Your taxes: Get your options right

In many companies, especially in the technology sector, shares (stock) or share options are an integral part of the salary package. The Israeli tax rules place heavy emphasis on using a trustee to hold the options or shares.

Types of plans

Shares and share options are addressed under detailed rules in Section 102 (mainly) or Section 3(i) of the Income Tax Ordinance (ITO). There are different rules relating to: (1) approved options for employees – capital-gains approach; (2) approved options for employees – ordinary income approach; (3) unapproved options for employees; (4) unapproved options for major (10-plus percent) shareholders and non-employees.

The employer selects the type of required plan prior to the date of grant and cannot change it for at least a year following the year in which options were first issued under the plan. 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.

Role of the trustee

When shares and share options are allocated by a company under an approved plan, they must be lodged with a trustee approved by the ITA. The task of the trustee is to hold the options on behalf of the employees until tax is paid. The trustee may be an employee or director/office holder who did not receive options under the plan, although major (10-plus percent) shareholders cannot be trustees. Section 102 plans must be in a prescribed format and notified to the ITA at least 30 days before the plan is first implemented.

Approved options for employees – capital-gains approach

This is the most popular alternative in practice as the employee pays reduced tax, which is deferred until he or she realizes a gain. The employer is not entitled to any expense deduction for tax purposes regarding the options.

Employees are deemed to realize a taxable capital gain upon the sale of shares after the exercise of options or upon the release of shares or options from trust (rare in practice), whichever is first. The gain is taxed at a fixed rate of 25%, and both the employer and employee are exempt from National Insurance Institute (NII) payments.

If the employer is a public company, any discount at grant will be taxed upon realization at regular income rates; the discount at grant being the difference between the exercise price and the average value of the company’s stock in the 30 days preceding the grant.

The options must be held in trust for at least 24 months after the date of granting and lodging them with the trustee (different rules apply to the options granted before 2006). If the holding period condition is not complied with (e.g., premature sale, etc.), the employee will pay regular income tax at his applicable rate, as well as NII contributions.

When do the shares or options have to be lodged with the trustee?

The ITA clarified the deadline for lodging options and shares with the trustee in a letter to the public on June 24, 2012, from Aharon Eliahu, the ITA’s senior deputy director for professional matters.

According to this letter, for each allocation of options or shares, the company must transfer to the trustee within 45 days after the board resolution (or resolution of authorized board subcommittee) the resolution and a list detailing the allocation, including personal details, class of securities allocated, the quantity, the vesting date, the realization premium, the expiry date and so forth.

In addition, in the case of options, the company has 90 days after the resolution date to transfer to the trustee the grant letters or other document with the employee’s consent. If the employee is late, he shoots himself in the foot.

In addition, in the case of shares, the company has 90 days after the resolution to transfer original share certificates registered in the name of the trustee on behalf of the employees concerned. If there are no share certificates, the company must transfer a copy of the share register showing the number of shares allocated to the trustee. If the shares are publicly traded, the company has 90 days to lodge the shares in the name of the trustee at the account of the relevant financial institution.

The trustee is expected to maintain on a real-time basis an orderly accurate record of the above documents. The allocation date is the date the board resolution becomes unconditional.

Can it all be done electronically?

Recently, the ITA published a tax ruling (No. 2584/13) dealing with restricted stock units (RSUs) allocated electronically via a website of the company’s stock administrator to employees who have passwords and consent electronically. The ITA ruled that this was okay, provided the electronic consent is done unconditionally by way of a secure digital signature that meets certain requirements in the Electronic Signature Law, 2001, and in the Income Tax Provisions (Bookkeeping Procedures) Regulations, 1973, as amended. Again, the allocation notice and documents must be transferred to the trustee within 90 days after the resolution.

What happens if the shares or options are lodged late?

Another recent ITA ruling (No.5943/13) deals with option grant letters signed by the employee but that were lodged more than 90 days the board resolution. The ruling scaled back the tax benefit of the capital-gains approach (25% tax instead of up to 50%) pro rata to the period of lateness relative to the total period from the board resolution to realization of the options or shares. The entire benefit was deemed to be Israeli-source income of Israeli residents. They were lucky to get any tax breaks at all.

To sum up

There is no option but to get it right for employee option/share arrangements in Israel. An approved trustee should be inserted into the share/option procedural loop for Israeli resident employees pursuant to a Section 102 annex to the plan.

This should be done as prescribed, in good time and recorded real-time.

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

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