n M&A transactions where a corporation acquires an Israeli company listed on a foreign stock exchange, the Withholding Tax (WHT) mechanism often presents a significant hurdle. The primary challenge for the acquirer is the inability to identify thousands of public shareholders and determine their specific tax residency. A new Tax Ruling (3986/26) provides a procedural "Safe Harbor," allowing the deal to close efficiently by using a dual-trustee mechanism and clear eligibility criteria.
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The Bottom Line:
The Israel Tax Authority (ITA) has approved a streamlined mechanism for paying consideration in the acquisition of Israeli companies traded abroad. This arrangement applies specifically to "Public Shareholders" (holding less than 5% and purchased post-IPO). While foreign residents can enjoy a WHT exemption based on a simple declaration (up to a specific cap), the responsibility for withholding tax for Israeli residents shifts directly to local brokers who receive the payment gross. This ruling provides the acquirer with much-needed certainty and dramatically accelerates the closing process.
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Executive Summary: Key Findings

• Definition of "Public Shareholders": The arrangement applies only to holders of less than 5% of the share capital who purchased their shares after the initial listing on the foreign exchange.
• Conditional Exemption for Non-Residents: Foreign holders who declare their residency will receive the consideration gross. However, payments exceeding a specific "Payment Cap" (defined in the dedicated annex) will require an individual tax clearance from the ITA.
• Liability Shift to Israeli Brokers: Israeli brokers will receive the consideration gross from the trustee and will be solely responsible for withholding tax for their respective clients.
• Dual-Trustee Mechanism: The use of a Foreign Paying Agent for offshore funds and an Israeli Tax Trustee to manage reporting and local compliance.
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Background: The Challenge of Anonymous Shareholders

The case involved an Israeli software development company, traded on a foreign exchange since 2015, facing a 100% cash acquisition by "Company X." A critical factor was that the company held no real estate in Israel—a prerequisite for foreign residents to qualify for a capital gains tax exemption.

The structural problem: Shares were held through various foreign financial institutions and Israeli brokers, making it impossible for the acquirer to identify the ultimate taxpayer at the time of closing.
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Legal Analysis: The Three-Tier Payment Structure

The ITA recognized the need for an efficient mechanism that does not stifle the transaction. The tax arrangement separates the shareholders into three distinct populations:

1. Public Foreign Residents: These shareholders must complete a "Dedicated Annex" (Residency Declaration). If the consideration is below the agreed-upon cap, the trustee transfers the funds without withholding Israeli tax. Crucially, if the payment exceeds the cap, the automatic exemption does not apply, and a specific tax clearance must be provided.
2. Israeli Residents via Local Brokers: This is a major innovation of the ruling. The acquirer transfers the consideration gross to the Israeli broker, who then assumes the legal obligation to withhold tax according to Israeli regulations. This removes a massive administrative burden from the acquirer.
3. Non-Compliant Shareholders: For those who fail to provide the necessary declarations or clearances, the Israeli Tax Trustee will perform a maximum withholding at the source.
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Practical Takeaways for CFOs and M&A Counsel

For financial executives and legal advisors managing cross-border exits or mergers:

• Verify the 5% Threshold: Ensure that major shareholders (above 5%) or those who acquired shares pre-IPO are handled through separate, individual tax arrangements.
• Appoint an Israeli Tax Trustee Early: The Israeli trustee acts as the essential link, authorizing the Foreign Paying Agent to release gross funds. Seamless coordination between the two is vital for a timely closing.
• Manage the "Payment Cap": Inform foreign shareholders that payments above a certain threshold will trigger Israeli withholding unless they proactively obtain a tax waiver.
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FAQ

Q: Does Ruling 3986/26 apply to all shareholders in an acquisition?
A: No. It applies only to "Public Shareholders" who hold less than 5% of the company and purchased their shares after the initial foreign listing.

Q: Can foreign residents receive their exit proceeds without Israeli tax?
A: Yes, provided the company is not a "Real Estate Association" and the shareholder provides a residency declaration. However, payments above a specific cap require individual ITA approval.

Q: Who is responsible for withholding tax for Israeli shareholders in this scenario?
A: Under this ruling, the responsibility shifts to the Israeli brokers. The acquirer pays the broker the gross amount, and the broker manages the withholding for the end client.

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