The employment agreement of two senior managers of an internet service provider (ISP) included a bonus in case of a merger and they also contended that they were entitled to employee stock options in the merged company. After the merger of the ISP with two other ISP’s and the merged company did not pay the bonus or issued the options the manager filed a claim at the Labor Court, which was settled in an agreement under which each received a few millions that were defined in the agreement as: “waiver of rights under corporate structural change and merger and waiver of right of claim for non-receipt of options.” The managers sought to pay capital gains, but the Tax Authority demanded payment of income tax (at the pertinent time 45% tax in lieu of 20% or 25%).
The Court held that except for extraordinary and special cases any payment to an employee by employer is a work income, unless the employee showed otherwise. The burden to show otherwise is very heavy and the employee needs to show that the payment received is not a substitute or camouflage of a work income. Compensation for loss of income is work income and compensation for loss of ability to work is the only one that will be deemed capital gain. The drafting of the settlement agreement does not influence on the classification of the income which will be done by the real essence of the income. The merger bonus was part of the employment terms and the managers even filed the claim at the Labor Court and therefore it is work income. Because the managers were unable to show that indeed they had the right to the options, the compensation for the right to claim due to non-issuance of the options is also work income.