On September 17, 2024, an amendment to the Israeli income tax regulations with respect to the tax relief provided in relation to the allocation of stock options/shares to employees was published.
The taxation of employee stock option plans (ESOPs) in Israel is governed by Section 102 of the Israeli Tax Ordinance and the regulations promulgated thereunder. Section 102 allows employers to choose from several tax-favoured tracks for granting equity awards to employees. Under Section 102, an equity-based employee benefit plan may be established either with or without a trustee, a choice that then determines the tax treatment of the options. The company elects the tax route under which the ESOPs are granted at the time of grant, and certain tax routes require prefiling of documents and waiting periods.
An employer may choose for employee options to be taxed either as regular employment income or as capital gains. Options issued under a regular employment track will be taxed at regular income tax rates and the employer may recognise related expenses in the year when the employee sells.
Under the capital gains route, any gain will be taxed at a reduced flat rate of 25%, with an additional 3% surtax if relevant (compared to the top marginal tax rate of up to 50% on employment income).
Favourable tax treatment under the capital gains route can be granted only for ESOP plans held via a trustee.
If the relevant requirements are not fulfilled, the employee will pay the marginal tax applicable at the tax event, with social security and health insurance contributions as applicable to all work income.
The amendment provides technical instructions regarding the submission of employee option plans in accordance with the provisions of Section 102 through a trustee. The amendment applies to plans submitted on or after 1 January 2025.
Currently, the employer has an obligation to notify the Israeli Tax Authorities (ITA) of allocation plans through a trustee, at least 30 days before the first allocation is granted so that the plan can be reviewed by the ITA after the date of submission; however, approval is not necessary before implementing the plan. Under the rules prescribed in the amendment, the application must be submitted to the ITA for approval, which will create more certainty when implementing the chosen allocations through a trustee.
The current rules stipulate quarterly and annual reporting obligations regarding the implementation of the allocation plan for employees in all routes. To date, for technical reasons, the ITA has not enforced these reporting obligations.
Under the rules introduced in the amendment, companies will be obligated to file periodic reports (proposed to be online reports) within 120 days from the end of the quarter and the year. It is important to emphasise that noncompliance with these reporting rules for the selected route through the trustee will void the eligibility of the selected route.
As part of the amendment, a questionnaire was added to the reporting requirements that the company is required to complete when submitting an application for approval of the share allocation plan through a trustee. The purpose of the questionnaire is to collect information about the plan for the ITA regarding the chosen route (equity or work income route), whether the employer is a public or private company, and for global plans, whether an "Israeli annex" was attached to the global allocation plan. The questionnaire also includes questions about the rights attached to the shares, the vesting conditions of the allocations, the purchase options, and other details.
A significant part of the questionnaire is intended to determine compliance with the conditions of Section 102. It may be reasonable to assume that compliance/noncompliance with these conditions as determined from the questionnaire will be examined by the ITA in accordance with its positions on any relevant issues. Companies may present arguments within the framework of the questionnaire to explain any special situations regarding its ESOP plans; hence, completing the questionnaire accurately is important.
For more information on this topic, please consult your regular BDO contact or the author of this article.
Frida Weissberg
BDO in Israel
Taxation of ESOPs
The taxation of employee stock option plans (ESOPs) in Israel is governed by Section 102 of the Israeli Tax Ordinance and the regulations promulgated thereunder. Section 102 allows employers to choose from several tax-favoured tracks for granting equity awards to employees. Under Section 102, an equity-based employee benefit plan may be established either with or without a trustee, a choice that then determines the tax treatment of the options. The company elects the tax route under which the ESOPs are granted at the time of grant, and certain tax routes require prefiling of documents and waiting periods.An employer may choose for employee options to be taxed either as regular employment income or as capital gains. Options issued under a regular employment track will be taxed at regular income tax rates and the employer may recognise related expenses in the year when the employee sells.
Under the capital gains route, any gain will be taxed at a reduced flat rate of 25%, with an additional 3% surtax if relevant (compared to the top marginal tax rate of up to 50% on employment income).
Favourable tax treatment under the capital gains route can be granted only for ESOP plans held via a trustee.
If the relevant requirements are not fulfilled, the employee will pay the marginal tax applicable at the tax event, with social security and health insurance contributions as applicable to all work income.
New Rules
The amendment provides technical instructions regarding the submission of employee option plans in accordance with the provisions of Section 102 through a trustee. The amendment applies to plans submitted on or after 1 January 2025.Currently, the employer has an obligation to notify the Israeli Tax Authorities (ITA) of allocation plans through a trustee, at least 30 days before the first allocation is granted so that the plan can be reviewed by the ITA after the date of submission; however, approval is not necessary before implementing the plan. Under the rules prescribed in the amendment, the application must be submitted to the ITA for approval, which will create more certainty when implementing the chosen allocations through a trustee.
The current rules stipulate quarterly and annual reporting obligations regarding the implementation of the allocation plan for employees in all routes. To date, for technical reasons, the ITA has not enforced these reporting obligations.
Under the rules introduced in the amendment, companies will be obligated to file periodic reports (proposed to be online reports) within 120 days from the end of the quarter and the year. It is important to emphasise that noncompliance with these reporting rules for the selected route through the trustee will void the eligibility of the selected route.
As part of the amendment, a questionnaire was added to the reporting requirements that the company is required to complete when submitting an application for approval of the share allocation plan through a trustee. The purpose of the questionnaire is to collect information about the plan for the ITA regarding the chosen route (equity or work income route), whether the employer is a public or private company, and for global plans, whether an "Israeli annex" was attached to the global allocation plan. The questionnaire also includes questions about the rights attached to the shares, the vesting conditions of the allocations, the purchase options, and other details.
A significant part of the questionnaire is intended to determine compliance with the conditions of Section 102. It may be reasonable to assume that compliance/noncompliance with these conditions as determined from the questionnaire will be examined by the ITA in accordance with its positions on any relevant issues. Companies may present arguments within the framework of the questionnaire to explain any special situations regarding its ESOP plans; hence, completing the questionnaire accurately is important.
For more information on this topic, please consult your regular BDO contact or the author of this article.
Frida Weissberg
BDO in Israel