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Beneficiary, vesting schedule, section 102 of the Income Tax Ordinance….don't understand what's it's all about? You've come to the right place. A properly structured benefits plan has many different components which all need to be designed and implemented correctly, so we have provided here a short glossary of terms and a couple of case studies to help you understand basically how it all works:

Glossary

Exercise - The process of converting options into shares through the purchase of the converted shares from the company at the exercise price.

Exercise price - The amount payable by the beneficiary to the company on the date he/she wishes to convert his/her options into shares.

Expiry date - The predetermined date for the expiry of options that were not converted into shares, as specified in the grant letter.

Grant date - The date of the resolution of the company board approving an options award. Also called the enrolment date.

Grant letter - A document detailing the terms of the allocation, including the date, exercise price, vesting schedule, expiry date, the size of the award, and taxation issues.

Incentive plan - A legal document setting out the principles governing the allocation of options to beneficiaries during the plan's life. These plans usually expire after ten years.

Option - The right to an asset (in this case a share) at a predetermined price.

Sale - The sale of shares to a third party.

Same day sale - A process where the employee exercises options and then sells the shares simultaneously.

Section 102 of the Income Tax Ordinance - The section containing the tax rates applicable to options awarded to employees and company officers. This section provides that a tax event occurs following a sale of options or their transfer out of the escrow account managed by the trustee. It set outs a series of requirements which, once fulfilled, render beneficiaries eligible for a tax benefit (25% tax only on profit earned following a sale. However, a sale of shares of a quoted company also includes a component of earned income, which is taxed at the statutory rate applicable to each beneficiary). These are as follows:

  1. The options award must be approved by the board
  2. The scheme must be filed with the Tax Authority and a trustee appointed.
  3. Section 102 stipulates that awards are subject to a 24 - month lock up period, during which beneficiaries may not exercise their options and sell their shares. If this lock - up is breached, the award will be subject to the prescribed sanction in Section 102.
  4. Awards must be held in an escrow account managed by a Tax Authority - approved trustee.

Section 3(t) – The section containing the tax rates applicable to the options awarded to the company's controlling shareholders and to vendors, contractors and service providers. The determining date for the tax event under this section is the date of conversion of options into shares.

Share - A security that confers a share of the ownership in a company. An ordinary share gives the holder the right to vote at shareholder meetings and a share of the company profits, or its assets in the event it is wound up.

Tax chapter - The chapter of the Income Tax Ordinance containing the sections specifying the rate of taxation of options according to the type of beneficiary.

Vesting schedule - The dates or milestones following which options are exercisable. These are specified in the grant letter.

And if you've reached this point (or perhaps you skipped the previous section), here are two brief case studies that explain everything:

Case 1 - Options award at a private company

Dana Yarden works at a biomed start - up. The company made an options award to certain employees and appointed IBI Capital as the scheme trustee in accordance with the provisions of Section 102.

The terms of Dana's award as set out in the grant letter were as follows:

Grant date: 1, May, 2014

Quantity: 5,000 options

Exercise price: $1

Governing taxation rules: Section 102

Expiry date: 1, May, 2024

Vesting schedule: 50% of the options will vest each year, which means the entire award will be exercisable after two years.

On 2, May 2015, the company agreed to be sold to a US rival in an all - cash transaction amounting to $20mn at a value of $100.

Dana and the rest of the shareholders and/or employees with options due to vest at the time of the sale were entitled to their share of the cash consideration following the closure of the sale.

In light of the fact that this was an enforced sale and that the employees were not given a choice, the company approached the Tax Authority and sought to reach a tax arrangement under which the distribution of proceeds distributed to Dana and her fellow beneficiaries would not be construed as a breach of the lock - up period under Section 102. The proceeds due to all the other beneficiaries with options still under lock - up would be deposited in the escrow account until the lock –up period had ended.

The reason for this is that a beneficiary will only qualify for the tax benefit if the options are exercised no earlier than 24 months after the grant date.

At the time of the sale Dana had 2,500 options that had vested. The amount received for these came to $250,000.

The following deductions were made:

Exercise costs payable to the company: $2,500

The amount paid in tax to the Tax Authority in respect of the sale (25% of the profit) came to NIS 235,125 or $61,875.

As a result the net consideration paid to Dana on 1, May, 2016 in respect of her shares totaled $185,625.

Case 2 - Options award at a quoted company

Dana Yarden works for a company quoted on the Tel Aviv Stock Exchange. The company made an options award to certain employees and appointed IBI Capital as the scheme trustee in accordance with the provisions of Section 102.

The terms of Dana's award as set out in the grant letter were as follows:

Grant date: 1, May, 2014

Quantity: 5,000 options

Exercise price: NIS 1

Governing taxation rules: Section 102

Expiry date: 1, May, 2024

Vesting schedule: 25% of the options will vest each year, which means the entire award will be exercisable after four years.

Dana wanted to exercise some of her options as early as the beginning of 2016 but knew that if she did this she would not be eligible for the tax benefit provided under Section 102

The reason for this is that a beneficiary will only qualify for the tax benefit if the options are exercised no earlier than 24 months after the grant date.

So Dana reconsidered her position and decided in the end to wait until the end of the 24 - month lock up and thus qualify for the discounted tax rate under Section 102.

On 1, July 2016, more than 24 months on from the grant date, Dana made a same - day sale of all the options that vested then. This amounted to 50% of her options award – 2,500.

Dana instructed IBI Capital to sell 2,500 shares for no less than NIS 3 per share, the going rate on the market that day.

On 2, July, Dana's 2,500 shares were sold at NIS 3.1 per share.

The consideration from this sale came to NIS 7,750. From this the following deductions were made:

Commission: NIS 7.775

Exercise costs payable to the company: NIS 2,500

The amount paid in tax to the Tax Authority in respect of the sale came to NIS 1,500. This amount represented the tax liability in respect of both equity and earned income.

As a result the net consideration paid to Dana in respect of her shares totaled NIS 3,742.25.

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