STO Registration Procedures in Israel

Ran Hammer, General Counsel at Orbs Group. Mattan Erder, Regulatory Compliance Strategist at Orbs Group. (https://medium.com/orbs-network)

What are the main regulations that exist in your region if you’d like to launch an STO/ICO?

The main regulatory bodies governing STO/ICO offerings in Israel are the Israel Securities Authority (“ISA”), which governs securities law questions, and the Israeli Anti-Money Laundering Authority.

The last main regulator to consider is, of course, the Israel Tax Authority. See more on the three major regulators below.

Depending on the nature of the project, some ICO/STOs may also be subject to other regulators, such as the Bank of Israel or the Commissioner of the Capital Markets, Insurance and Savings, which govern certain financial entities.

Are there any examples of ICO/STO projects that have already complied with regulations? Do you consider their pick to be appropriate or not?

I am not aware of any project that has engaged in a public offering of security tokens or an offering of utility tokens that has been registered under the Israeli securities laws. This is natural due to the current lack of guidance from the authorities on how to do a registered offering of this type. Companies who comply with regulations in Israel do so by conducting a private offering to qualified investors or only conduct their offerings abroad.

What are the recommended legal arrangements (legal structure) for pre-sale (private sale) investment deals (ST buyout, SAFT, options, etc.)?

Most projects that I am familiar with have, due to the regulatory uncertainty, not conducted public offerings to Israeli token purchasers. Unless the ISA’s future guidance creates new exceptions or provides a clear pathway to registration, projects who want to sell to Israeli purchasers should probably do so only in a private offering, limited to no more than 35 purchasers or only to purchasers who are deemed “qualified investors.”

Israeli blockchain projects who are issuing a token have typically used SAFT-type arrangements.

What are the main liabilities of an STO team to the ST holders and who is in control over the fulfillment of this obligation?

Assuming no major regulatory changes, a security token that is issued in a registered public offering would have the same liabilities as a typical public company. The requirements would include publishing a prospectus, filing regular reports with the ISA, registering with an exchange (which in turn have their own rules), bans on insider trading, and more. The issuer of the security token would have the responsibility to fulfill these obligations.

In general, at this stage it would likely not make sense for most projects to try to conduct a public offering of securities tokens or a public ICO in Israel. The ISA still has not given a definitive view on whether “utility tokens” are considered securities or not, or under what circumstances. Even for security tokens, there is no framework or precedent for proper disclosures from the ISA and little guidance on how the various secondary market rules would be complied with (for example, there is no exchange registered in Israel for securities tokens).

Is there any special territory in your country that is a tax haven or has other beneficial regulations for cryptocurrencies and blockchain startups?

No special territory or geographic zone has been set aside in Israel. However, the Israel Securities Authority recently announced that it has joined the Global Financial Innovation Network’s cross-border regulatory sandbox program, so it may be possible for the blockchain and other fintech companies to receive some favorable regulatory treatment in that context soon.

In addition, Israel provides favorable tax breaks to technology companies that meet certain qualifications. In its most recent tax circular the Israel Tax Authority expressly stated that ICO companies who otherwise meet the definitions are eligible for these benefits. The benefits are increased for technology companies who locate their businesses in areas of Israel that are less economically developed, which are primarily in Jerusalem and the northern and southern regions. Qualifying companies with less than NIS 10 billion in revenue who are located in those regions are eligible for corporate tax rates as low as 6% (instead of 23% generally and 12% for qualifying companies located in central regions).

What is legal status of cryptocurrencies in your country?

In the two main areas of securities and AML/CFT things are still very much in flux.

The most significant development in the area of securities regulation is the Israel Securities Authority’s interim report on the regulation of public ICOs, which was issued on March 19, 2018. Like other market participants, we had the opportunity to meet and discuss issues with the ISA as they prepared their research. They actually did an amazing job of researching, understanding, and summarizing both the crypto space and the approaches adopted in various jurisdictions around the world. The 188-page interim report is by far the most comprehensive study of token sale regulation ever put to writing in Hebrew (although now it is somewhat outdated).

It is also very clear from that report and our own discussions with ISA committee members that they are not out to kill the market, but are looking to strike the right balance between allowing crypto business to flourish within Israel and protecting token/cryptocurrency holders’ rights. However, we are still waiting on a final report to find out what approach they are ultimately going to do and we haven’t seen a lot of activity from the ISA since they came out with the report. Clarity on this issue will make it easier for Israeli companies to plan their token sales.

The application of AML/CFT law to the crypto space is also still a work in progress. Virtual currencies have been defined as a “financial asset” under Israel’s financial services laws, so providing financial services in virtual currencies requires a license and compliance with other related regulations. However, the regulations on exactly which documents financial services providers are required to obtain from their customers and the required procedures for verifying the source of funds in the crypto space remain unclear. The Israeli Anti-Money Laundering Authority is scheduled to come out with regulations on these issues, but currently it is very unclear what compliance procedures are required for blockchain companies and for banks to open accounts for these companies.

The most important consequence of this uncertainty is that many banks are hesitant to deal with blockchain companies and they will refuse to open accounts, process some transactions, or receive certain funds. This has resulted in highly contested lawsuits, which have actually come out favorably for the blockchain community. Bits of Gold, an important local exchange, won a lawsuit against Bank Leumi that required the bank to lift a block on transactions from the exchange’s account. In a similar case, an individual who made money from sales of Bitcoin was able to prevail when Bank Hapoalim refused to open an account for him. The court ruled that the bank could not refuse to open an account only because the customer had been involved in crypto transactions.

In preparation for its planned release of its guidance, the AML authority has been engaged in serious conversations with a lot of market participants and appear to have a good understanding of the issues, so there is reason to be hopeful that these regulations will give clarity and allow blockchain market participants to operate in Israel in a compliant way.

Can you describe general/ special taxation schemes for cryptocurrency owners and token issuers?

Israel’s tax authorities have come out with two tax circulars that are fairly advanced and favorable for the blockchain industry.

According to the first circular, virtual currencies are considered to be a type of “financial asset,” rather than an actual currency. Therefore, virtual currency transactions made by individuals and not conducted as a business are generally subject to capital gains taxes. Capital gains tax is capped at 25%, which is a favorable rate compared to other forms of taxation in Israel.

The second tax circular deals with the taxation of ICOs and utility tokens. It allows ICO issuers to defer revenue recognition until the occurrence of certain events. The circular also clarifies the treatment of tokens given as compensation to employees and other service providers and it allows a choice between two different structures; one in which taxation is calculated based on the price at the time the tokens are exercised and one where taxation is calculated based on the price on the date the tokens are allotted. These rules give a good deal of flexibility to create a favorable structure.

In addition, the second circular makes it clear that blockchain and crypto companies take advantage of the special tax benefits that the government makes available to qualifying technology companies and other innovators, again creating favorable opportunities for blockchain companies. These tax breaks are significant, allowing a 12% corporate tax rate (and as low as 6% for those in economically undeveloped regions), instead of the typical 23% rate. One requirement to qualify for these benefits is that companies need to invest at least 7% of its revenues into R&D expenses. The second tax circular expressly states that developing blockchain technology and cryptocurrency activities can count as R&D expenses for purposes of calculating these tax benefits if all of the relevant conditions are met.

Do you have anything further to say about the legal nuances of cryptocurrency/token regulation?

The answers to all these questions reflect the current state of regulation, which is slowly being applied to cryptocurrency and blockchain technology. In the long term, it is doubtful that this approach can work as cryptocurrency and the blockchain develops. At some point, legislators and regulators will need to realize that this new type of asset requires its own unique regulatory approach.

In my experience, many blockchain tokens combine different elements — they don’t have the classic features of a security and are intended for practical use on a platform, but at the same time they are purchased and sold for investment purposes as well. Applying standard securities law rules, like limiting the transfer of the token to a closed group of trading platforms, could inhibit the effective use of such token on the platform for which it was initially designed, and therefore stifle innovation. At the same time, people purchasing the tokens for investment purposes should not be left without a fair disclosure regime, and markets should be protected from manipulation. It isn’t really possible to strike the right balance under the current framework, which takes an all-or-nothing approach.

Ultimately, countries that want to facilitate the growth of this technology will need to adopt fresh approaches that take into account the unique features of this new asset class. I am hopeful that Israel will be one of the countries that takes this initiative, and I have been involved in a variety of productive discussions between the blockchain industry and our local regulators. If all goes well, the answers I gave before will become outdated as new guidance tailored to the latest developments emerges.

Questions asked by Kirill Shilov

Entrepreneur, the product guy at Geekforge. Has answered over 10k questions on digital marketing and is now in the process of asking 10k experts about the way to technical singularity at formula.geekforge.io