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Precedential Court Ruling on Option Plans for Employees

A precedential judgment was handed down on option plans for employees in respect of section 102 of the Income Tax Ordinance. Although the judgment considers several issues, we wish to focus on the significant new precedent set.


The relevant facts for our purposes are as follows:

  • A company had two types of shares, regular and class A, the latter of which entitle rights only as to receiving dividends.
  • Under a 102 plan, an employee was allocated, through a trustee in a capital gains track, options to 23% of the company’s class A shares, which remain in effect so long as he is a company employee and are not transferable, and which consist of 9.99% of the total rights of dividends in the company.
  • The company submitted the plan to the tax assessor, who raised no reservations about it.


The tax assessor claimed that due to the limited rights in class A shares, they are not, de facto, ordinary capital shares, and thus are not covered under section 102 of the Ordinance. In addition, the tax assessor argued that the employee is a “controlling member” as he holds about 23% of class A shares. Therefore, section 102 does not apply and this is effectively a bonus that represents income-yielding compensation, which is taxable as employment income (according to the tax brackets, and up to 50%) and not at a rate of 25%.


The court ruled that:

Section 102 of the Ordinance is not a formal matter, but a substantive one. This section provides that should the tax assessor not respond within 90 days of receipt of notice of the allocation plan, the allocation plan and the trustee are viewed as approved. Thus, because the tax assessor failed to respond within the time period established by law, the plan is approved.


The allocation of shares that entitle the employee only to receive dividends and that are limited in their transferability are covered under section 102 of the Ordinance. The term “share” is not defined in section 102, and therefore the definition of this term is as established in the Companies Law. According to the Companies Law, a company may establish which rights are attached to each type of share (as long as the company is private), as well as set a share’s lack of transferability or other restrictions. Therefore, even “non-standard” shares fall under section 102 of the Ordinance.


The examination as to whether an employee is a “controlling member” in terms of section 102 shall be done in relation to all the company’s shares and not merely in relation to the type of shares held by the employee.


An allocation of shares to an employee through a trustee in a capital gains track is an artificial act that is completely lawful and that is designed to allow the conversion of employment income to capital income—which is the life breath of section 102. This is the purpose of the section and therefore it is not an artificial transaction in terms of section 86. The tax assessor’s claim about an artificial transaction undermines the provisions of the section and its purpose.



For more information on this development, contact a member of our tax team.

Source: barlaw.co.il

Tags: Income Tax | Option Plans | Section 102