Israel

Equity-based compensation has become a cornerstone of employee incentive strategies, particularly in the tech industry. As a result, the design and tax planning of such plans are especially critical. Getting it right means allowing the employee to maximize value without exceeding the bounds set by Israeli income tax law. Knowing the dos and don’ts will help you avoid unpleasant surprises with the Israeli Tax Authority. The most common framework for granting equity to employees is Section 102 of the Israeli Income Tax Ordinance [New Version] 5721-1961, specifically the capital gains route. This route allows startups to offer options or shares through a trustee, with potential tax advantages. If certain conditions are met, including a minimum holding period of 24 months, employees may be taxed on exit at the 25% capital gains rate, instead of higher rates on employment income. The challenge, of course, is that eligibility depends on proper structuring and strict compliance with the income tax rules. Mistakes in documentation, timing, or plan approval can lead to full marginal tax rates and employer tax exposure. The challenge has grown even greater since January 1, 2025, when the ITA replaced its manual reporting regime with a mandatory electronic system. The digital submission process now includes a detailed questionnaire that is designed to flag certain features in equity plans that may be inconsistent with the requirements of Section 102. To ensure that your employee equity plan qualifies for the capital gains route, be sure to pay attention to the following issues. Promising equity without executing a formal grant: This is one of the costliest mistakes. In their employment or founder agreements, many startups include language about future option grants but then fail to adopt a formal Section 102 plan or to submit it to the ITA. By the time an exit becomes likely, it is often too late to grant options under the capital gains route. Note that a plan must be submitted at least 30 days before any grant and that grants made within 90 days preceding an exit are classified as employment income, not capital gains. To avoid any problems, equity plans should be adopted and implemented early in the company’s life cycle. Vesting contingent on an exit: In many startups, the real financial upside for employees comes only at exit, since these companies do not typically distribute dividends during their growth phase. To align incentives, employers often want equity awards to vest only if and when an exit occurs; in this way, employees are rewarded when shareholders realize value. This structure, however, raises a red flag with the ITA. According to the Authority’s position, vesting that is contingent on a liquidity event resembles a contingent bonus rather than genuine equity compensation, and it makes no difference whether the liquidity event occurs alone or comes as part of a double-trigger structure (i.e., time-based vesting combined with a required exit). When vesting is contingent on an exit, the plan does not qualify for capital gains treatment under Section 102, and the gain will be subjected to full employment tax rates. To maintain compliance while keeping rewards tied to a successful exit, companies can use time-based vesting with an acceleration clause that is triggered by an exit. Because the exit is not a precondition for vesting itself, this structure is not prohibited by the ITA. Vesting contingent on performance goals: The ITA generally expects equity awards under Section 102 to vest based on objective and time-based criteria, not on subjective or discretionary performance metrics. When vesting is tied to performance goals such as meeting sales targets, launching a product, or securing funding, the Authority may view the award as a compensation for specific services rather than a long-term equity incentive. To mitigate this risk, companies should clearly define performance criteria in advance and ensure that those criteria are objectively measurable and impervious to discretionary interpretation. Grants based on preference shares: Granting options or shares based on preference is another red flag for the ITA. This is particularly true when employees receive instruments that carry rights similar to those of preferred investors; examples include liquidation preferences, anti-dilution protections, and guaranteed returns. The Authority generally expects employee equity to be granted over ordinary shares, not over instruments designed to protect capital or ensure a minimum return. To comply with the requirements of Section 102, companies should grant options over ordinary shares, which are defined as shares that carry voting rights (including through proxy arrangements), are entitled to dividends, and participate in liquidation proceeds. An exclusive reliance on ordinary shares, however, may be problematic for companies with heavily preferred capital structures, where common shareholders—including employees—may receive little or no proceeds upon exit. In such cases, the Israeli Tax Authority may accept the use of a carve-out arrangement, a contractual mechanism for allocating part of the exit proceeds to employees, provided that it is properly structured and submitted in advance for tax approval. It is crucial to plan such arrangements early, with sufficient time to obtain a tax ruling. Repurchase rights and put/call options: These mechanisms are common in shareholder agreements, especially in early-stage companies and founder arrangements. But when they are applied to employee equity awards, repurchase rights and put/call options may raise serious concerns under Section 102. The ITA may consider the award to lack genuine equity risk in either one of the following scenarios: 1) the company or its shareholders retain a call option—especially one that limits upside—to repurchase shares at a fixed or formula price; or 2) the employee holds a put option that guarantees liquidity or a minimum return. In these cases, the ITA may view the award as compensation income and disqualify it from capital gains treatment. Call options that allow the company to repurchase shares upon termination of employment are permissible, but only if they meet strict criteria. Under no circumstance may the employee hold a put option that obligates the company or its shareholders to repurchase the shares. These are just the most common considerations involved in ensuring that employee equity plans qualify for the capital gains route under Section 102. On top of all this complexity, the ITA’s new electronic reporting system is likely to catch issues that might once have gone unnoticed. Early and professional planning is more critical than ever, since a single misstep can turn what should have been a meaningful reward into a costly tax event. At STL, we have the expertise, creativity, and commitment to guarantee the optimal structuring of your equity plan. To request further information or to schedule a consultation, please contact Anat Shavit at [email protected] .

In the wake of prolonged geopolitical instability, internal political uncertainty, and the rise of global anti-Israeli sentiment, a growing number of Israeli entrepreneurs are choosing to incorporate their startups abroad—seeking stability, greater access to international investors, and strategic insulation from regional volatility. While this trend may offer meaningful business advantages, it also carries significant tax implications that Israeli entrepreneurs must be aware of. Without proper planning, these cross-border structures can inadvertently expose founders to unexpected Israeli tax liabilities and compliance risks. In this article, we will examine the potential tax exposure associated with creating a permanent establishment (PE) in Israel, particularly in cases where Israeli entrepreneurs are actively involved in developing the company’s intellectual property from within Israel. It is increasingly common for Israeli entrepreneurs to incorporate their startups as foreign entities—most often in the United States—at the very early stages of the venture. This strategy is typically driven by commercial considerations such as easier access to venture capital, favorable legal infrastructure, and alignment with future expansion plans. In many cases, the founders envision relocating abroad at a later stage once the company matures or begins scaling its operations. However, during the initial development phase, much of the core activity—including product development and IP creation—continues to take place in Israel. This disconnects between the legal structure and the actual business activity may inadvertently trigger a permanent establishment (PE) in Israel, exposing the foreign company to Israeli taxation. If not properly addressed, this risk can significantly complicate matters at critical junctures such as raising funds or executing an exit, where investors and acquirers scrutinize the company’s global tax exposure. When Israeli entrepreneurs remain in Israel and continue to lead key functions such as product development, R&D, and strategic decision-making, their activities may give rise to a permanent establishment (PE) of the foreign company in Israel—even if the entity is formally incorporated abroad. Under Israeli tax law, a PE can be triggered where there is a fixed place of business or where core entrepreneurial functions are conducted locally. Once a PE is established, the foreign company is required to allocate an appropriate portion of its global income to Israel based on transfer pricing principles. This means that even at early stages—when the company may be operating at a loss on a consolidated basis—it must still file annual tax returns in Israel and may become liable for Israeli corporate tax on the income attributed to the Israeli PE. Failing to recognize and plan for this exposure can result in significant compliance issues and unexpected liabilities later on. Importantly, the existence of a PE in Israel is not the only concern. When Israeli entrepreneurs are actively involved in the development of the startup’s intellectual property (IP) from within Israel, the Israeli Tax Authority may argue that the IP is at least partially—if not fully—owned by the Israeli PE. In such cases, even if the legal ownership of the IP is held by the foreign parent company, the economic substance of the IP creation may be attributed to Israel. This can have far-reaching implications: if the IP is later licensed, sold, or transferred as part of an exit event, the Israeli tax authorities may assert that a significant portion (or even all) of the resulting income should be subject to Israeli taxation. This position can lead to unexpected tax liabilities and complicate the valuation and structuring of future transactions. In an increasingly globalized and uncertain environment, structuring your startup abroad may seem like the logical path—but Israeli entrepreneurs must recognize that legal incorporation is only one piece of the puzzle. The location of actual business activity, especially IP development, has real and potentially costly tax implications. Early-stage companies can and should take proactive steps—whether through tax rulings, proper transfer pricing, or long-term planning—to reduce exposure and avoid unpleasant surprises at later stages. Consulting with experienced advisors early on can make all the difference between a clean, scalable structure and a future entangled in tax disputes. Have questions or faced similar challenges? Anat Shavit from STL will be happy to assist you and your company with the tax planning.

Local Civil Litigation in Israel Israeli civil courts have a three-tiered system comprised of trial courts, known as Magistrate Courts; intermediate appellate courts, known as District Courts; and a final court of appeal and the highest court – Israel's Supreme Court. Magistrate courts serve as courts of first instance for most civil disputes, with subject matter jurisdiction of claims in which the sum claimed is not higher than 2.5 million NIS and some real estate cases. Cases that begin in the Magistrate courts can be appealed as of right to the District courts. The district courts sit as an appellate court of judgments rendered by the Magistrate courts and act as a court of first instance for disputes over land ownership and monetary claims exceeding 2.5 million NIS. District courts have residual jurisdiction over civil matters that are not under the jurisdiction of Magistrate courts. The Tel Aviv and Haifa District courts each have a specialized economic division. These economic courts have exclusive jurisdiction over financial matters (such as derivatives disputes). Decisions by the District courts can be appealed to the Supreme Court. The Supreme Court is the final court of appeals and a High Court of Justice (HCJ). As the High Court of Justice (Bagatz), the Supreme Court is hearing primarily administrative and constitutional petitions for judicial review of executive action and legislation.  When sitting as an appellate court, the Supreme Court hears appeals as of right and applications for leave to appeal. It primarily hears appeals from final judgments of District courts sitting as trial courts and appeals on leave from final decisions of District courts sitting as appellate courts. Leave to appeal is granted when the question at issue carries general implications for the public, beyond the applicant's case; or when a substantial injustice has occurred. The President of the Supreme Court heads the Israeli judicial system. The Supreme Court consists of 15 Justices and two Registrars. Generally, the Supreme Court sits in panels of three. However, a single Justice may hear certain matters, such as interlocutory applications, temporary orders, and applications for leave to appeal. Under the binding precedent principle, a precedent ruled by the Supreme Court binds every court except the Supreme Court. A ruling by a District court guides the Magistrate courts. Professional judges comprise Israeli civil courts, and there is no jury system. The Israeli legal system is adversarial. The passive role of the judge in the adversarial system grants the parties significant control over litigation management. Yet, in practice, Israeli judges have a more active role. Where a civil claim is brought in the court, the procedural rules are found in the civil procedure regulations. Recently, these rules of procedure underwent a massive reform. The new regulations came into effect in 2021, detailing the rules for conducting court proceedings. The new Israeli rules of civil procedure formally express the trend toward more robust judicial activism and reflect the managerial role of judges. Under the new civil procedure rules, judges have formally received broadened authority to conduct legal proceedings efficiently and justly to resolve the conflict between the parties quickly. For instance, the pretrial stage allows the judge significant involvement in the process. During pretrial, the judge can cross-examine witnesses or the parties themselves to resolve the case at that stage. Also, during cross-examination of witnesses in the trial, the judge may ask witnesses questions. The rules formalize the common practice of judges who offer settlement proposals to the parties. The new regulations aim to help the court conduct the trial while maintaining a proper and fair judicial system. The rules seek to achieve the following goals: to bring about the simplification and unification of legal procedures; to root out barriers that cause prolonged court hearings; to bring about mutual disclosure and complete transparency between the parties before and during the filing of a claim; to bring about a balance between the needs of the litigants and the consideration of unrepresented litigants; to promote accessibility to the judicial process; and to ensure a proper and fair procedure and prevent the waste of valuable judicial time. The rules of civil procedure emphasize fair trials, public access, and prompt dispute resolution time. Generally, civil claims have a seven-year statute of limitations; in a case of a claim relating to land – 25 years. The parties may contractually agree on a more extended or shorter limitations period for matters other than real property, but at least six months. Generally, there are no pre-action conduct requirements before commencing a commercial lawsuit. Civil proceedings commence with the filing of a complaint with the court. The statement of claim, along with a summons to court, is served to the defendant. Generally, the defendant must serve an answer within 60 days, and the plaintiff may serve a reply to the answer within 14 days. After the last pleading is submitted to court, the parties exchange demands for disclosure and questionnaires. Following this, motions are submitted concerning the preliminary proceedings under a strict timetable before the first pretrial hearing. The parties have limited control over procedures and timetables. Generally, the timetable is set by the regulations and the court's orders. Nonetheless, the courts tend to grant time extensions liberally when the parties reach procedural agreements concerning time extensions. Parties are bound to full mutual disclosure of the documents that are part of their claim. During discovery, each party discloses to the other party the relevant records and correspondence in its possession, custody, or control. Privileged documents, such as attorney-client correspondences or materials prepared in anticipation of litigation, are not presented to the other party. Yet, in the discovery affidavit, it is customary to furnish their existence and indicate that these documents are privileged. Instead of oral testimony, the witnesses (including experts) often submit their testimony in a written affidavit (or a written expert opinion). The witnesses and experts are subject to cross-examination in court. Following the recent civil procedure reform, preference is given to hearing oral summations and evidence and direct examinations. The court decides whether witnesses shall give oral evidence or file affidavits. In most cases, witnesses submit affidavits that serve instead of oral testimony. Remedies may include enforcement of contracts, damages, and declaratory relief. Generally, prevailing parties may recover court costs and attorney’s fees from the opposing side. Interim remedies are available for parties, including temporary restraining orders, preliminary injunctions, and prejudgment seizures. Typically, an interim remedy is issued to maintain the status quo when the lawsuit is filed until a final decision is made on the merits to ensure the implementation of the judgment if the permanent remedies are granted. Generally, court hearings are open to the public. In certain circumstances, court hearings are held behind closed doors (e.g., where concerns about disclosure of trade secrets or other sensitive information exist or to maintain national security, etc.). The Foreign Judgments Enforcement Act (FJEA) governs the recognition and enforcement of foreign judgments in Israel. The FJEA provides for separate procedures for recognition of a foreign judgment: declaration of the foreign judgment as an enforceable judgment, direct recognition, and indirect (incidental) recognition.  Under the FJEA, a foreign judgment is eligible for enforcement if the following requirements are met: the foreign judgment must be rendered by a court of competent jurisdiction according to the laws of the state of origin; the judgment must be final; the obligation imposed by the judgment must be enforceable according to Israeli law; the content of the judgment must be compatible with public policy; and the judgment must be enforceable in the state of origin. The enforcement of foreign judgments is subject to reciprocity. This means that a foreign judgment shall not be declared enforceable if entered in a state under the laws of which judgments entered by Israel courts are not enforceable. This requirement has been interpreted by Israeli courts as 'potential of enforcement’. The court may, however, on application by the Israeli Attorney General, enforce a foreign judgment even where there is no reciprocity. The defendant may raise defenses against the enforcement of a foreign judgment, including: the judgment was obtained by fraud; the defendant was not given a reasonable chance to bring a defense before the foreign court; the judgment was given by a court with no jurisdiction over the case according to Israeli private international law; the existence of inconsistent judgments on the same subject-matter and between the same parties; or at the time that the action was brought in the foreign court, a lawsuit on the same subject-matter between the same parties was pending before an Israeli court. It is worth noting that pleadings have a strict page limit under the new civil procedure rules. Also, courts can dismiss an appeal without hearing the other party. The new civil procedure rules have made the legal process more strategic and structured. On top of this, essential substantive principles that judges employ such as good faith and reasonableness – allow them broad discretion. This broad judicial discretion, manifested in both substance and procedure, reinforces the importance of clear, precise, and robust legal pleadings and a high-quality legal representation of the parties. Arbitration and Alternative Dispute Resolution The Arbitration Act requires an arbitration agreement to be in writing. If the arbitration clause is silent on the arbitrator’s identity, and the parties disagree, they can request the competent court to appoint an arbitrator. Courts will often appoint a retired judge or an esteemed lawyer with the qualifications to adjudicate on the matter as arbitrator. Israeli Arbitration establishments have “pools” of arbitrators, and the establishment's president typically appoints an arbitrator from the arbitrators’ list. The court may remove an arbitrator if the arbitrator is unworthy of trust (e.g., due to conflict of interests); the arbitrator's conduct during the arbitration distorts justice, or the arbitrator cannot fulfil the role. The Arbitration Act sets default rules which exempt the arbitrator from the civil procedure rules, substantive law, and evidence rules. The arbitrator should detail his reasoning. It is customary to require the arbitrator to adhere to the substantive law in the arbitration clause. The arbitration award must be in writing and signed by the arbitrator. An arbitration award can be cancelled as follows: Ten statutory grounds allow the court to revoke an arbitration award, including lack of authority, lack of reasoning (when applicable), the award contradicts public policy, the arbitrator was not lawfully appointed and due process considerations. The parties may also agree that an appellate arbitrator will hear an appeal. If the arbitration agreement or clause stipulated a right to appeal to court, the parties might request it where a fundamental error in applying the law caused grave injustice. A domestic award can be enforced when submitted by the winning party to the competent court for approval and the other party does not submit a leave for cancellation or an appeal. A foreign award may be approved according to the New York Convention, which was incorporated into domestic law. The Israeli rules of civil procedure incorporate alternative dispute-resolution procedures into the legal process. The referral of cases from the court system reflects the judicial attempt to decrease case load and minimize litigation costs. The most common ADR processes in Israel are mediation and arbitration. Commonly, the court asks the parties to consider ADR. In most cases, the civil procedure regulations set forth a mandatory mediation meeting by a court-appointed mediator before the first hearing; if the meeting is unsuccessful, the court cannot compel the parties to continue participating in the ADR process. About Lipa Meir Lipa Meir & Co. is one of the leading law firms in Israel. The firm offers a full range of civil, corporate and commercial legal services, and provides a comprehensive and top quality framework of legal services to both domestic and multinational clients, while always providing its clients with service that is personal, professional and creative. The firm operates through six key departments, dedicated respectively to Commercial Law; Litigation and Dispute Resolution; Technology. Corporate. M&A Department; Real Estate and Finance; Real Estate, Hotels & Leisure Department; Employment Law; The firm has earned the recognition of leading domestic and international legal ranking guides, such as: Chambers & Partners, The Legal 500, IFLR 1000, WTR1000, BDI and Dun’s 100.  

Israel fell into turmoil last month, amongst other reasons, due to a Supreme Court’s ruling regarding the deposit contributed by employers of foreign nationals working in Israel.This ruling is relevant and has significant implications on the future security of all Israeli employees’ pension savings. Had the Supreme Court not prevented the State from encroaching into these deposits, which are contributed for the benefit of foreign workers, the way to fully nationalizing the pension savings of each employee in Israel would have become extremely short. Israeli labor and employment laws mandate a minimal threshold of rights for every employee: minimum wages, weekly rest hours, paid vacation, sick pay, severance pay and more. An employee’s agreement to deviate and accept lesser rights than those stipulated by law – has no validity. In this way, the State imposes a social paradigm of fair employment conditions and non-exploitation of employees, preventing a race to the bottom. 2008 marked an additional fundamental change to employee rights in Israel, the right to have one’s employer contribute (on a monthly basis) towards employees’ pension savings and termination severance pay. This addition anchored the recognition of a fundamental and basic principle, that a working person is entitled to a dignified living, spanning not only  the duration of his or her work-life, but also upon retirement. Prior to this legislative change, an employee was entirely dependent on being granted this right by his or her employer in an agreement. Naturally, some employees enjoyed stronger bargaining powers given their field of employment (such as those employed in the Hi-Tech sector) or by virtue of being members of a union that ensured more beneficial employment terms for its members. By law, the funds contributed by employers to pension schemes are protected to ensure they provide for employees’ a livelihood following retirement. Under applicable law, the employers’ contributions towards severance pay “are non-refundable, non-transferable, may not be hypothecated nor forfeited”; high rates of taxation were imposed on employers withdrawing these funds; and employers who seek to deny an employee his or her severance pay must file a legal claim within 4 months of termination of employment and prove, why the employee is not entitled to severance pay. Labor courts repeatedly ruled that the denial of severance pay from employees is an extreme form of punishment limited for the most severe and rare transgressions, since “termination of employment is in and of itself a punishment”, and there is no justification to exacerbate the punishment by denying the funds intended to serve the employee and his or her family during unemployment periods. The employers’ contribution towards employees’ provident funds (pension) may not be denied under any circumstances, regardless of how the employment relationship ended. Recently, the State of Israel added an extra layer of protection to employees’ pension, mandating, through regulations, that the first layer of pension savings must be through a pension fund vehicle, rather than under a mangers insurance scheme. A foreign worker is also entitled to contributions by his or her employer towards pension savings and severance pay, however, for practical reasons, the law stipulates that these are deposited on behalf of the foreign worker in a bank deposit, rather than in a pension scheme. The right of the foreign worker is inferior by comparison to that of his or her Israeli Citizen counterpart since the foreign worker is only entitled to receive the deposited funds when leaving the country’s borders. In this way, these contributions on account of pension savings and severance pay designed to protect the future livelihood of the worker, are being used to enforce Israel’s immigration laws. The Supreme Court ruling did not strike out this mechanism. A foreign worker will still receive the deposited funds only after exiting Israel. What the Supreme Court did strike out (in a qualified manner and permitting the State to legislate otherwise), is the provision by which a delay in exiting Israel upon expiration of the foreign worker’s work permit, will gradually cause the de facto “nationalization” of the funds, reaching a full forfeiture of the funds, for the benefit of the State, in case the worker’s delay in leaving the country exceeds 6 months. In a majority ruling, the Supreme Court, made clear that the social benefits of the foreign worker, which come in lieu of an employer’s contribution towards pension and severance pay, are the property of the worker, and therefore the State’s ability to encroach on these funds is limited (there is no absolute prohibition on encroachment, but the specific provision is too extreme). To quote Thomas Jefferson, “the measure of society is how it treats the weakest members”. This is a moral principle, yet it goes beyond the mere boundaries of morality. For those out there that rushed to announce the ruling as too far-reaching and expanding the court’s limits, we suggest considering their own pensions. If these funds, were not declared as the individual property of each employee, and are not protected against State acts, the next target by any government could be to allow encroachment on the money that each and every Israeli employee saved during their working years. Authors: Adv. Miriam Kleinberger-Attar and Adv. Noa Bar-Shir