Israel Tax Authority Clashes With Tech Sector Over Secondary Share Sales

The Israel Tax Authority is engaged in disputes worth hundreds of millions of shekels with shareholders in high-tech companies, including employees, founders, and investment funds, who have sold shares in secondary transactions. These disagreements center on whether such sales should be taxed as capital gains at 25%-30% or as employment income, potentially subject to a marginal tax rate of up to 50%. Some of these cases are currently in court, while others are under discussion with tax officials. Many employees and entrepreneurs in startups are awaiting professional guidance from the Tax Authority to clarify these issues, which the authority has committed to publishing soon.

According to Yair Binyamini, a tax expert, the problem is widespread, affecting major accounting and law firms dealing with these transactions. He noted that assessments totaling hundreds of millions of shekels have already been issued, and the core issue is the unexpected potential for significantly higher taxes. Secondary transactions, where investors buy shares from existing shareholders and the money goes to the sellers rather than the company, have become a key tool in the Israeli tech industry. Recent examples include DriveNets, Cato Cyber Security, and ScaleOps, where employees and founders were involved in substantial secondary share sales.

The Tax Authority's position is that when employees or service providers have their shares converted into preferred shares or other instruments during a secondary transaction, the difference in value should be taxed as employment income. This is particularly relevant when the company's valuation before the sale was lower than the final sale price, which the authority views as a benefit to the employee. Historically, there has been inconsistency in how tax officials handled these cases, leading to confusion.

To address this, the Tax Authority issued interim guidance in July, requiring all assessments for secondary transactions to be approved by the head of the professional department. The authority's head, Shai Aharonovitch, stated that a professional circular on the tax aspects of secondary transactions is expected in the coming months to provide certainty and support the tech industry. A tax expert, Moti Balalti, argues that the tax treatment should be based on the transaction's circumstances and a genuine link to employment, not just the seller's status as an employee.

A Tax Authority official clarified that the goal is not to hinder entrepreneurs but to support the tech sector and encourage founders to remain in Israel. While current disputes amount to hundreds of millions, potential disputes could exceed a billion shekels. The authority aims to provide market certainty regarding tax liabilities, with the professional circular anticipated near the end of the year. Individual urgent cases will be handled while broader policy is formulated to ensure consistent treatment.