Israel: New Tax Circular 18/2018 Regarding Equity-Based Awards

Last Updated: 10 January 2019
Article by Oren Biran

On December 5, 2018, the Israeli Tax Authority (the "ITA" ) published the Income Tax Circular number: 18/2018, on the topic of "Performance Equity-Based Awards" (the "Circular").

The Circular discusses conditions according to which allocation of equity-based awards ("Awards") to employees whose vesting is dependent on certain mile-stones, will be considered in compliance with the provisions of Section 102 of the Israeli Tax Ordinance [New Version], 1961 ("Section 102" and the "ITO", respectively).


Companies often chose to grant their employees with Awards (i.e. options, restricted stock units, restricted stock etc.), in order to motivate them to continue their employment for the long run. According to the provisions of Section 102, when an employee exercises1 his options, he/she will be able to enjoy a reduced capital gains tax rate of 25%, where the grant was classified as a "Capital Gains Tax Track with a Trusteeˮ.

Section 102 does not state any specific provisions regarding the vesting period and/or conditions, and it is under the discretion of the "employing companyˮ'2. Nonetheless, the legislator did apply a minimum two (2) years holding period from its commencement to its end, during which the Awards must be deposited with a trustee, in order for the employee to benefit from the benefited tax track (the "Holding Period").

Occasionally, the vesting conditions which are determined are not only time contingent, but also contingent on the occurrence of certain mile-stones based on performance or on market conditions, only upon their fulfilment of which, the entitlement to company's rights shall vest, and the amount of the underlying shares will be determined.

For example:

  • Work conditions (services) – time based conditions obligating the employee to a specific time frame of employment (for example four years).
  • Performance conditions – conditions requiring certain thresholds and milestones such as reaching a sales goal or an increase in the company's profit.
  • Market conditions – conditions relating to the value of the company derived from the price per share, such as an increase in the company's price per share according to a pre-determined value or an increase in the market value of the company relative to the market value of other companies in the same field of activity.

The ITA's Position as Reflected in the Circular

When a vesting schedule of Awards based on performance conditions and/or market conditions is determined, a question is raised regarding the date of grant of the Awards, which activates the two (2) years Holding Period according to Section 102.

The grant of such Awards must be according to the following conditions in order to qualify for the benefited tax track of Section 102:

  • All of the conditions of the grant (exercise price, expiration date, vesting schedule etc.) must be approved by the certified body in the company (usually the board of directors). Following its approval, the conditions will no longer be in the board's discretion.
  • The vesting conditions subject to mile stones shall be fixed, measurable and predefined starting from the date of grant of the Awards. If the board of the company choses to refer to the vesting conditions in a vague and general way and/or to the vesting periods and/or leaving discretion to the board and/or someone on its behalf following the date of grant, thus the Holding Period will commence from the materialization and/or fulfillment of those conditions.
  • The grant of an Award shall be by virtue of an equity-based plan which includes and supports the grant of performance based Awards, and which was submitted to the respective assessment tax officer, as determined in the Israeli Tax Regulations (Tax Relief in the Allocation of Shares to Employees), 5763-2003.

The Circular determines that the two (2) years Holding Period shall commence on the date the Board of the company decided to grant the Awards and determined its conditions, only when at that date the board establishes the basic amount of underlying shares received following the exercise of the Awards, and the conditions according to which the Awards shall vest. If the amount of underlying shares issued to the employee upon exercise, is larger than the amount determined by the Board at the date of grant, the excess will be considered as a new allocation for all intents and purposes, and the Holding Period will be recounted from that date on.

Vesting of Performance-Based Awards on the Occurrence of an Exit Transaction or IPO

The Circular further clarifies that vesting of Awards which will only occur upon an exit event (i.e. the sale of all the rights in the company) or upon the issuance of the company's shares for trading on the stock exchange (IPO), should not be considered as qualifying condition for the benefited capital gains tax track under Section 102. It will, however, qualify for a cash-based compensation provided as a benefit as part of the employer-employee relationship.  The income deriving from such compensation shall be classified as ordinary income under section 2(2) of the ITO, as a bonus or success grant to the employee upon the occurrence of the qualifying event.

It should be emphasized that this position applies and is expressed also in cases where the allocation and vesting dates are based on a period of employment, while at the same time dependent on the goal of making an exit or IPO. This position does not apply to acceleration of the vesting schedule in an exit or IPO event, which does not create the very entitlement to rights, but only accelerates the date of entitlement.

Applicability Provisions

The Circular clarifies that it also applies to grants that were allocated in the past. However, insofar as there are grants that were made in the past and the rights have already vested in a manner that does not meet the conditions of the Circular but for which the "exercise dateˮ has not yet taken place, these companies will be able to apply to the Professional Division of the ITA for a specific tax ruling.

In addition, with respect to rights that have not yet reached their vesting date, the Circular allows companies to change the vesting conditions for a period of 180 days from the Circular publication date (that is, until June 4, 2019), so that they comply with the provisions of the Circular, as stated above, by approaching the Professional Division of the ITA and their respective assessment tax officer and submitting the form entitled "Tax Arrangement of a New Grantˮ (the "Tax Arrangementˮ), which is attached as an appendix to the Circular. In this case, a change in the vesting conditions will fully "cureˮ the "past faultsˮ with respect to the vesting conditions and will start a new two (2) years Holding Period.

The Tax Arrangement can be an excellent opportunity to amend all or correct additional deficiencies, insofar as there are any, or to update the plan to a format that is more suitable following the publication of the Circular. Our firm has extensive experience in accompanying companies throughout the process of adopting an equity-based compensation plan to their employees, which includes among others: drafting the plan, receiving ongoing clarifications from the ITA, handling transactions and even disputes.


1 The term 'exercise' under Section 102, refers to the transfer of the underlying shares from the trustee to the option holder or their sale to a third party by the trustee, whichever is first.

2 The term 'employing company' shall refer to (1) an employer which is an Israeli company or a foreign company which has a permanent factory or R&D center in Israel; or (2) a company which is a controlling shareholder of the employer or the employer is a controlling shareholder in it; or (3) a company whose controlling shareholder is also a controlling shareholder of the employer.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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