The Israel Tax Authority has recently published a tax ruling on taxation of options and participating units of shares for relocated employees.
In the tax ruling, a case was examined in which an employee in an international company allocating him options or Restricted Stock Units – RSU’s (hereinafter: “options”) in an approved track (according to which the employee is liable to 25% tax on the options as capital income and not as ordinary income at a marginal rate of income tax as high as 48%) leaves Israel during the vesting period and realizes the options after ceasing to be an Israeli resident (and probably after the vesting period).
In this tax ruling, the approach taken in previous taxation decisions has been adopted, according to which tax liability in Israel is determined according to the vesting period of options occurring in Israel. Another approach included here is that of Israeli tax authorities, according to which residence is not severed on the day of departure, at least not already at the stage of deduction at source by the Israeli employer or trustee:
“Exit tax” provisions applying to an Israeli leaving Israel enable postponement to the day of realization with respect to the part of the period from the day the option is granted until the day of departure (“Israeli profit”), Israel is the source country and the employer must deduct tax on this part, with no relief given, including relief usually given to new immigrants, and including credit for foreign tax paid.
With respect to the part of the period from the day of departure until the end of the vesting period (“remaining profit”), Israel constitutes the country of residence;
hence, tax will be deducted by the employer/trustee but foreign tax credit will be permitted already at the deduction at source stage. In the decision it was determined that the carry of credit surpluses for next years will not be permitted with respect to this part, and it is not clear why, since the credits section of the Tax Ordinance allows the transfer of surplus credits as stated from the same “basket” (i.e., same source) over the next five years.
It is not clear what the period is for which the Tax Authority wishes to keep taxation rights, as country of residence with regard to relocated employees. We should note that there is no specific requirement for employees to file returns; however, to the extent an employee claims severed residence from day of departure (or a later stage but before the vesting period is over) he will be able to file returns and require a tax refund for tax deducted from him at source in Israel.
We should note that the later the realization day after the end of the vesting period, a claim could be made that in light of the “exit tax” provisions (which apply to options too), the linear division must be based on the period in which the rights are held until realization, and not until the end of the vesting period; thus, the profit balance (non-Israeli profit) will be given more weight in the linear calculation.
With regard to employees returning to Israel it was determined that realization will be on the date the option is converted into a share and on this day the employee will be charged with the marginal tax, as salary\business income. In this case, the “Israeli profit” (part of profit from day of return until end of vesting period) will be taxed as stated above; in other words, with no reliefs including foreign tax credits.
It looks as though the “remaining profit” in this case of employees returning to Israel (part of profit from day of grant to day of return) will be taxed in Israel according to the aforementioned while crediting for foreign taxes. The question here is, does this also apply to those who were foreign residents on the day the options were granted? If so, this means that there has been a change in the policy of the Tax Authority with regard to taxing profit from options produced abroad by a resident returning abroad by a resident returning to Israel, if realization was made when he was an Israeli resident. This position is in line with the tax ruling recently published on the matter of returning residents receiving salary differentials and bonuses, and classifying them as taxable income since they are taxed on a cash basis. Nevertheless, this position of the tax ruling is not clear and, in any case, it was explicitly clarified within the tax ruling that this relates to liability for deduction at source applying to the trustee, assuming that the relocated employee is an Israeli residents; however, this does not relate to determining an employee’s final tax liability, who can as stated make other claims as part of returns filed by him.