On 16 December 2019 the Haifa District Court determined that so long as shares awarded pursuant to Section 102 of the Israeli Income Tax Ordinance (New Version) (5721-1961) (Section 102) are held by a trustee for the benefit of a grantee, they confer no shareholder rights on the grantee.
In general, the award of shares or rights to shares (share awards) to Israeli employees is subject to Section 102 for tax purposes. Section 102 provides several tax tracks, the most common of which is the capital gains track, under which a company that grants a share award to an Israeli employee must nominate an Israeli trustee to hold the award (including the underlying shares) for the benefit of the grantee for at least two years from the date of grant (the holding period). Subject to compliance with the holding period, the grantee would be subject to capital gains tax at the rate of 25%, payable on the earlier of:
- the sale of the share award (or the underlying shares, as applicable); or
- the transfer of the share award (or the underlying shares, as applicable) from the trustee to the grantee.
As the transfer of a share award from a trustee to a grantee constitutes a tax event, the share award (or the underlying shares, as applicable) typically remains deposited with the trustee until the share award or underlying shares are sold or otherwise disposed of (the realisation date).
A company adopted an equity incentive plan (the plan), under which a grantee received options to purchase company shares (the options and shares, respectively). The options were granted pursuant to the capital gains track of Section 102 and were accordingly deposited with an Israeli trustee. The plan stipulated that any shares issued on exercise of the options would be voted by an irrevocable proxy, pursuant to the directions of the company's board of directors.
The grantee exercised the options and the underlying shares were issued to the trustee for the benefit of the grantee. The grantee claimed that he was forced to execute the proxy and that the proxy should therefore be deemed void. Further, although the shares were held by the trustee, the grantee claimed that he was entitled to shareholder rights, including the right to receive information and vote.
The Haifa District Court reviewed the Israeli Companies Law (5759-1999) and concluded that the trustee rather than the grantee was the shareholder. Therefore, the trustee (not the grantee) was entitled to all rights conferred by the shares, including voting and information rights. The court added that in the event that the grantee wanted to receive information from the company to which a shareholder would be entitled, the grantee should ask the trustee, as the registered shareholder of the shares, to request said information from the company.
The court also determined that the purpose of the deposit of the shares with the trustee under Section 102 was to ensure that the grantee enjoyed shareholder rights only after the realisation date: therefore, as long as the shares were held by the trustee, no shareholder rights should be conferred upon the grantee.
With respect to the proxy, the court ruled that the proxy's validity should be examined only after the shares were transferred to the grantee, because while the shares were held by the trustee, the grantee would not be entitled to the rights underlying the shares, including voting rights. The court stated that the grantee's claim that he was forced to sign the proxy was not supported by the facts, given that the plan provided for the execution of the proxy and the grantee was represented by counsel when the award agreement had been signed.
While the Haifa District Court judgment is not a binding precedent, it confirms the common practice of treating Section 102 trustees as shareholders of Section 102 shares held in trust, thus depriving grantees of shareholder rights so long as the shares are held by trustees.
The judgment also reinforces the practice of requiring Section 102 grantees to sign an irrevocable proxy.
