Israel Tax Authority in Dispute Over Hundreds of Millions in Tech Stock Sales

The Israel Tax Authority is engaged in disputes totaling hundreds of millions of shekels with shareholders, including employees, founders, and funds in high-tech companies, over the taxation of secondary stock sales. The core of the disagreement lies in whether these sales should be classified as capital gains, taxed at 25%-30%, or as employment benefits, subject to marginal tax rates that can reach approximately 50%. Some of these cases are currently in court, while others are still under discussion with tax officials. Many employees and entrepreneurs in startups are awaiting a professional directive from the Tax Authority to clarify the situation and resolve these tax dilemmas.

According to Yair Benyamini, a founding partner at Benyamini & Co. and an expert in Israeli and international taxation, these disputes are occurring in nearly every secondary transaction and are a major concern for major accounting and law firms in Israel. He noted that assessments already amount to hundreds of millions of shekels, and the primary issue is the unexpected potential for significantly higher taxes.

A secondary transaction, or "secondary deal," involves investors purchasing shares from existing shareholders, with the proceeds going directly to the sellers rather than the company. This contrasts with a primary funding round where the company issues new shares to investors, and the funds go into the company's coffers. The Tax Authority argues that when shares of an employee or service provider are converted into a different equity instrument during a secondary transaction, the difference in value should be taxed as employment income. This often arises when ordinary shares are converted into preferred shares with specific rights.

Disagreements also emerge when the company's valuation before the share sale is lower than the price at which the shares are eventually sold. The Tax Authority contends that this difference constitutes a benefit granted to the employee who sold the shares and should be taxed as employment income. The situation has been complicated by inconsistent approaches within the Tax Authority itself, with different tax officials applying varying policies.

In response to the growing number of disputes, the Tax Authority issued an interim directive in July, requiring all assessments in secondary transactions to be approved by the head of the professional department until the matter is formally resolved. Shi Aaronovitch, Director of the Israel Tax Authority, stated that a professional directive clarifying the tax aspects of secondary transactions is expected in the coming months, aiming to provide certainty and support the high-tech sector. Tax expert Motty Blalaty from Goldfarb, Gross, Seligman & Co. emphasized that the taxation of these deals impacts the ability to grow technology companies in Israel, arguing that the burden of proof should be on the Tax Authority to demonstrate a genuine link to employment if it seeks to classify the proceeds as employment income.

A Tax Authority source clarified that the authority's approach is not to hinder entrepreneurs but to support the high-tech industry and encourage founders to remain in Israel. While acknowledging disputes in the hundreds of millions, the source also noted the potential for these disputes to exceed one billion shekels. The primary goal, the source added, is to provide market certainty regarding tax liabilities, with the professional directive anticipated around the end of the year. Urgent cases where assessments might expire are being handled individually, but a unified policy is being developed to ensure consistent treatment across all cases.