The Israeli Tax Authority now accepts that an M&A deal accelerates vesting – it didn’t always before if the start of the vesting period wasn’t clear-cut. This means Israeli employees in an ESOP (employee stock/share option plan) are more likely now to enjoy Israeli tax breaks (25%-30% tax) if an Israeli company gets sold. But it remains a complicated issue.

The Israeli Tax Authority (ITA) has just issued a “Professional Position Paper” (1/2025 of March 11, 2025) regarding Israeli taxation of employee share (stock) option plans (ESOPs) in the event of an exit (M&A deal) or an initial public offering (IPO).

If the ITA thinks the conditions are not met, employees in an ESOP may face an income tax bill of up to 50% while the founders may only pay 25%-30% capital gains tax.

The Israeli hitech sector thrives on dreams of a successful exit. So does the new ITA position paper clarify things?

The issue at stake relates to the two year minimum vesting period. This means how long the employee must wait to take ownership of options or shares in an ESOP. As explained below, the ITA aligns vesting with parking shares with an approved Trustee.

Tax regulations accelerate the end of the vesting period to the date of an exit.

But the ITA complicates things by saying perhaps the vesting period never started!!

The Position Paper tries to clarify these vesting complications…..

The ESOP Tax Breaks in Israel

Section 102 of the Israeli Income Tax Ordinance (ITO) generally prescribes a 25%-30% tax rate for an ESOP instead of up to 50% for salary bonuses AND this is deferred until an employee receives cash, if various conditions are met. An ESOP may relate to options or shares (stock) including reverse stock units (RSUs).

In brief, Section 102 conditions include: (1) The “capital” track must be elected (rather than the “salary” track); (2) The options or shares must generally be parked at an approved trustee for at least 2 years; (3) Approval of the ESOP and the Trustee must be requested upfront from the Israeli Tax Authority (ITA) at least 30 days before the ESOP is implemented. Starting in 2025, approval requests are filed online.

(4) Only employees entitled to under 10% of the shares or control rights are eligible; (5) If the ESOP relates to shares/stock of a foreign parent company, there must be an Israeli annex superimposing Section 102 conditions on Israeli employees; (6) Other conditions also apply.

In practice, Section 102 ESOPS are popular in Israel because of the tax breaks.

What Happens To An ESOP On An Exit?

Section 102 regulations accelerate  the end of the trust/vesting period on an exit if: (1) all the shares or options are sold as part of a sale of at least 80% of the issued share capital of the company to an unrelated purchaser, or (2) if there is a sale of all the assets and activity of a company (not to a major shareholder) followed by a voluntary liquidation of the company within 6 months.

What Did The ITA Say About Exits Until Now?

Until now, the ITA focused on the start of the ESOP vesting period. If the start of the vesting depends on meeting performance milestones (sales, R&D, etc) the ITA’s position is that vesting begins when the outcome is known and final. If vesting only occurs upon an exit, that was not “probable” enough until now for the ITA, meaning up to 50% salary taxation on an exit (ITA Tax Circular 18/2018, ESOP approval request question 14).

What does the ITA Position Paper now say?

The ITA homes in on the vesting acceleration trigger.

In the case of a “Single Trigger Acceleration”, vesting occurs if all or most shares or assets of the company are sold or if there is an IPO. The ITA now says tax breaks for ESOPs should apply as Section 102 is not infringed.

In the case of a “Double Trigger Acceleration”, vesting occurs if there is: (1) an exit, AND (2) termination of employment when an exit occurs. The ITA now says tax breaks for ESOPs should apply as Section 102 is not infringed. However, if the cash received by the employee is more than the share price upon the closing date, the excess portion is apparently taxed as salary at up to 50% according to a prescribed formula. But, if new shares are issued in exchange for old unvested shares or options of terminated employees under a double trigger, they may apparently qualify for beneficial Section 102 taxation.

To sum up:

Israeli employees in an ESOP (employee stock/share option plan) are more likely now to enjoy Israeli tax breaks (25%-30% tax) if an Israeli company gets sold in an exit. But it remains an over complicated issue.

Comment:

The clarification in the ITA Position Paper is written in a hedged ambivalent style and there are no examples. In cases of doubt, consider adding your ESOP to the list of things to include in an exit tax ruling request. In any Israeli exit, a tax ruling is generally needed anyway for such matters as collecting capital gains tax from Israeli resident shareholders,

Next Steps:

Please contact us to discuss any of the above matters further, or any other matter.

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

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© Leon Harris 14.3.2025