As always, consult experienced tax advisers in each country at an early stage in specific cases.
By LEON HARRISAn electronic board displaying market data is seen at the entrance of the Tel Aviv Stock Exchange, in Tel Aviv, Israel January 29, 2017.(photo credit: BAZ RATNER/REUTERS)
There has been high drama in the stock options world. The Israeli Tax Authority issued a circular that appears to aim at exits – IPOs and takeovers – but largely misses. But the ITA also sneaked in a ruling that appears to encourage yerida - emigration from Israel!Stock (share) options are common in Israeli hi-tech and other sectors.The BasicsEmployees holding under 10% of a company receiving stock or stock options in a company may enjoy a 25% tax rate instead of up to 50% if the stock or option instruments are held on their behalf by an approved trustee for at least 24 months. Moreover, the tax may be postponed until the stock is sold. This is known as the “capital track” – the employer gets no expense deduction in this case. There is the less popular “income track” in which the employer gets an expense deduction and the employee pays up to 50% tax.Various conditions apply. In particular, the ITA must be notified at least 30 days before the stock/option plan is implemented. If the employer company is compensated on a cost plus basis (e.g. for R&D), the Supreme Court ruled in 2018 that the employee gain should be included in the costs.Two-Year Minimum Vesting PeriodOn the capital track, the “end of the period” should be at least 24 months after the grant of the stock or options. If the exercise date is sooner, any gain is taxed as salary at up to 50% (ITO Section (b)(4).Does the “end of the of the period” need to be fixed in advance?The ITA thinks so. In a new circular, the ITA says that the rationale for options is that employees to shoulder a risk (Circular18/2018 of December 5, 2018). The ITA claims that if the vesting is conditional on performance (e.g. sales or R&D progress), share price or exit (see below), the vesting period only starts, not ends, upon the occurrence of such a conditional event. According to the ITA, the terms of the option/stock plan should be: fixed, quantifiable, pre-defined upon grant, not arbitrary, with vague vesting periods, or discretionary.Exits: The ITA circular attracted widespread controversy for stating that if vesting is conditional on an exit – IPO or takeover – employees will pay up to 50% tax on the gain, because these terms are not “clear, quantifiable or final.”Is the ITA right?We doubt it. Most stock/option plans have fixed vesting periods of a number of years and conditional vesting is rare. But the ITA might be reading things into the law. The circular itself admits “the legislature did not fix rules regarding vesting and/or vesting conditions” (Paragraph 1, Page 2). It remains to be seen whether a conditional vesting case will reach the Israeli courts.The Emigration RulingIn a separate development, the ITA published no-name ruling (0989/18 of November 7, 2018), which dealt with a Israeli software person who left Israel to reside and work for the same group in the US in September 2011 and returned to reside in Israel in August 2016. While he resided in the US, he was granted US stock options (not approved under ITO Section 102 apparently), which vested partly before and partly after his return to Israel. What happens when he sells the underlying stock?The ruling overturns previous ITA rulings and claims that the gain is salary, which is taxed upon receipt. Therefore, if the individual sells the US options after returning to live in Israel, the full gain is taxed as salary at rates of up to 50%, but a credit for US taxes may be given for the portion of the vesting period when he was a US resident on a pro rata basis.But, significantly, if the individual leaves Israel to reside abroad a second time and then sells, he will not be taxed on the portion of time he is a foreign resident.CommentThe emigration ruling apparently encourages people to move abroad and avoid Israeli tax on stock option gains. Moreover, there is no mention in the ruling of Israel’s “exit tax”, i.e. capital gains tax on deemed sales of assets if a person stops residing in Israel – presumably because the ITA regards the gain as salary, not from an asset sale. So the ITA appears to be giving two prizes for emigration – no tax on option gains arising after leaving Israel and no exit tax. Perhaps the ITA should reconsider the ruling and the circular? As always, consult experienced tax advisers in each country at an early stage in specific cases.leon@hcat.coThe writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.
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