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Section 102 Options: The Unwritten Rules and Pitfalls to Look For

Client Updates / Apr 25, 2024

Written by: Moshe Sister and Nir Kamhi

As you all know, granting equity awards (collectively referred to as “Options”) is one of the most popular ways for a company to incentivize and compensate its employees, in addition to the traditional salary compensation. It requires no cash to be paid out by the company; and, if issued in accordance with the capital gain track of Section 102 of the Israeli Tax Ordinance (“ITO”), and the unwritten position of the ITA, the employees’ tax rate applicable to such award is reduced from a significant high tax rate that can go of up to 62% (income tax and national insurance tax), to 25% – a tax benefit of almost 37%.

In order to qualify for the beneficial tax regime under Section 102 of the ITO, both the employer and the employee must comply with the law and the published guidelines of the Israeli Tax Authority (herein: “ITA”).

This may seem straightforward enough, however, every so often, the ITA comes up with new unwritten positions and rules. These unwritten rules are “published” in private rulings, discussions with the ITA, discussions with the trustees responsible to administer Section 102, and through word of mouth. According to such unwritten rules, certain actions or features applicable to the options granted violate the application of the capital gain track for these options. These violations result in a much higher tax liability for the employee and withholding tax exposures for the company. These consequences often occur long after the options were issued, under the then applicable unwritten rules.

Below we provide a brief review of the most common situations where those “unwritten rules” come into play and disqualify the Section 102 option form capital gain treatment. Please note this is not a conclusive list, and the unwritten rules change periodically. The issues listed below are only the recently encountered issues.

“Double” and “Singel Trigger” mechanism

A double trigger mechanism is a common benefit companies often grant to executives and other leaders of the business. In general, a double trigger means that unvested options held by an employee on a “change of control” date, will be accelerated to become vested once the holder’s employment is terminated. This mechanism provides protection to the holder. If their employment is terminated within a set time period following the change of control event, without “cause”, then some or all of their unvested option will be accelerated and become vested. However, the ITA is taking the position that such a mechanism is a “severance pay substitute” and whereas severance pay is taxed at a normal tax rate, so will options that have double trigger in them, will not qualify for 102 treatments and be taxed at a normal tax rate.

“Newly Issued Options”

The ITA does not qualify options issued within 90 days prior to the signing of an acquisition agreement or IPO for 102 capital gains treatment. Recently, the ITA has revised this policy designating the signing of a letter of intent or term sheet as the cutoff date. We believe that this will, at some point, be further changed, to include completion of substantial negotiations of a letter of intent or term sheet. The idea here is to disconnect the grant of the options from the following transaction, while trying to not to rely on formal dates (as such dates might be played with by the parties in order to comply with this rule). Thus, every grant of options under section 102 in the face of a transaction might become problematic.

Repricing and other changes to options grants

As a general rule, the ITA’s position is that any change in the conditions of an option after its issuance will likely disqualify the options from the beneficial tax track of Section 102(b), unless approved in a tax ruling or exempted from the requirement of a tax ruling.

One common change we encounter is the repricing of options, i.e., changing the exercise price after the grant of the options. Repricing of options in Israel typically requires a tax ruling from the ITA. In its ruling policy, the ITA refuses to allow (except for special cases) repricing for a specific person and allows repricing only to all option holders, or only for a category of options, the exercise price of which is higher than the repriced exercise price. Also, the repricing may only reduce the exercise price to a new price that is lower than the initial exercise price. Note that the ITA requires a valuation of the ordinary shares, such that the new price should be equal to the new fair market value. Another common change is a change in the vesting schedule and a change in the tax track.

Equity Awards of Equity Other than Ordinary Shares

Although not stipulated in the law, the ITA’s position is that only options to ordinality voting shares of a “company” (according to the meaning of such term in the Israeli Companies Law) are eligible for section 102 capital gain tack. Under some scenarios, preferred shares and membership units in an LLC may also be granted under the 102 capital gains track, but such issuance has to be approved in advance by the ITA.

We would like to note that the above is not an exhaustive list of the unwritten rules and pitfalls applicable to options in Israel. Therefore, we recommend consulting with us whether our template form is being used or not. Additionally, we advise the client to consult with us prior to issuing any options to any person, in case more unwritten rules were published.

For further information or any questions, please do not hesitate to contact us, Pearl Cohen Tax Team.


[1] An additional 3% tax may be imposed on individuals who earn more than [NIS] a year (in 2024).