Taxation of Options in General, and in Relocation in Particular
Planning to relocate from Israel soon? Considering which assets to sell before leaving, and which to sell at another time? If you hold options, it is advisable to also consider deemed taxation on those options .
What Are Employee Options?
An option is the right to purchase a share at an amount specified in an agreement. Sometimes it is a form of compensation granted to employees as part of a company’s development and growth, and sometimes it is granted because of common market practices, for example in the high-tech sector. In most cases, it is intended to retain employees, create an interest in the company’s success and growth, and sometimes serve as a bonus.
Generally, the right can be converted into a share at the end of a predefined period. The “exercise date” for tax purposes is determined under the rules of Section 102 of the Income Tax Ordinance.
Tax Rate Applicable to Employee Options
The applicable tax rate depends on the route chosen in advance by the allocating company. Under the employment income route, progressive tax of up to 47% will apply, and an additional 3% surtax may also apply under Section 121B, depending on the employee’s level of income. This rate also applies to an allocation that is not subject to Section 102, but rather to Section 3(i) of the Ordinance. By contrast, under the capital gains route, tax at a rate of 25% applies to the real gain only, while the inflationary amount is fully exempt from 2003 onward. Under this route as well, surtax liability may apply.
Comparison Between the Different Tax Routes
Route | Tax Rate | Advantages | Disadvantages |
Employment income through a trustee | Marginal tax of up to 47% | The employer may deduct expenses; vesting period of only 12 months | Generally high tax |
Capital gains through a trustee | 25% on the real gain | Taxation of the real gain without the inflationary amount | No deduction for the employer; vesting period of 24 months |
Allocation without a trustee | Depending on the type of security | For tradable securities and private shares: capital gains tax of 25% upon the actual sale, on the gain accrued from the allocation until the sale | Marginal tax of up to 47% at the time of allocation, and no deduction for the employer at the time of sale |
Private options without a trustee | Tax event only upon the actual sale | Deferral of the tax event until actual exercise | No deduction for the employer |
However, upon an exercise, as defined in the Ordinance, that occurs before the end of the vesting period, the provisions of the Israeli Income Tax Guide (HaBak) prescribe a form of penalty, in which case a higher tax liability will apply.
Exit Tax from Israel – Definitions and Implications
The opening part of Section 2 of the Ordinance establishes a dual basis of taxation in Israel, both on a personal basis, which applies to an Israeli resident, and on a territorial basis.
In order not to “miss” the taxation of capital gains accrued by Israeli resident taxpayers who leave Israel, Section 100A of the Ordinance was enacted to regulate the tax issue when relocation takes place. It does so by establishing a deemed sale of assets as of the departure date, which gives rise to exit tax liability in Israel. Therefore, if you have decided to sever Israeli tax residency, it is very important to carry out smart and precise tax planning.
Section 102 and Relocation
As noted above, Israel applies a dual taxation system. But how is the place where income is produced determined? Section 4A of the Ordinance governs this issue. However, where a tax treaty applies, the treaty provisions prevail pursuant to Section 196 of the Ordinance.
In addition, an income tax circular was published establishing tax liability in respect of options held by employees who leave Israel, in accordance with Section 102(f), meaning exit tax for option holders.
However, if the asset is located in Israel, such as options that vested in Israel, there may be an option to defer the tax calculation until the actual sale date, pursuant to Section 100A(c). This is because, in any event, Israel will impose tax upon the sale, unless a treaty provides for taxation on a personal basis only.
Although the capital gains route may allow for significant tax savings when the clear rules are met, in the event of a breach, meaning exercise before the end of the prescribed period, Section 102(f) provides for ordinary income taxation without any right to capital gains treatment. Among other things, the date on which a taxpayer changes residency under Section 100A will also be treated as an exercise of the option. In other words, an employee who severs Israeli residency during the vesting period will be taxed as a result of the breach.
In addition to the above, an employee who chooses to sever residency retroactively from the beginning of the tax year may pay the tax applicable to the options held by them as a foreign resident. This means, on the one hand, that they will not be entitled to tax credit points granted only to Israeli residents, and on the other hand, that the tax liability will be examined according to the period during which they were an Israeli resident.
Practical Example
Meet Eyal – Eyal works for a private foreign-resident company. It should be emphasized that Eyal is not a controlling shareholder of the company at the time of the allocation or as a result of it.
- Eyal received options under the capital gains route on 01/01/2024, with a 24-month lock-up period, meaning until 01/01/2026.
- At the time he received the options, he paid ₪50, while the value was ₪100, and an exercise price of ₪0 was set.
- Eyal leaves Israel on 01/03/2025 as part of a relocation from Israel. On that date, the value is ₪150.
- The inflation rate during the relevant period is 0%, and Eyal’s marginal tax rate is 47%.
- Eyal’s tax liability under Section 100A of the Ordinance and Section 102(f) of the Ordinance is as follows:
- The exercise date occurs on 01/03/2025, and therefore this is a voluntary breach. Accordingly, Eyal will be taxed at the marginal tax rate on the benefit value calculated on that date.
Value on the exercise date: ₪150
Less acquisition cost: ₪50
Benefit value: ₪100
Calculated tax: 100 multiplied by 47% = ₪47.
If Eyal had severed residency only in January 2026, he would have been entitled to significantly lower taxation, meaning capital gains tax at a rate of 25% .
We have seen that personalized tax planning may significantly reduce the tax burden. This is done by examining a range of solutions, properly timing the relocation, and selecting the optimal alternative according to the employee’s specific circumstances, the nature of the allocation, and the destination country.
Nimrod Yaron & Co. specializes in Israeli and international taxation. Our team is composed of professionals with years of experience at the Israel Tax Authority, alongside experience at leading firms and law offices, bringing a combination of legal and economic perspective. We advise private and public companies, Israeli and foreign companies, global venture capital funds, and clients seeking focused advice in clear and accessible language. We also work with a professional network of accounting firms and law firms around the world in order to provide a full framework of support in cross-border matters.
If you are considering relocation and hold options or equity-based compensation, it is advisable to examine the tax implications, the timing of severing residency, and the reporting method in advance, in order to reduce exposures and avoid costly mistakes. You may contact us for a focused strategic consultation on this matter.
FAQ
What is the optimal date for severing residency in order to reduce the tax liability on options as much as possible?
There is no clear-cut answer. The optimization varies according to the type of share, the allocation route, and the prescribed lock-up period.
Is it possible to defer payment of exit tax on the options I hold?
It depends on the type of share or option you hold. In certain cases, it is possible to defer payment of exit tax if the conditions of Section 100A are met.
Do tax treaties affect the taxation of options in a relocation?
Yes. In many cases, tax treaties materially affect the allocation of taxing rights between countries. However, each case must be examined according to its circumstances, and foreign residency must be proven as required.
