Companies Forum:
Developing an Open and Free Crypto Industry in Israel

Opening a bank account is one of the first actions of any company. However, once a company wishes to open a bank account and discloses that it deals with digital assets, the banks refuse to serve the company or require the company’s attorneys to declare that funds originating in a digital asset will not be deposited in an Israeli bank account - a statement that, naturally, the company's attorneys cannot provide. It is important to note that without a bank account, the company cannot pay its employees, suppliers, or tax authorities. Therefore, the banking policy practically prevents establishing digital asset companies in Israel. On the other hand, the US and Western European countries employ a completely different approach, and companies focusing on digital assets can open a bank account quickly. This is one of the key reasons why Israeli entrepreneurs who engage in the field transfer company management abroad. Without an Israeli bank account, it is impossible to establish and operate a business in Israel. Therefore, the commercial banks practically have the power to decide which company will work in Israel and which business will be forced to operate in another country. In a report from May 2021, the Israel Competition Authority stated that this barrier damages the development of fintech activity in Israel in general. Within fintech, this barrier is particularly effective when it comes to businesses in the crypto industry. According to the Competition Authority report, banks often do not outright “refuse” to open an account; instead, they drag their feet, adding demands upon demands in a never-ending due diligence process while clarifying to the applicant that this is a hopeless process. Those who have sought to open an account understand that they certainly will not be able to do so in a reasonable time and see no point in continuing the struggle (which may end in an official "Refusal to open an account" that will hurt them further down the road with other financial institutions). The result is that the business is established in another country (or transferred there), and the fact that another company left Israel because the banks did not find it appropriate to allow it to operate is left unnoticed. The inability to open a bank account is perhaps the most sweeping and far-reaching barrier to Israel's crypto industry development. Still, it exists “below the radar” in its entirety, and not a single official complaint to the Central Bank of Israel may be found, let alone legal proceedings against banks. It is also essential to note that crypto companies are blocked, in a sweeping and challenging way, even when they are not engaged in a regulated financial service that requires licensing (e.g., companies focusing on technology or services provided to other companies in the market.) Almost none of the recommendations of the Competition Authority presented in the report have been implemented. These recommendations included: establishing an inter-ministerial team to formulate proper practices and white flags; rapid promotion of the licensing process; and completion of legislation regarding the regulatory sandbox. One recommendation that has been implemented is completing legislation prohibiting money laundering. Still, the resulting change in the policy of the Bank of Israel was not yet published (draft of Proper Banking Procedure 411, published following the legislation, does not refer to companies whose business is in the cryptocurrency domain.) We believe that it is necessary to act quickly to implement the recommendations. In particular, consideration should be given to legislation of the inter-ministerial team’s establishment to ensure the cooperation of all the regulators involved. In particular, attention should be paid to addressing blocked businesses despite not being regulated in Israel.

This sabotages activity and prevents payments to suppliers and employees, office leases, and anything related to the company's day-to-day operations. Companies that have already overcome the barrier of opening bank accounts encounter arbitrary blockages of bank transfers simply because the source of the money deposited is in the sale of digital currencies. It should be noted that, naturally, companies engaged in digital currencies cannot operate without accepting funds from digital currencies while still complying with all the necessary money laundering and terrorist financing prevention rules. In this regard, we should also add the inability of employees to deposit funds received from selling tokens paid to them as wages (even though they were taxed at 50%!) and the employer's inability to use funds yielded from the sale of digital currencies to pay salaries or bonuses.

Inability to comply with the law and pay taxes for the sale or exchange of digital currencies under the regulation of the Israel Tax Authority because the Tax Authority receives payments only from Israeli banks that, as mentioned above, block deposits of funds originating in digital currencies. Using digital currencies imposes frequent reporting and tax obligations on the venture. However, when an enterprise or, in many cases, the entrepreneurs want to pay the tax legally, they can not do so because the tax authority only collects the tax from an Israeli bank account. At the same time, banks in Israel refuse to accept funds originating in digital assets or open bank accounts for companies in the field. Non-payment of the tax imposes interest payments, fines, and even criminal liability on the enterprise. An interim solution allows payment vouchers to be issued by the Tax Authority, which will be paid directly by licensed providers of currency services. Nevertheless, these entities fear that these transfers would be flagged or outright blocked by the banks, and therefore, regulatory intervention is necessary. Moreover, wiring funds to licensed currency service providers significantly increase transaction costs. Institutional entities currently charge about 4% of the amount of money transferred to them for the tax payment, which reduces the profitability of operating in the field. Therefore, we think that the best solution is that the income tax payment will be made directly from an Israeli bank that would allow deposits originating from digital assets.

Failure to equalize the status of foreign investors in digital assets to the status of foreign investors in securities. Foreign venture capitalists who invest in startups that meet the conditions of Ruling 16A or the new bill promoted by the Ministry of Finance enjoy an exemption from paying tax in Israel for their shares, considered eligible investments. However, the law only applies to claims and not to digital assets. Therefore, foreign investors will not enjoy an exemption for investments in digital assets and will be required to pay tax in Israel. As a result, venture capital funds will refrain from investing in digital assets in Israel, and foreign investors will invest in digital assets in other countries through foreign venture capital funds. The same is true for hedge funds and private equity funds.

Prevention of token distribution as stock options provided to employees (according to section 102 of the Income Tax Ordinance) with a 25% taxation, similar to the taxation in the "traditional" IT industry. An IT company employee granted options or shares of the company is entitled to a tax benefit, whereby he will only pay 25% tax on the profits generated from the sale of the security, according to section 102 of the Income Tax Ordinance. In contrast, an employee in a company whose value is stored in digital assets rather than in shares and is granted digital assets or rights in such assets is not entitled to a similar benefit and must pay fruition tax (up to 50%) upon receipt of digital asset or defer the taxation until the sale of a digital asset. Therefore, an employee who receives a digital asset will pay double the tax of an employee who received equity options of similar value.

Many regulators impose rules or unclear or unfavorable policies that create uncertainty and regulatory burden. The non-regulation of the status of digital assets in Israel causes entrepreneurs who want to engage in the field to move to countries where certainty is provided by regulating the area of digital assets and creating an adapted regulatory environment that develops parallel to innovations in the field. Many entrepreneurs we meet fear misunderstanding on the part of regulators in Israel, which, in turn, results in procrastination in regulating and promoting the ecosystem, as well as on the part of Israeli law enforcement. They fear personal liability and reputation damage caused by activities unfamiliar to the regulator and unencouraged. Hence, they choose to distance their activities from Israel. The uncertainty exists mainly in the following regulatory aspects: a. Securities: In December 2020, the Securities Authority issued a precedent-setting decision stating that a virtual currency is a security. In addition, in March 2019, the final report of the Securities Authority was published regarding the examination and regulation of the issuance of distributed cryptocurrencies to the public. The Committee recommended, among other things, the imposition of disclosure requirements under the Securities Act on the allocation of cryptocurrencies constituting securities; considering the creation of an infrastructure for the establishment of a dedicated platform for cryptocurrency trading; and examination of the application of a model similar to crowdfunding for issuing cryptocurrencies. To date, no legislation has been formulated in the field, and statements by the Chairman of the Securities Authority that any public investment in crypto should be considered an investment in security and be subject to all related laws add to the uncertainty. B. Financial Services Provider License (under the Israel Capital Market Authority, Financial Services Provider License under the Financial Services Supervision Law (Regulated Financial Services, 2016 (a.k.a. “The Supervision Law”)): Companies dealing with digital assets may require licensing by the Capital Market Authority relative to the service they provide in digital assets, due to the law being worded very broadly and the definition of the term financial asset also includes "virtual currency." Today, the process of obtaining the license is very cumbersome and takes years(!) due to a heavy bureaucratic burden. In addition, the costs involved in getting the permit and the actions required to meet the licensing requirements are very high. They include, among other things, a series of reports to the Authority, capital requirements, a long list of required documents (in Hebrew), and corporate governance rules (including the appointment of local officers). Therefore, newly-established companies cannot finance this procedure. It should be noted that until a few months ago, the Capital Market Authority did not issue such licenses despite the change in legislation. Now, it aims to address hundreds of applications accumulated over a long period, causing significant delays in obtaining the permit. At the moment, almost four years have passed since the Authority was authorized to grant licenses in the field of digital currencies. Still, no permit has been issued, despite the law stipulating that the Supervisor will decide on license applications within 70 days. C. Anti-Money Laundering Authority: The Authority is an intelligence department in the Ministry of Justice whose guidelines affect the behavior of banks and financial services providers. The legislation was only published recently (in November last year), and some of the provisions included in it are not in line with current technological developments and accepted international standards (such as a requirement for face-to-face identification of each customer.)