Hiring in Israel: How Section 102 Shapes Equity Compensation

While equity compensation instruments function similarly across jurisdictions, Israel’s tax framework introduces distinct structural considerations that materially affect their implementation and outcomes.

Equity compensation tools — including stock options, Restricted Stock Units (RSUs), Restricted Stock (RS) and Employee Stock Purchase Plans (ESPPs) — are widely used worldwide to attract, retain, and motivate employees. While their core economic features are similar across countries, Israel’s tax system introduces unique structural elements that significantly affect how these plans are designed, taxed, and ultimately benefit employees.

This article explores the distinct features of Israel’s equity compensation framework under Section 102 of the Israeli Income Tax Ordinance ("Section 102"), focusing on its tax deferral provisions and the preferential 25% capital gains tax rate. Understanding these elements is essential for employers operating in Israel and their workforce, as they shape both plan administration and financial outcomes.

Equity Compensation: Global Mechanics and Israeli Tax Nuances

At their essence, stock options, RSUs, RS and ESPPs operate similarly in Israel as elsewhere. Employees gain conditional rights—typically subject to vesting—to receive or purchase company shares, aligning their incentives with corporate success.

• Stock Options: Provide employees the ability to exercise their right to buy shares at a set price once vesting conditions are met.
• Restricted Stock Units (RSUs): Promise delivery of shares upon meeting vesting conditions. Unlike options, no purchase is required; shares are granted outright at vesting.
• Restricted Stock (RS): Grant of actual stock, priced at zero, allocated to an employee as of day one, yet they are subject to some restrictions, primarily a vesting schedule. Although entitling the employee to any of the stockholders' rights, the stocks cannot be sold or transferred until they vest.
• Employee Stock Purchase Plans (ESPPs): Allow employees to buy company stocks at a discount via payroll deductions during a defined offering period, promoting ownership and engagement.

What Makes Israel Different: Tax Deferral and Capital Gains Treatment

Israel’s Section 102 introduces a fundamental tax distinction for equity incentive plans: taxation is deferred until the actual sale of shares. This contrasts with many countries where taxable events may occur at grant, vesting, or exercise, which can impose cash flow challenges on employees required to pay taxes before realizing gains. This mechanism reduces cash flow burdens for employees and better aligns tax timing with actual financial gain.

When the equity plan complies with Section 102 requirements—including approval by the Israeli Tax Authority and adherence to a typical minimum holding period of two years from the grant date ("Holding Period")—profits realized from the sale of shares can enjoy a preferential capital gains tax rate of 25%.

This rate is significantly more advantageous than Israel’s top marginal income tax rates, which can exceed 50%, resulting in a substantial tax benefit for employees.

Section 102 and the Trustee Track

The most commonly used method under Section 102 is the "trustee track," whereby a qualified independent trustee is nominated to verify that due to the deferral of the tax event to the actual sale of shares, taxes will indeed be paid to the Israeli Tax Authorities. Accordingly, the awards and underlying stocks will be secured by such third-party agent during the holding period. This trustee structure ensures compliance with tax regulations, proper reporting, and facilitates tax deferral. In order to benefit from reduced tax benefits and defer the regulatory tax event, the appointment of an Israeli trustee is required.

Conditions and Compliance

To benefit from this preferential regime, equity plans must meet regulatory criteria, including:

• Formal approval of the equity plan by the Israeli Tax Authority prior to implementation.
• Appointment of a qualified trustee responsible for holding shares, reporting and managing tax withholding.
• Imposition of a minimum holding period, commonly two years, during which employees cannot sell shares without forfeiting benefits.

Failure to meet these conditions results in the equity compensation being taxed as ordinary income, and in certain situations at the time of vesting, subjecting employees to higher tax rates and immediate tax liabilities and imposing reporting and withholding obligations on the company.

Public vs. Private Companies

Although the overarching principles apply to both public and private companies, there may be nuances in tax treatment. For example, in public companies, part of the benefit realized at grant may be taxed as ordinary income, with capital gains treatment applying only to appreciation after grant till sale date. However, the principal feature of tax deferral and preferential capital gains taxation upon sale remains central in both contexts.

Unlike the strict FMV requirements in the U.S., Israeli tax law offers private companies incredible flexibility in pricing equity awards. This opens the door to significant tax advantages, potentially applying reduced capital gains rates to the entire profit. Combined with customizable vesting milestones and acceleration terms, Israeli equity plans are a powerful, flexible tool for attracting top talent. Also, non-Israeli public companies can get a relief from the Israeli Tax Authorities regarding the trustee mechanism such that, upon meeting certain conditions, the trustee will only be responsible for the reporting and tax withholding obligation without having the requirement to hold the shares.

Adaptation of ESPP Plans to Israeli Regulations

Employee Stock Purchase Plans (ESPPs) are a popular equity compensation vehicle internationally, enabling employees to acquire shares at a discount through payroll deductions. While the economic concept is consistent, adapting ESPPs for compliance with Israeli regulations (including also a pre-tax ruling from the Israeli Tax Authorities) requires careful design considerations to align with Section 102 provisions and maximize tax benefits.

Practical Implications for Employers and Employees

For Employers:
Employers must carefully design equity plans to comply with Section 102 regulations, including securing tax authority approvals and engaging qualified trustees. Proper plan administration is essential to ensure employees receive the intended tax benefits, reduce compliance risks, and maintain efficient record-keeping and reporting. Additionally, employers should educate employees on the timing and tax consequences of their equity awards to foster informed decision-making.

For Employees:
Understanding the deferral of taxation until share sale is crucial for financial planning. Employees benefit from the preferential 25% capital gains tax rate (for all or part of the gain) but must be mindful of holding period requirements and plan rules. Decisions regarding vesting, exercise, and sale timing should consider both market conditions and tax implications to optimize after-tax returns.

Strategic Equity Compensation for U.S. Companies in Israel

Companies expanding to the Israeli market, a clear roadmap has emerged to ensure compliance and tax efficiency. The standard setup usually involves adopting the "Capital Gains Track," adding a local tax annex to the existing equity plan, and appointing a specialized Israeli trustee to manage tax withholdings and reporting. To keep things seamless, plans are typically pre-filed by the Israeli trustee with the Israel Tax Authority, followed by routine tax reports processed and submitted by the Israeli trustee to stay fully compliant.

Conclusion: Navigating Israel’s Section 102 Equity Framework

Israel’s equity compensation framework stands out due to its tax deferral of equity awards until sale combined with a preferential 25% capital gains tax rate under Section 102. This framework reduces liquidity constraints and lowers tax burdens for employees, enhancing the attractiveness of equity compensation.

While stock options, RSUs, RSs and ESPPs operate on similar principles globally, Israel’s unique tax environment requires specialized plan design, administration and trustee services. Companies and employees who effectively navigate this landscape can maximize the financial and motivational benefits of equity compensation.

Note: the information presented herein provides a general overview for information purposes only and does not constitute financial, tax, legal, or any other advice. Parties reviewing the above recognize that each model has distance, various tax and regulatory implications based on applicable jurisdiction and circumstances.

For additional insights into global equity compensation, including Israel-specific considerations, see the NASPP blog Global Stock Compensation: Key Considerations and Resources.