With increasing global mobility of tech professionals and startup employees, a common challenge has emerged: how to tax stock options granted abroad when employees relocate to Israel. The Tax Authority has now addressed this gap with new guidance that provides clarity and flexibility. For the first time, employees who received foreign stock options as non-residents and later became Israeli residents have two clearly defined beneficial taxation alternatives, moving beyond the uncertainty that previously characterized this area.
Stock options granted to employees are generally subject to Section 102 of the Income Tax Ordinance (tax rates range from 25% to 47% before surtax and potential social security duties). However, there are circumstances in which the beneficial provisions of Section 102 do not apply and to which a different tax track applies under Section 3(i) of the Income Tax Ordinance, such as in the case of an employee who is considered a “controlling shareholder” (as defined in Section 32(9) of the Ordinance), independent service providers such as third party consultants, managers working through their own companies, employees or directors who provide their services outside of Israel, etc. Another type of employee who is not entitled to benefit from Section 102 are those who do not meet the condition of being employed by an “employing company” (which generally requires employment by an employer that is an Israeli company or an Israeli branch of a foreign company if appropriate approval has been given).
The Tax Authority recently published a position paper addressing foreign stock options (or RSUs) granted by a foreign company to a foreign resident (that is, when the condition of employment by an employing company is not met) who later became an Israeli resident and exercised the options after immigration to Israel.
For such employees, two beneficial taxation alternatives are available:
• The default is to tax the income in accordance with the arrangement of Section 3(i) of the Ordinance, i.e. income classified as “employment/ordinary income” (regular tax rates), with the tax event date generally occurring upon exercise of the stock options. The place of production of income in this case will be determined according to the place where the work was performed during the vesting period of the options (i.e., part of the income may be classified as “Israeli” and the balance as income produced abroad).
• However, the employee will be entitled to request to spread his income from the foreign options over a period of up to 6 years (from grant to exercise), when the portion of income attributable to tax years in which the employee is considered a “foreign resident” will be classified as income generated outside of Israel and will therefore be exempt from tax in Israel (except where the individual worked also in Israel while he was a foreign resident). Regarding the portion of income taxable in Israel that was generated outside of Israel, it will be possible to credit foreign taxes imposed on that income in the foreign country.
• The above tax arrangement also applies to an individual classified as a “Returning Resident” (abroad 6+ years), however this arrangement is not relevant for an individual classified a a “Veteran returning resident” (abroad 10+ years) or new immigrants, for whom a slightly different arrangement applies: If vesting completed while still being a foreign resident, all income is exempt; if vesting completed after becoming Israeli resident, partial exemption based on work days in Israel during vesting period.
• Company may request a tax ruling (green track) to convert the taxation track of the options from Section 3(i) to Section 102.
• Such a ruling may allow the employee to benefit from a preferential tax treatment for capital gains (through trustee) and pay a lower tax rate on this income.
• The allocation date of the “alternative options” (Section 102 Options) will be set on the date of submission of the ruling request, as long as the options are deposited with the trustee within 30 days. This date is relevant for the purpose of counting of the blocking period according to Section 102, the period during which the options/shares are supposed to be held by the trustee.
• Exact tax calculation differs based on whether options were vested at “conversion” date.
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For tax advice, contact Adv. Ophir Kaplan, Partner, Tax Department.
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