Kesselman & Kesselman
Certified Public Accountants
Trade Tower, 25 Hamered Street
Tel Aviv 68125 Israel
P.O Box 452 Tel Aviv 61003
Telephone +972-3-7954555
Facsimile +972-3-7954556
missim/zeev/doc/tax alert ESOP regulations-2.doc
February 16, 2003
Our PwC Israel International Alert of July 30, 2002 provided an outline of the Israeli tax
treatment of employee stock option plans (ESOPs) under the new Section 102 of the Israeli
Income Tax Ordinance (“ITO”) as legislated pursuant to Israeli tax reform legislation that
generally came into effect on January 1, 2003. The new Section 102 prescribes the tax
treatment that will apply under a trustee and non-trustee structure for ESOPs granted after
January 1, 2003.
We present below highlights of new rules recently issued by the Israeli Tax Commissioner
regarding the application of certain areas of these new Section 102 tax laws for the trustee
and non-trustee routes.
The rules principally relate to the appointment and qualifications of plan trustees and
notification and tax reporting requirements due to the Israeli Tax Authorities (ITA) in the
case of trustee and non-trustee structures. The rules include standard forms to use for the
notification and reporting process.
It should be noted that the language of the new law and rules pertaining to certain issues still
remain unclear. Further clarity concerning the ITA position regarding these issues is
expected within the context of their anticipated guidelines.
It should be emphasized that these rules do not apply to ESOPs granted prior to January 1,
2003. The previous tax regime will continue to apply for such plans.
A. TRUSTEE STRUCTURE PLANS
1. Appointment and qualifications of plan trustees
A written application providing details of the trustee selected and of the ESOP plan must be
submitted to the ITA in order to obtain the ITA’s approval of the trustee.
A trustee’s appointment will not be confirmed unless the person, or entity is either:

An attorney;

A certified public accountant (CPA);

A company which is not a limited liability company where all the
shareholders are either attorneys or CPAs;

Any party permitted to serve as a trustee pursuant to The Joint Investment
Trust Funds Law;
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For these purposes, the employer company or a controlling shareholder of the employer
company are prohibited from serving as trustees.
In addition, an employee of the Israeli employer company that has granted options to its
employees under the plan may be appointed as a trustee, provided that such employee is an
attorney or CPA and is either the general manager, deputy general manager, the company
controller or legal adviser and provided that the employee has not been granted options under
the ESOP concerned.
Substitution of an appointed trustee is permitted pursuant to required notification rules.
2. Prior to the grant of options - Notification required to the ITA
The company and the trustee must apply to the ITA on a prescribed form for approval of the
plan not less than 30 days before the grant of any options under the plan. The regulations
state that if the plan documentation is in a foreign language, the ITA may request the
production of a certified translation into Hebrew.
The above application must contain the following particulars regarding the:

taxation route applicable to the plan (i.e. employment income or capital gain
route);

taxation route previously utilized by the company and the date it was
selected;

name, registration number and tax residency of the company granting the
options;

relationship between the company granting the options and the employer
company;

the trustee and its approval by the ITA.
3. Following the grant of options – Notification required to the ITA
The company and the trustee must report the following particulars to the ITA within 90 days of
the grant date of options:

date of grant;

names, identity numbers and addresses of the employees to whom
options have been granted;

number and type of shares granted to each employee;

any amounts paid by employees in consideration for shares;

expenses charged to the Israeli employer company by the option
granting affiliate company and anticipated dates of payment (i.e.
details pertaining to chargeback arrangements);

where the company issuing the shares is listed on a stock exchange,
the listing date, or the date upon which it is intended to list its shares
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for trading where the stock exchange listing process has not yet been
completed;

date upon which the shares concerned were deposited with the trustee.
4. Disqualification of the Plan
An employee stock option plan will neither be approved or regarded as approved in the
following circumstances:

where more than one trustee has been selected;

where more than one taxation route has been selected unless certain
conditions are met;

where the documentation fails to include a provision prohibiting the
employees from selling the shares before the conclusion of the
minimum trustee retention period.
As explained in our Alert of July 30, 2002, a minimum trustee retention period of
12 / 24 months is required starting from the end of the tax year in which the
options were granted and deposited with the trustee. Options or shares will be
regarded as having been sold for these purposes upon the earlier of: (i) a sale by
the trustee; or (ii) transfer of control of securities to an employee.
The regulation’s requirement requires further clarification with the ITA since the
new tax law includes provisions explaining the tax consequences for an employee
who sells the shares before the conclusion of the restriction period.

where the documentation makes no reference to the deposit of the
shares with a trustee who will have full powers concerning the shares
(including bonus shares issued in regard to these shares) and that the
same taxation route (i.e., employment income or capital gains) will
apply to all the shares.
5. Payment of tax
A trustee is prohibited from transferring, assigning, withdrawing or encumbering shares
(except under the terms of a will or for any other reason as a result of the operation of law)
before proper payment or guarantees have been made for any taxes due arising with regard to
such shares.
Tax will be withheld in accordance with the tax rules applicable under each taxation route, as
detailed in the prior Alert of July 30, 2002.
Under the employment income taxation route, where shares are sold or transferred to an
employee before the end of the plan restriction period, the tax amount to be withheld must be
the higher of either any tax that would have applied as at the date of grant together with
consumer price index increase adjustments and interest calculated from such date to the date
of payment or the amount of tax that would be due as at the date of sale.
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6. Annual trustee report
A trustee must file a report with the ITA by March 31 following the tax year in which the
options were granted. The report must reflect particulars regarding:

names, identity numbers and addresses of employees to whom options were
granted and the number of options granted to each such employee;

number of options and shares held by each employee at the beginning and on
the last day of the tax year;

transactions executed with respect to option and shares issued to employees,
including the transfer of options or shares to the employees or the sale of
shares (as well as details regarding the value / consideration received and of
tax paid);

rights acquired, including bonus shares, as a result of the issue of such
shares;

dividends distributed relating to the shares held by the trustee;

employees that have terminated their employment;

employees that have ceased to be Israeli tax residents
Regarding the last point, the question of when an individual ceases to be Israeli tax
resident is a complex area of law and depends upon a series of criteria focusing on
where the person's center of life is located with presumptions to be applied based on a
"day's test" and with tax treaty tie breaker tests to be applied where a person is deemed
tax resident in two countries. We would anticipate that trustees would decline to bear
this responsibility of determining whether an employee has ceased to be Israeli tax
resident. This issue would require further deliberation with the ITA.
B. NON-TRUSTEE STRUCTURE PLANS
1. Following the grant of options – Notification required to the ITA
Within 90 days of the grant of options, an employer must report details concerning the
option issuances with particulars similar to those required in the case of a trustee
structure as listed in paragraph 3 above. The regulations do not require any notification
prior to the grant of options.
2. Annual employer report
The employer must file a report with the ITA by March 31 following the tax year in
which the options were granted. The report must reflect particulars similar to those
required in the case of a trustee as listed in paragraph 6
3. Guarantees from employees upon employment termination
The regulations require employers to secure guarantees from employees upon
termination of employment for the payment of tax due upon realization of the shares.
It will accordingly be necessary for plan documentation to include provisions that afford
the necessary security for employers where an employee’s employment is terminated
prior to the realization of his /her shares.
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4. Payment of tax
The employer is obliged to withhold and to remit tax to the ITA in accordance with the
tax rules applicable under the non-trustee taxation route.