ESOP EXCELLENCE

The Right Option for you

The below is not considered as tax advice and reflect the general description only. Qualified tax advice should be obtained before engaging in any transactions.

In the case of an ESOP plan, in order for an equity incentive plan to qualify for a preferred tax route, the Israel Tax Authority requires, in Section 102 to the Israeli Tax Ordinance, that all grants be put into escrow with the Trustee. The Trustee’s role is to ensure that all taxes due are properly calculated, withheld and paid in to the Israeli Tax Authority and reports are submitted to support such tax deductions.

ESOP EXCELLENCE has been approved by the ITA as a qualified ESOP Trustee.

Section 102 is the section of the Israel Tax Ordinance that deals with the taxation of equity based compensation awards to employees and company officers (including directors). Section 102 lays out three different options—or “tax routes”—for how and when the awards are taxed. Companies choose a route when they grant awards. Two of the routes require that the Company nominate a Trustee; the third does not.

The routes are as follows:

Section 102 Routes requiring a Trustee

Ordinary Income Track

Capital Gains Track

 

Income from the grant is considered ordinary income and is taxed at the recipient’s marginal tax rate, plus National Insurance and health tax (plus a surtax, if relevant).

Private companies: after a two- year holding period, income from the grant is considered capital gains, and is taxed at capital gain rates (plus a surtax, if relevant).

Publicly-traded companies: after a two-year holding period, a portion of the income from the grant may be considered capital gains and taxed at capital gain rates (plus surtax, if relevant) The balance of the income from the grant will be considered regular income and is taxed at the recipient’s marginal tax rate, plus National Insurance and health tax (+plus a surtax, if relevant).

How are grants taxed?

So long as the grants remain with the Trustee, the grant is taxed only when the shares are sold.

So long as the grants remain with the Trustee, the grant is taxed only when the shares are sold.

When are the grants taxed?

 

 Section 102 Route not requiring a Trustee

Ordinary Income Track

 

Income from the grant is considered ordinary income and is taxed at the recipient’s marginal tax rate, plus National Insurance and health tax (plus a surtax, if relevant). 

How are grants taxed?

The grant is taxed on the date the shares are sold. As the shares are not held by a Trustee, the company needs to have a 'guarantee' ensuring that the company will know when the shares are sold and will have sufficient funds to cover taxes due.

When are the grants taxed?

When people refer to a preferred tax route, they are generally talking about the capital gains track, with a Trustee. You can learn more about the capital gains track below. 

The Capital Gains Track is the most common tax route selected for grants to employees and officers as it offers significant tax benefits. However it includes a number of key provisions; violation of any of these provisions will result in the grant being treated as Non-Trustee Section 102 grant (see explanation). Below are the main provisions:

  • Trustee administration. All grants must be deposited with a qualified Trustee. Trustees must receive notifications and deposits of all Israeli grants within set time limits.
  • Holding period. All grants, whether of options or shares, must be held in trust by the Trustee for a minimum of 24 months starting from the grant date.
  • Tax on release of a grant. The release of grant from the Trustee to a beneficiary is a tax event, even if the share hasn’t been sold. At that point, the Trustee will calculate the tax due (based on the increase in value of the share), and will only release the grant on receipt of the tax due from the beneficiary.

Capital Gains Track plans are subject to a series of restrictions and requirements. ESOP - EXCELLENCE will work with your management team and your advisors to ensure that all of your tax-advantaged grants start—and stay—tax advantaged.

Yes, but while the tax deferment will still apply, the tax calculation is different. Instead of the full amount of the income being treated as capital gains (if the Holding Period is not breached), income is divided into two components:
1. Discount on the share price (the difference between the value of the share as of the grant date and the grant exercise price)
2. Gain on sale of share (the difference between the exercise price and the sale price)

Tax due is calculated as follows.

Gain on sale of share

Discount on the share price

 

Capital Gains

Ordinary Income

How are grants taxed?

25% (plus a surtax if relevant)

Taxed at the recipient’s marginal tax rate, plus National Insurance and health tax (plus a surtax, if relevant)

Tax rate

Section 102 covers grants to:

  • Company employees
  • Company officers, including directors

There are two important exceptions to the above. First, any employee or officer who is considered a “controlling shareholder” is not eligible to receive a grant under Section 102. A controlling shareholder is, broadly speaking, someone who owns 10% of a company’s shares, who has rights to 10% of a company’s profits or who has the right to appoint a director of the company. In calculating this 10%, the ITA will also include shares held by the individual’s relations and certain business partners.

Grants to controlling shareholders, consultants, service providers and anyone else not eligible to receive grants under Section 102 will fall under Section 3(i) of the Israel Tax Ordinance. Section 3(i) grants are taxed in two stages. 

When are grants taxed?

 How are grants taxed?

 

When the shares are issued or, in the case of options, when the options are exercised (conversion to shares)

Income from the grant is considered ordinary income and is taxed at the recipient’s marginal tax rate, plus National Insurance and health tax (plus a surtax if relevant).
The company is required to withhold this tax at source and submit it to the Israel Tax Authority.

Tax point 1

When the shares are sold

As capital gains. Tax rate of 25% (plus a surtax if relevant)

Tax point 2

In order to actually grant options under a preferred tax route, you need to have a formal Equity Incentive Plan in place, it needs to be approved by the Israel Tax Authority and you need to appoint a Trustee. The steps are as follows:

Step one: draft your plan with your advisors.

Step two: select a tax route.

Step three: choose a Trustee.

Step four: approval of the Equity Inceptive Plan, the tax route and the nomination of Trustee by the company’s Board of Directors.

Step five: Israel Tax Authority approval. All Equity Incentive Plans must be approved by the Israel Tax Authority.

In Israel you can make grants starting 30 days from the date the plan was submitted to the Israel Tax Authority for approval;

You can start to issue grants starting 30 days after the plan was submitted to the Israel Tax Authority for approval. The steps are as follows.

Step one: the Board must approve the grant. The approval must be unconditional and must include all key terms. The date the Board approves the grant is the “grant date” (unless other approvals, e.g. shareholder's approval, are required).

Step two: the employee must sign off on a formal grant agreement.

Step Three: a copy of the Board resolution, including the list of the grants approved, must be deposited with the Trustee within 45 days of the grant date.

Step Four: a copy of the signed grant agreements must be deposited with the Trustee within 90 days of the grant date.

Step Five: the grants must remain in with the Trustee for the full 24 month holding period.

Any delay in depositing the Board Resolution or grant agreements, and any violation of the holding period, will result by in the grants being considered ineligible for a preferred tax route.

In general, the person designated as the administrator by the Equity Incentive Plan can approve changes to a grant. Depending on the nature of the change and the specific plan and /or grant terms, the change may require approval by the Board of Directors.

Please note that certain changes may have tax implications, and might even result in a grant being considered ineligible for a preferred tax route. Therefore, before making any changes it’s recommended that you review the matter with tax advisors. In certain cases, you may be able to request a tax ruling from the Israel Tax Authority, approving a change.

Yes. Performance-based awards are grants where the vesting terms are set based on the achievement of a set commercial goals, such as closing a round, hitting a development milestone, reaching a defined sales target, etc.

As some performance-based goals may result in the grant being considered ineligible for a preferred tax route, it’s recommended that you review the matter with your tax advisors before issuing the grant.

The Q&A are not considered as tax advice and reflect the general description only. Qualified tax advice should be obtained before engaging in any transactions.