The Israel Tax Authority published a tax ruling given by it recently that sheds light on the existing ambiguity when classifying proceeds from a sale of shares of a company, where the payment of the consideration to the sellers of the shares, is contingent upon the continuing employment of the sellers in the company.

The tax ruling prescribes that, where a portion of the purchase price is subject to a holdback arrangement – i.e., it is retained by a trustee and released to the sellers in portions, subject to their continuing employment in the company – capital gains tax will apply to the entire consideration. This tax ruling was issued in respect of a case where it was agreed between the parties that, even if the sellers shall cease to be employed by the company under particular circumstances (such as death, disability, dismissal, a pay cut of 10% or more, etc.) then they shall still be entitled to the entire consideration.

The ruling opens alternatives for classifying the receipt of employment-related earnings as a capital gain where the sale agreement contains a provision that enables the consideration to be received even if the seller is no longer employed by the company.

The ruling clarifies that not every consideration that is made contingent on the continuing employment of sellers constitutes earned income, which was an interpretation which could have been applied after the Helman decision was published a few months ago.

We clarify that the tax ruling prescribes, inter alia, that the sale agreement must include an undertaking for the company to pay a wage to the sellers that is not inferior to their wages prior to the sale of the shares, and that the company shall not claim expenses in respect of this consideration in its tax reports in Israel. Furthermore, the company must declare that the consideration is an integral part of the proceeds in respect of the shares.