By Odelia Pollak, Adv. - CEP– CEO of ESOP - EXCELLENCE
In many companies, especially in the technology sector, options to purchase shares are an integral part of the compensation package and are considered as 'Long Term Incentive'.
Planning the grant of Options in advance may allow the company to gain tax benefits (for the company or its employees).
Alternative Tax Tracks
In general, Options to Office Holders and Employees (who are not considered 'Controlling Shareholders') are granted in Israel under Section 102 to the Israeli Tax Ordinance ("Ordinance). There are different Tax Tracks under Section 102: (1) With Trustee: (a) 102 capital-gain; (b) 102 ordinary income; and (2) Non Trustee.
The majority of the Companies in Israel grant Options under Trustee in the 102 Capital-Gain Track.
Each of the above Tax Track results in different taxation and requires different administration and reporting, and before making the election, the Company should obtain advice (changing the Tax Track after the grants are made will require a Tax Ruling).
Optionees that do not qualify for 102, will receive their option under Section 3(i) to the Ordinance.
102 capital-gain track under Trust
Under the Capital-Gain Track there are 2 main advantages for the Option Holder: (a) payment of reduced tax (in private companies 25% (+ surplus tax if applicable) Vs. regular income tax plus social security and health tax which may be up to 59% (+ surplus tax if applicable)); (b) deferred tax event (not upon grant or exercise of the option to share, only upon sale or release of shares from the Trustee). However, the employer will not entitled to any expense deduction for tax purposes regarding the options.
The options (or resulting shares) must be held in trust for at least 24 months after the date of grant. If the holding period is breached, the employee will pay regular income (plus social security and health tax and surplus tax if applicable).
Main things to consider before granting
The Plan, and related documents, should be prepared by a tax advisor that is familiar with the High Tech sector as there are many important things that the company may not consider in advance but may be relevant in the future.
Nomination of Trustee as required under the Israeli Law is critical as well. The Company should not compromise with only 'checking the box' on the legal requirement but also try and find a business partner that will support the company in this field.
Once the Plan is approved by the board and filled to the Israeli Tax, the Company should plan the Option 'budget' and take into consideration any commitment made to the investors and or employees. The 'budget' should include, among other things – the expected growth, expected funding events and vesting schedule.
The Company should set its policy as to the exercise price - should it be 'Fair Market Value' (as required in the US, for example) or should discounted price should be offered (this is feasible under the Israeli law).
Last, but not less important, the company, itself or through its agents, should plan education sessions to the optionees that will provide more clarity and transparency on the basic terms, taxes and more. The main goal is retention and without understanding the vehicle, this will not be achievable.
What can the optionees do with their grants?
The main goal is to allow the employee to benefit from the company's growth and giving them the right to become shareholders in the company.
In private companies there are restrictions as to the transferability of shares (this is relevant to all shareholders in the company) so options, and resulted shares, are not liquid in most cases.
The Optionee may exercise the options into shares by paying the 'Exercise Price' to the Company (this is not a tax event under Section 102 but is a tax event under Section 3(i) to the ordinance) and wait till a 'liquidity event'. Under Section 102, the shares will be deposited with the Trustee and any release will be deemed as tax event.
In some cases there are secondary sales also while the company is still private.
In case of a 'Liquidity Event' if the options are vested and outstanding, are 'in the money' and if Common Share class is entitled to proceeds, then the holders will be entitled to their related portion of the proceeds.
About ESOP - EXCELLENCE
ESOP-EXCELLENCE provides comprehensive Trust and administration services to Option Plans. ESOP – EXCELLENCE is a qualified trustee, as required under Section 102 to the Israeli Tax Ordinance. ESOP – EXCELLENCE is leading Trust Company in Israel and serves more than 2,000 private (for pre seed) and public traded companies (in Israel and abroad).