Amendment to Income Tax Rules on Employee Equity
On September 17, an amendment to the Income Tax Rules (Relief in Issuance of Shares to Employees) was officially published, approximately 20 years from the last amendment.
The amendment will enter into force on January 1, 2025 and will mainly affect the processes of approving equity incentive plans and of reporting to the Israeli Tax Authority.
Section 102 of the Israeli Income Tax Ordinance and the options’ rules prescribe the main rules and provisions that apply to the companies and the grantees of the equity awards.
The amendment mainly comes following to Tal Shochat ruling published by the Israeli District Court in Nazareth during 2019, which ruled, inter alia, that submitting an equity incentive plan is not a technical action, but rather a substantive action and as far as the Israeli Tax Authority does not respond within 90 days from the submission date, the equity incentive plan is deemed approved. The ruling also stated that, to the extent that the shares that were issued pursuant to the equity incentive plan meet the definition of “shares” as described under the Israeli Companies Law, then these shares must be considered as complying with the provisions of section 102 of the Israeli Income Tax Ordinance, since the term “shares” is not explicitly defined in section 102 – a position that is not in line with the Israeli Tax Authority.
In fact, the new amendment regulates the process of approving equity incentive plans and allows the Israeli Tax Authority to review the plans before approving them. The amendment also establishes a special approval track for the equity incentive plans (providing certainty to companies and taxpayers). This new process provides more certainty, unlike the process to date, where the equity incentive plans are largely examined at the time of the exit event, when the employee is already supposed to receive the proceeds.
Highlights of the amendment:
Online submissions of equity incentive plans for the approval of the tax officer
Instead of the physical submission process currently, equity incentive plans will be submitted online directly to the Israeli Tax Authority for its approval, which will provide certainty to companies and to their representatives. Furthermore, the submission process is expected to be carried out by the company or by anyone on its behalf, while disclosing the relevant data, including uploading of the equity incentive plan, the trustee’s documents, and the completion of a special questionnaire (addendum 4 to the options rules) as elaborated below.
Adding a questionnaire for completion by the company as part of the submission documents (addendum 4 to the options rules)
The questionnaire includes a list of questions and representations about the nature of the equity incentive plan, in order to ensure that it does not raise red flags and that the equity incentive plan itself as well as the company’s actions are in line with the Israeli Tax Authority’s position.
The following are some of the questions under the questionnaire:
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- The issued shares or those shares to be issued under the awards are ordinary shares with similar rights to the company’s ordinary shares;
- The granted instrument is an equity instrument and not a debt instrument;
- The vesting terms comply with the Israeli Tax Authority’s guidelines and instructions, including vesting not subject to an exit or an IPO event;
- The issuance of shares are of newly issued shares;
- Whether the issuing company, reporting company, employer company or any related party is obligated to buy (put option) the awards and/or the shares issued under the equity incentive plan;
- Whether the issuing company, reporting company, employer company or any related party has a right to repurchase (call option) awards and/or shares issued under the equity incentive plan. We note that, a call option mechanism can be adopted under the equity incentive plan subject to obtaining a special tax ruling from the Israeli Tax Authority, therefore, it is worth mentioning under the questionnaire that the company intends to apply to the Israeli Tax Authority in this regard.
- Is it an amendment to an existing equity incentive plan? (in which case it requires renewed approval).
Online filing of quarterly and annually reports of employee equity awards and updates to the existing rules
The amendment requires quarterly filings (Form 146) and annual filings (Form 156) of the employee equity awards (this has not been enforced to date).
Quarterly reports will be in respect of awards granted during the quarter and must be filed by 120 days after the end of such quarter, while annual reports must be filed by April 30 of the preceding tax year with respect to the previous tax year.
The amendment will come into effect on January 1, 2025.
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Barnea Jaffa Lande’s tax department is at your disposal for questions regarding the new option rules in particular, and legal and commercial guidance and advice in the area of manager and employee compensation and incentives, as well as with respect to the adoption of equity incentive plans for Israeli and multinational companies