UNFOLDINGIsraeli Market Developments

Welcome to the sixth issue of Unfolding, the quarterly newsletter of

Herzog Fox & Neeman, Israel’s leading international law firm. Once again,

Unfolding provides updates on developments in the Israeli marketplace,

including legal and regulatory developments. Unfolding also highlights

significant business trends and notable transactions taking place in Israel

or with a particular Israeli flavour.

Contents:

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

CENTER FOLD Legal Developments - Critical Information for New Immigrants and Returning Residents Regarding Tax Benefits

THE FOLD OF THE MATTER Updates and Information on the Developing Energy Sector in Israel

THE MANY FOLDS OF HFNHFN Highlights

Contacts:

Meir Linzen, Managing Partner, linzen@hfn.co.il

Alan Sacks, Head of HFN’s International Practice, sacksa@hfn.co.il

Gil White, International Relationships Partner, white@hfn.co.il

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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

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

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.

For more information about the latest developments in the Israeli market, please contact

Alan Sacks, Head of HFN’s M&A and Banking and Finance Departments

sacksa@hfn.co.il or on +972-3-692-2072

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.

CENTER FOLD Legal Developments - Critical information for new immigrants and returning residents regarding tax benefits

A New Governmental Proposal to Significantly Narrow the Tax Benefits for New Immigrants and Returning Residents in Israel

Cancelation of the exemption from reporting obligations.

Death of a settlor of a trust who is a new immigrant.

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 –

(i) 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.

(ii) 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).

The Law for the Strengthening the Enforcement of Labour Laws

The Law for the Strengthening the Enforcement of Labour Laws

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.

For more information about the latest developments in Tax, please contact Meir Linzen, Head

of HFN’s Tax Department

linzen@hfn.co.il or on +972-3-692-2035

Proposed changes in taxation of foreign Trusts

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.

Independent Power Plants

Solar Power

FOLD OF THE MATTER Updates and information on the developing energy sector in Israel

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.

For more information about the latest developments in Energy, please contact Mark Phillips,

Joint Head of HFN’s Energy and Natural Resources Department

phillips@hfn.co.il or on +972-3-692-2072

Oil and Gas

HFN continues to lead the Israeli market in the 2013 Chambers Global rankings, with six practices

ranked in Band 1 and HFN lawyers named as leading individuals 28 times, the most of any law

firm in Israel.

HFN has been named a Tier 1 law firm in eight practice areas in the 2013 Legal 500 rankings. In

addition, nine partners are recognised as leading individuals and 20 are recommended.

HFN again leads the Israeli market in the 2013 BDI rankings. HFN has 17 practice areas ranked as

Tier 1, and an additional two ranked as Tier 2.

HFN is again ranked in 18 practice areas, of which 17 are recognised as “Leading”, in the 2013

Dun and Bradstreet rankings.

HFN is the only law firm to be recognised for Business Excellence in the 2013 Dun & Bradstreet

awards for “exceptional business results and material impact on the Israeli economy”.

Project Finance Magazine has named the Ashdod and Ramat HaNegev financing as the EMEA

Power Deal of the Year 2012. HFN advised the syndicate of lenders (arranged by Bank Leumi

Le-Israel), in this complex and innovative transaction which saw two separate cogeneration power

plants financed as part of a single financing transaction.

THE MANY FOLDS OF HFNHFN Highlights

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