Your Taxes: Employee Share Options Update

In the start-up nation, many hitech employees enjoy share (stock) plans and share option plans.

In May 2018 the Israeli Tax Authority (ITA) published a new batch of tax rulings which clarify Section 102 of the Income Tax Ordinance (ITO). What did the ITA say?

Section 102

Section 102 of the ITO allows employees to postpone tax on the benefit until they cash it in, if certain conditions are met. An approved trustee must hold the options or resulting shares until the tax is paid. Employees must remain with less than 10% control.

There are two alternative tracks.

If the income track in which employees pay tax at rates ranging up to 50%, and the employer company receives an expense deduction. The minimum holding period is a year.

If the capital track is adopted, the tax to the employee is limited to 25% if the employer agrees to forego an expense deduction regarding the share/share option gain. The minimum holding period is two years. If the shares are publicly traded, or about to be, when the options are granted, the gain at that point is taxed at regular rates up to 50% (instead of 25%).

In practice, the capital track is far more popular than the income track.

Repricing the options:

In a new ruling (4253/18) the ITA allowed a private company to change the exercise price for turning options “out of the money” into shares, upwards or downwards, to arrive at a uniform exercise price.  This is done by filing tax form 911. But the minimum holding period runs from the date of re-issuing the re-priced options.

Limited Partnership:

A new ruling relates to employees of a company which is the general partner in a limited partnership (LP) in the oil and gas sector going public on a stock exchange. Normally the options must be issued by an employing company or its parent. Section 102 treatment was allowed for options issued by the LP provided it agrees to be treated like a company for all Israeli tax purposes (Ruling 1138/18).

Vesting Period Switch:

The ITA’s position is that making the vesting period end upon an exit (i.e. acquisition) does not comply with Section 102, resulting in taxes up to 50% sooner for employees. A new ruling (2775/18) says that if the vesting period is switched to at least two years, this period will begin on the earlier of directors’ board approval or application to the ITA for approval of a plan.

M&A Option:

To avoid abuse, the ITA normally stipulates that there be no call or put options. In a new ruling (9165/18) the ITA allowed Section 102 tax breaks in a company where an investor was allotted new shares giving 20% control and had an option to buy the other 80% of the shares and options. But the exercise price set for shares and options granted should reflect the resulting market value when granted – any discount is taxed as salary at rates up to 50%.

Service Provider Becomes Employee:

Normally service providers cannot enjoy Section 102 tax breaks, instead they pay up to 50% Israeli tax when they exercise any options from a company they provide services to. In a case where a service provider in an option plan became an employee, the ITA gave a negative ruling – still no section 102 tax breaks (5561/18). The ITA says that Section 102 requires participants to be employees of a company when the shares or options are first allotted. Comment: Some disagree with the ITA interpretation – perhaps the participant should be an employee by the time shares are allotted (issued) not when the options are first granted?

Kontera Case:

As mentioned in another recent article, the Israeli Supreme Court sided with the ITA and ruled that if an Israeli company is compensated by a foreign company on a “cost plus” basis, share option gains must be treated as a cost for Israeli company tax purposes. This case is causing reverberations in some multinational groups.

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

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