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 after the previous amendment.
The amendment will enter into force on January 1, 2025, and will primarily affect the processes for approving equity incentive plans and reporting to the Israel Tax Authority.
Section 102 of the Israeli Income Tax Ordinance and the options rules set out the main provisions applicable to companies and recipients of equity awards.
The amendment largely follows the Tal Shochat ruling issued by the Israeli District Court in Nazareth in 2019. The court held, among other things, that submitting an equity incentive plan is a substantive rather than a technical act, and that if the Israeli Tax Authority does not respond within 90 days of submission, the plan is deemed approved. The court also held that, to the extent that shares issued under an equity incentive plan meet the definition of “shares” under the Israeli Companies Law, they must be considered compliant with Section 102 of the Israeli Income Tax Ordinance, as that section does not explicitly define the term “shares.” This position differs from that of the Israel Tax Authority.
The amendment regulates the approval process for equity incentive plans and allows the Israel Tax Authority to review plans before approving them. It also establishes a special approval track, providing greater certainty to companies and taxpayers. This contrasts with the current process, under which plans are largely examined at the time of an exit event, when employees are already due to receive the proceeds.
Highlights of the Amendment
Online submission of equity incentive plans for approval by the tax officer
Equity incentive plans will be submitted online directly to the Israel Tax Authority for approval, replacing the current physical submission process and providing greater certainty to companies and their representatives. The submission process is expected to be carried out by the company or someone acting on its behalf. It will include disclosing relevant information, uploading the equity incentive plan and the trustee’s documents, and completing a special questionnaire (Addendum 4 to the options rules), as described below.
Addition of a questionnaire to be completed by the company as part of the submission documents (Addendum 4 to the options rules)
The questionnaire includes questions and representations about the nature of the equity incentive plan, intended to identify potential red flags and ensure that both the plan and the company’s actions align with the Israel Tax Authority’s position.
The questionnaire covers, among other things, the following matters:
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- Whether the shares issued or to be issued under the awards are ordinary shares with rights similar to those attached to the company’s ordinary shares.
- Whether the instrument granted is an equity instrument rather than a debt instrument.
- Whether the vesting terms comply with the Israel Tax Authority’s guidelines and instructions, including the requirement that vesting not be conditional on an exit or IPO event.
- Whether the shares issued are newly issued shares.
- Whether the issuing company, reporting company, employer company or any related party is obligated to purchase the awards and/or shares issued under the equity incentive plan (a put option).
- Whether the issuing company, reporting company, employer company, or any related party has a right to repurchase awards and/or shares issued under the equity incentive plan (a call option). A call option mechanism may be adopted under the plan subject to obtaining a special tax ruling from the Israel Tax Authority. Accordingly, if the company intends to apply for such a ruling, this should be noted in the questionnaire.
- Whether the submission concerns an amendment to an existing equity incentive plan, in which case renewed approval is required.
Online filing of quarterly and annual reports on employee equity awards and updates to the existing rules
The amendment requires quarterly filings (Form 146) and annual filings (Form 156) relating to employee equity awards. These filing requirements have not been enforced to date.
Quarterly reports must cover awards granted during the quarter and be filed within 120 days after the end of that quarter. Annual reports must cover the previous tax year and be filed by April 30 of the following year.
The amendment will take effect on January 1, 2025.
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Barnea Jaffa Lande’s Tax Department is available to answer questions about the new options rules and provide legal and commercial guidance on executive and employee compensation and incentives, as well as the adoption of equity incentive plans for Israeli and multinational companies.