So what are my options

So what are my options

December 30, 2019

So you succeeded in realizing “the Israeli dream” - you were hired by a high-tech company and are on the right path to "big money". You arrive at your first day at work and received the standard new employee set of documents, including a "standard" employment contract, which also notes that you are entitled to options. You don’t know much about options, but everybody knows that there is’nt much difference between options and shares ... right? So, before you run out to buy your dream car, let's try and understand what those are.

An option is not a share. An option is a contractual right to purchase a property (share) for a price (the strike price) on a sepcific exercise date or by a specific dates, and usually, it is restricted in a manner that it may not be exercised prior to the meeting of certain terms (vesting) such as passing of time or achievement of certain milestones.

In the high-tech market, it is customary to grant certain employees options as it promotes the interests of both sides, the company and the employee. The company is able to pay the employee a lower salary (because the employee receives options instead of part of the salary) and create higher loyalty and commitment of the employee to the company (the employee is no longer just an employee but is also a shareholder and if resigns or is terminated, the employee may lose the options). As far as the employee is concerned, the employee not only gets a sense of belonging to the company but also the potential for a high future profit with the increase in share value. When one understands that options are in facts a salary replacement, it becomes clear why such should be taxed as any other salary component, subject to the tax rate at which the employee is taxed. Furthermore, in the case of options, there are three potential scenarios where such are taxed: upon grant of the options (because the employee received such in lieu of salary), upon exercise of the options and receipt of shares (because the shares are purchased at a reduced price and the difference is a taxable benefit) and at the time of the sale of the shares in profit. The income tax in this case can be above 50%.

To enable the route of employee stock option plans, Section 102 of the Israeli Income Tax Ordinance allows for the selection of a few routes in which the employee will be given significant tax benefit, the common of which being the 102(b) Route, whereby the options (or the shares, if the employee exercise options during the period) will be held by a tax authorities preapproved trustee for at least two years and in exchange (provided that the strike price was above the share price at the time the options were allocated) the tax payment is deferred until the date of sale of the shares or withdrawal of such from the trustee and is considered as capital gains tax. Or, in simpler language, the tax burden is reduced from 50% to 25% and the payment is deferred until the time the employee “meets” cash.

What reason does an employee have to withdraw shares from the trustee, other than in order to sell? Options are not entitled to rights granted to shares, such as voting at shareholders meetings or right to dividends (thus, it is advise to wait a little before entering the neighbourhood Audi agency), but what happens when the employee exercises the options but the share remain with the trustee? In a case discussed in the Haifa District Court in December 2019, a start-up company employee exercised options but kept such with the trustee. The Court held that the employee is not entitled to the rights accompanying the shares as long as he did not withdraw such from the trustee (and paid tax). The reason being that under law a person is considered a shareholder only when he is registered in the register of shareholders and until then, the trustee is deemed the shareholder. Note that usually the option plan will state that for so long as the shares are held by the trustee the voting rights are held by the CEO or the board of directors.

So what to do when your employer offers you options? First, hold your horses, you are not rich yet. Second, its is recommended to consult a lawyer who is very familiar with the field to discuss the different paths available, so that maybe in a few years you might not buy your dream car, but even a fancy new flower pot is not that bad ...