Inbar Lavy Garfunkel, Regulatory Affairs Manager at IBI Capital

Employers, are you looking for ways to reward and retain employees who will contribute to your company’s success?

We assume there isn’t a chief executive who would answer ‘no’ to that question.

One effective way to reward employees is through equity – based benefit schemes that include options. These schemes are very much the norm in the high – tech industry but they are now being adopted by companies in other sectors too. They can be an important component in a remuneration scheme, not just for the company’s employees but also for suppliers and consultants.

For employers, these schemes are a way of incorporating options in its remuneration arrangements, as an alternative to a salary component, for example.

For employees, remuneration schemes like these encourage them to be proactive and forward – thinking and motivate them to work to achieve the company’s business objectives.

Of equal importance is the fact that these schemes also enable employees to get their fair share of any increase in company value in addition to a tax benefit under section 102 of the Income Tax Ordinance as we explain below.

What is an option?

An option is right to receive an asset (in this case a share) at a specific price

When an employee receives an options award, the terms of the award will include the following:

Exercise price – the amount paid by the employee to the company to convert his/her options into shares.

Vesting schedule: The program specifying the quantity of options and the dates on which they vest.

Expiry date: If an option is not converted into a share it automatically expires after a number of years (as specified in the legal guidelines of the scheme and the terms of the options award)

Tax treatment under Section 102 – The benefits

Most of the companies that make options awards to their employees and/or the people employed by their subsidiaries apply for the reduced tax rate specified in Section 102 as mentioned above.  Section 102 specifies which groups qualify for the discounted tax rate on options awards – employees, directors and company officers. Controlling shareholders and all other persons eligible for options awards receive their grants under Section 3(i), as we explain below.

As a rule, when an employee is awarded a benefit by his/her employer, he/she is taxed at the time the award is made according to the tax rate applicable to his/her income (which can be as high as 48%). Section 102, on the other hand, exempts employees from this and allows the tax event to be deferred to the date on which the shares converted from options are sold or the date on which they are transferred out of the  escrow account managed by the scheme trustee, whichever is earlier.

The tax rates under section 102 are also lower.

Option awards by private companies: As a rule these are taxed at sale at rate of 25% only.

Option awards by quoted companies: Tax is charged on the difference between the exercise price and the average price of the share (in the 30 days prior to the award). This difference is classed as a work – related income, and any increase in value will be taxed at a rate of 25% only.

How can a scheme be eligible for tax relief under Section 102?

A number of conditions have to be complied with:

  1. The company needs to structure its scheme so that it qualifies for Section 102 status – this can be done by its legal advisers or tax consultants.
  2. A trustee for the scheme will need to be appointed – this must be someone authorized by the Tax Authority to act as trustee to enable the scheme to comply with Section 102 requirements.
  3. The scheme must be filed with the Tax Authority following which there must be a 30 day waiting period before any awards can actually be made.
  4. The options must deposited with the trustee and are subject to a 24 – month lock up (this applies to the equity – based arrangement that most companies choose), during which the shares may not be sold or transferred out of the escrow account managed by the trustee. Failure to observe this lock – up period will result in the award being taxed as work – related income.

    So far we’ve covered tax regulation that applies to company employees, but what happens to the options awarded to other parties, such as consultants, suppliers and service contractors?

These options fall under Section 3(i) and thus are taxed on sale as a work – related income (the company will be charged tax at the statutory corporation tax rate).

In addition, a tax event is triggered when options are converted into shares under Section 3(i), unlike a conversion under Section 102 when the tax event is automatically deferred until the end of the lock – up period or until such time as the options are released by the trustee from the escrow account.

What else is there apart from options?

Aside from options, equity – based remuneration schemes can include other forms of equity – based incentives. These include Restricted Stock Awards, Restricted Stock Units or bespoke schemes such an Employee Share Purchase Plan (ESPP) where employees save a certain amount each month for a set period at the end of which the company will offer them shares at a certain discount on the market value.

A company that sets up an options scheme or an ESPP will need trustee services and also general administration services including data base management, a share dealing platform, and the handling of share transactions and tax withholding. Additional services can include the advising on and handling of share offerings, mergers and acquisitions.

Like everything else related to taxation, managing remuneration schemes can be complicated. That’s where we at IBI Capital come in. We are one of Israel’s leading experts in the design, implementation and operation of employee share schemes and also offer a range of trustee services.

To find how you can unleash the power of employee ownership in your company please contact us. We look forward to hearing from you and working together with you to realize your goals.

Inbar Lavy Garfunkel



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