Dr. Avi Nov Adv.
The taxation of employees’ option plans in Israel is generally divided into two regimes. One set of rules applies to plans in which a trustee holds the options. This regime accords beneficial tax treatment to the employees, as explained below, including the characterization of profits as capital gains and the deferral of the tax event until the shares are sold (rather than when the options are granted or exercised).
The other regime applies to options not held by a trustee (see: Non-trustee option plans). In this regime, the employees do not enjoy similar benefits as in the first mentioned one.
Section 102 of the Israeli Income Tax Ordinance [New Version] 1961 (the "Ordinance"), regulates the taxation of employees’ options and other models of equity-based compensation. Under Section 102, employees who are Israeli residents for tax purposes are subject to either capital gain tax or ordinary income (employment) tax, upon the exercise of their options, as provided by the specific tax route elected under Section 102 of the Ordinance.
Basically, if the “capital gains tax” route is elected, the employees will be subject to capital gains tax at the rate of 25% (except that portion of the profit which existed at the time of grant).
However, if the “ordinary income tax” route is elected or applies in the absence of qualifying conditions for the capital route, then the employees will be subject to tax at the holder's marginal tax rate. The taxation pursuant to Section 102 is payable by Israeli employees employed by Israeli or foreign companies.
The “capital gain tax” route
The employee’s income deriving from the allocation of options to shares of the employer company is usually not subject to tax at the time of allocation, but will be subject to tax upon the earlier to occur of: (i) the sale of the options/shares by the trustee; or (ii) the transfer of such options/shares from the trustee into the name of the employee.
The employee’s aforesaid income shall be deemed a capital gain (and not employment income) having regard to the value of the benefit and capital gains tax at the rate of 25% shall be payable by the employee.
The “ordinary income tax” route
The employee’s income deriving from an allocation of such options in the employer company shall generally not be subject to tax at the time of the grant. The employee shall be subject to regular income tax, as well as National insurance fee at varying rates, in respect of the benefit gained by the employee upon the earlier to occur of: (i) the sale of the options through the trustee; or (ii) the transfer of the options from the trustee into the name of the employee.
Please note that this summary does not discuss all the details of the pertinent laws, rules and regulations that may apply in this matter, and it serves to give you an overview of the legal situation.