Israel failing to collect billions on tech share options

Dollars Photo: Shutterstock

Tech employees in Israel need only pay 25% capital gains tax on share options rather than the much higher income tax rate.

Awarding options to employees by startups has taken root in the Israeli tech sector as an incentive that allows entrepreneurs to hire employees and promise them a slice of the possible future success. Through these options, employees are given the opportunity to buy expensive shares in the future for low amounts, and when they want to they can sell the shares and rake in the profits that they deserve, subject to paying tax, of course.

Recently, sources close to the matter have told "Globes," more and more senior executives in Israel's tech sector have discovered that the taxation on options in Israel has become a benefit worth millions of dollars, and thus these options that have come to maturity following the initial public offering (IPO) have become an instrument for almost certainly becoming rich without any special risks, in contradiction to the spirit of the legislation, and to a great extent at the expense of the state.

The intensive wave of tech IPOs over the past two years has created a layer of senior managers in tech companies such as vice presidents, CMOs, COOs, CTOs, CFOs etc. as well as other senior employees who find themselves with options worth millions of dollars, amounts typically between $5 million and $20 million.

Yet Israeli legislation has fixed a relatively low tax rate for these options because of the risk element it contains. A senior figure at one of Israel's accounting firms told "Globes," "While the entrepreneurs are taking a risk in founding companies, vice presidents and other senior employees do not take the same level of risk, and so the millions of dollars earned from the IPO are a payment in every sense of the word on work that should be subject to income tax. Yet they only pay capital gains tax of just 25%, when it is clear to everyone that the income is from work. It wasn't a problem until this year when a vice president takes home $10 million or rank and file employees take home $1-2 million, and pay just 25% tax, when the rest of us are paying much higher tax on our salary."

Meitar law firm tax partner Adv. Dr. Michael Bricker claims that taxing share options in Israel played a positive role in developing the industry. " I wouldn't look at it as a lacuna in the law - it is a benefit that has contributed over the past 20 years to the development of an industry that has hundreds of thousands of employees."

He also claims that if the tech companies were to forego awarding options and instead pay salaries wroth similar amounts, then the companies would be entitled to deduct expenses, which is not the case with the options. The result would be even lower tax payments, so that in terms of the Israel Tax Authority, it is not certain that such an 'arrangement' would be preferable to awarding options and the tax regime applied to them.

Despite this a senior accountant at one of Israel's large accounting firms says there would be logic in capping the amount at which this tax benefit would be granted. In the US, for the sake of comparison, the terms for options as an incentive are much stricter. In the US, these options, which are called incentive stock options (ISOs), are restricted to up to $100,000 per year, while in Israel there are no restrictions at all on the amount of options. In the US the employee must keep the shares for one year after exercising the options in order to enjoy the tax benefits while in Israel there is no such requirement. In the US, the price of the options must be identical to the price of the shares on the date that the options are awarded while in Israel, the options are usually given at a cheaper price of just a few cents.

Published by Globes, Israel business news - en.globes.co.il - on August 9, 2021

© Copyright of Globes Publisher Itonut (1983) Ltd. 2021

Dollars Photo: Shutterstock
Dollars Photo: Shutterstock
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