The Tax Authority’s Guidelines Exclude Granting Options to Employees from Application of the Provisions of Section 102 of the Ordinance
On February 11, 2021, our firm issued a client circular on receipt of options under Section 102 of the Ordinance, in which we stated that over the years the Israel Tax Authority has developed a kind of oral law in connection with granting employee options under Section 102 of the Ordinance, beyond the few simple conditions the Legislator stipulated in the Section itself.
The capital track in Section 102 of the Ordinance enables the taxation of the allocation of capital instruments, which have been deposited and held by a trustee during the period set forth in the law, as capital gains (a 25% tax rate) and not as employment income for the employee (a marginal tax rate which could reach 50%), provided the remaining conditions stipulated in the above Section are met.
In order for the allocation of capital instruments a company executes to its employees to come under the auspices of the provisions of Section 102 of the Ordinance, the allocating company must submit a detailed plan to the Tax Authority, in which it must state, inter alia, the types of capital instruments it will allocate and the conditions of allocation (the “Plan”). The Tax Authority is authorized to study the Plan and decide, within 90 days of the date on which the Plan was submitted to it, whether it approves it or not. Yet, if the Tax Authority neither approves nor rejects the Plan during this time period, the Plan would be seen as approved.
Recently, our firm encountered several cases in which the question arose whether a 25% tax rate could be applied to the allocation of capital instruments that include additional conditions, which do not conflict with the capital gains track in Section 102 of the Ordinance yet are incompatible with the oral law the Tax Authority has developed.
In one case that came before us, the question arose whether the allocation to employees of options whose maturity period would commence when the allocating company’s shares are offered in an IPO in the future, excludes the options from the application of the provisions of Section 102 of the Ordinance. It should be noted that the company included this condition in the Plan it submitted to the Tax Authority. This question arose due to the Tax Authority’s position, as expressed in Income Tax Circular 18/2018 on the topic “Capital-Based Remuneration Whose Maturity Is Performance-Dependent”, as well as Tax Ruling 2775/18 on the topic “Cancellation of Options Whose Maturity Depends on an Exit Event, and Their Allocation Under the Capital Gains Track Through a Trustee, Under Section 102 of the Ordinance – An Agreed Tax Ruling”. These stipulated that the addition of a maturity condition dependent on a share offering or exit event, excludes the capital instruments allocated from Section 102 of the Ordinance.
In another case that came before us, the question arose whether the company’s consent to extend the option realization period for an employee when the employee left the company, excludes the options from application of the provisions of Section 102 of the Ordinance. This question arose due to the Tax Authority’s position, as expressed in Tax Ruling 8597/17 on the topic “Changing Option Terms Within Termination of the Employer- Employee Relationship – An Agreed Tax Ruling”. This Ruling stipulated that changing the option terms within the termination of an employee’s employment, including extension of their exercise period, excludes the options from Section 102 of the Ordinance.
We might preface our words by stating that we hold the position that, if the Tax Authority does not approve or reject a Plan submitted to it within the time stipulated in Section 102 of the Ordinance, it should be seen as having approved the Plan in practice, including the terms included therein, provided the terms included therein do not conflict with the provisions of law. Support for our position can be found in Tax Appeal 55937-01-17 Shochat v. the State of Israel (the “Shochat Case”). Since the terms described in the cases above do not conflict with the provisions of the law, we believe that as long as the conditions do not conflict with the stipulations of the Plan they should not be seen as excluding the options from the application of the provisions of Section 102 of the Ordinance.
We might also state, regarding extension of the option exercise date when an employee leaves the company, that our opinion also conforms with the agreed tax ruling the Tax Authority granted in the case of Equitybee Technologies Ltd., which developed a platform connecting employees who hold options they received from a company under Section 102 of the Ordinance on the capital track, and who finish working for the allocating company, with external investors, who can grant the employees loans (up to the value of the amount of the options’ exercise premium), so the employees will be able to exercise the options before the option exercise date expires due to termination of their employment.
In summary, we believe that rights or duties a company chooses to attach to the capital instruments it allocates to its employees, which do not conflict with the provisions of law, do not necessarily exclude the capital instruments from the application of the provisions of Section 102 of the Ordinance, even if the Tax Authority has a different position. An examination must be conducted according to the concrete circumstances of each and every case.
 It is worth mentioning that an appeal was filed with the Supreme Court against the District Court’s decision in the Shochat Case, but in the end a settlement agreement was signed between the parties, which was granted the force of a Supreme Court decision, and therefore there is no binding precedent on the matter.