Your Taxes: Recent rulings on share options

Here is an update on recent Israeli tax rulings relating to share and option plans.

October 25, 2016 22:24
4 minute read.

Money. (photo credit: INGIMAGE / ASAP)

The children of Israel in biblical times sat in succot and ate manna from heaven. Modern Israelis sit in air-conditioned offices and receive shares (meniot), share options and restricted share plans from their employers.

Here is an update on recent Israeli tax rulings relating to share and option plans.

Taxation of options, an overview: Plans approved under Section 102 of the Income Tax Ordinance can both reduce Israeli tax and defer it until cash is realized if various conditions are met.

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The capital-gains approach is the most popular alternative in practice for employees with less than 10% ownership of the company. Under this approach, the gain from options or shares is taxed at a fixed rate of 25%, and both the employer and employee are exempt from National Insurance Institute payments. The employer is not entitled to any expense deduction for tax purposes regarding the options.

There must be an approved Israeli trustee who holds the options or shares for at least 24 months. The tax is deferred until the employee sells the options or shares or withdraws them from the trustee.

Section 102 plans must be in a prescribed format and notified to the Israel Tax Authority (ITA) at least 30 days before the plan is first implemented.

Late application for dollar-based plan: In a tax ruling on the options related to stock of a US publicly traded corporation, the employer did not realize it had 45 days to elect a dollar basis when calculating the taxable gain employees faced. The ruling allowed an extension of this deadline provided it was applied consistently to all share-option plans of that employer.

Adding exit priority to worthless options:
In another ruling, investors received preference shares with priority in any exit transaction. Employees held options to ordinary (common) shares with no such rights, making them out of the money and worthless. To give the employees an incentive, it was proposed to bolt onto the existing share-option plan an additional new plan relating to preferred shares with exit rights at a pre-agreed percentage of the investors’ rights in both cash and share deals. There would be no repricing or revesting (over a different vesting period) of the existing ordinary share options. There would be no call or put options.

The ruling allows the Section 102 capital approach to be applied provided various conditions are met, including the following: • The exit consideration must come from a third-party acquirer, not the company or any party holding 50% or more in it, nor a public share issue on a stock exchange; • If the share consideration per share paid to the employees exceeds the average price per share paid for all shares of the company, on a fully diluted basis, the excess is taxed as salary (up to 50% tax); • A nine-month waiting period is prescribed before any exit transaction; • The preferred share options must be on a named basis (not an employee pool) and deposited with the Section 102 trustee; • The gain is treated as derived in Israel by an Israeli resident; this means no exemption for olim or foreign resident employees.

Private company: In the case of private companies, the ITA is worried that options or shares would be issued to favored employees at an undervalue. Therefore, in 2014, it issued a tax ruling and a “green channel” procedure for implementing it (Form 923).

Form 923 applies the “net exercise” approach. The employee exercises options and converts them to shares of the company without payment or by paying just the par value of the stock. But the number of shares depends on the paper gain upon conversion.

For example, a company issues 10 options to an employee, with a conversion price of NIS 20 each. The market price of the shares upon conversion is NIS 100 each. So the total conversion price is NIS 200, and the paper gain then is NIS 800. So eight shares can be issued upon the conversion. If more shares are issued, they are taxed at marginal regular rates of up to 50%.

A new tax ruling may apply if an employee leaves the employment of a company (in this case the Israeli subsidiary of a foreign private company) and provides no further services to the group.

In such a case, the exercise price may be at market value “known” at the time of the grant. The consideration should be the market value at the time of the exercise and/or sale.

Any difference between the two market values (upon grant and upon exercise/sale) will be taxed as salary (up to 50% tax), and only the balance of the gain may be treated as capital gain (25% tax).

The consideration must be based on a market valuation of the parent company by an external appraiser based on relevant economic and business factors, including cash flow, liabilities, ability to function as an independent unit and as a going concern, and financial stability.

The Israeli subsidiary company or companies may not claim an expense except regarding the salary component.

As always, consult experienced tax advisers in each country at an early stage in specific cases.

[email protected]

Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.

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