As a rule, everyone wants their options to fall under the 25% capital gains tax track stipulated in Section 102 of the Ordinance. Everyone also hopes that Section 102 will apply to the options granted to them, given the deferral of the tax event until the shares are sold or received from the trustee.
However, many clients who consult with us do not meet the conditions of Section 102 and the 25% capital gains tax track. In some of these cases, a relevant solution can be found through specific tax planning advice.
Main Obstacles and Possible Solutions
The first obstacle
Is the definition of an employer in Section 102, which only applies when the options are granted by an ’employing company’ as defined in Section 102. This includes an Israeli company, a sister company of an Israeli company, or a parent or subsidiary of an Israeli company. Therefore, if the client is employed in Israel by a foreign company without a related entity in Israel, they cannot benefit from Section 102 but would instead receive stock warrants typical of options received by an investor in the company, and Section 3(i) of the Ordinance would apply—resulting in earlier taxation at marginal rates.
Is there a solution?
Sometimes, through tax minimization consulting. Occasionally, it may be relevant for the foreign company to establish a permanent establishment in Israel, subject to approval by the tax authorities and with additional implications. At times, it is indeed relevant for the foreign company to open a subsidiary in Israel (for other reasons as well). It is also possible to try to apply for a ruling if there are significant and substantive reasons for applying Section 102 of the Ordinance.
The second obstacle
Is the definition of an employee. To benefit from the conditions of Section 102, one must fit the definition of an employee outlined in this section. An employee is defined as ‘including someone who holds a position in the company, except for a controlling shareholder’. That is, an employee who holds 10% of the rights in the company or the right to appoint a manager and becomes a controlling shareholder as a result of the allocation—Section 102 will not apply to the options.
Is there a solution?
Each case should be discussed on its own merits; sometimes we recommend separating the options so that at least some of them may fall under Section 102.
The third obstacle
Involves freelancers who provide services and issue invoices to the company.
The solution
Is to examine whether an employee-employer relationship exists according to the criteria of jurisprudence and whether Section 102 could apply (provided that the additional conditions specified in Section 102 are met).
How are those options that do not fall under Section 102 taxed?
Such options are taxed as employment income or business income at marginal rates according to Section 2 of the Ordinance and often according to Section 3(i) of the Ordinance at marginal rates, depending on the case facts and, among other things, if the option is tradable. In cases where there is no connection to employment and it is purely an investment, entirely different rules apply.
In summary, there are limitations and complexities to applying Section 102 of the Ordinance, but expertise in the field can yield significant tax savings. For more details, contact us.
