.
“They are deferring the revenue recognition, thereby enabling the company to make use of the money in order to build the platform, to support the community, to upgrade and do whatever is required according to every platform. So there’s a huge benefit,” Chikorel said.
VAT liability is also deferred until the service is provided and zero-rated for token holders who aren’t Israeli residents.
The authority also acknowledges that such companies in some cases can benefit from the special tax status of a “preferred technological enterprise” which allows them to reduce their corporate tax from the regular 23 percent rate to 12 percent if they are located in central Israel, or to as low as 7.5 percent if they operate from one of the country’s “preferred zones” in Jerusalem or the periphery. In addition, the status allows shareholders to pay only 20 percent tax instead of 50 percent on dividends. “Another huge benefit,” Chikorel said.
The change in attitude is leading to a more positive stance from the banks, which until now have refused to open accounts for cryptocurrency-based companies. “At least one of the big banks” is willing to consider opening accounts, subject to strict conditions, he said.
“This is a breakthrough. It’s like the first swallow of spring. It’s the first one, but if they will open the doors, others will follow. It’s not approved yet. It’s still the main obstacle for those companies but I think we see signs of solutions,” Chikorel said.
Israeli companies with revenue from ICOs abroad are actively negotiating with the tax authorities to repatriate their funds and pay tax, using innovative solutions including brokers, escrow agents, and inter-company transfers to bypass the ban the country’s banks have imposed on them, Adereth said.
“These companies are going to the tax authorities and saying: We did an ICO, we raised funds in ether, we have earnings, we wish to pay taxes but we’re only allowed to pay taxes in shekels. We’re willing to pay whatever you tell us, just find a solution how we can pay you,” he said.
“The banks are also afraid of the U.S. regulator,” he said. “The more they will open up to see there are technological solutions to some of the issues that bother them on anti-money-laundering and know your client, how actually each bitcoin can be tracked to its origin and all the wallets it passed through in the middle, they will accept solutions in the end.”