The Israel District Court has recently ruled against a taxpayer who sought to challenge his tax assessment on employee stock options granted by a foreign parent company, finding that returning to court with additional evidence after a prior ruling constituted bad faith.

The case involved Henry Schwarzbaum, the former Chief Financial Officer of the Israeli subsidiary of Applied Materials, a U.S.-based technology firm listed on the NASDAQ. Schwarzbaum was granted stock options between 1994 and 1996, which he exercised and sold intermittently from 2005 through 2018. The dispute centered on the applicable tax rate for gains realized from these options, which took place under complex and evolving Israeli tax regulations governing employee stock option plans (ESOPs).

Under current Israeli Tax Ordinance Section 102, gains from ESOPs can be taxed at a preferred rate of 25%, lower than the general income tax rates that can reach up to 50%. However, for stock options granted before 2003, and especially those linked to foreign parent companies, tax authorities have traditionally applied the higher rate.

In 2013, Schwarzbaum initially challenged the tax authority’s imposition of the higher rate, arguing that because he exercised the options after 2003, the 25% rate should apply. The court rejected his claim, upheld the higher rate, and required him to withdraw that lawsuit.

Years later, in 2021, Schwarzbaum discovered that back in 2003 he had filed a so-called “deemed sale and repurchase election” under Section 102. This procedural election could have made him eligible for the 25% tax rate on the gains. Finding this information, Schwarzbaum reopened litigation, accusing the Israel Tax Authority (ITA) of bad faith for not notifying him earlier.

The District Court, presided over by Judge S. Bornstein, ruled against Schwarzbaum again, determining that the taxpayer, not the ITA, acted in bad faith by failing to present the election in the earlier case. The court also noted that Schwarzbaum had misinterpreted two tax rulings issued by the ITA in 1996, which the authority maintained did not reduce the applicable tax rate from 50% to 25% but pertained only to a deferral of taxation.

The ruling underscores the complexities of Israeli ESOP taxation, especially where foreign parent companies and pre-2003 stock are concerned. It also highlights the importance of maintaining thorough documentation and acting promptly within prescribed legal timeframes. Once a taxpayer discovers critical information too late, the opportunity for relief may be foreclosed.

Experts caution that while taxpayers may expect some guidance from the tax authority, officials are not mandated to proactively inform them of potential tax elections or relief options. Moreover, reopening tax assessments is possible within certain statutory periods, typically six years from the initial assessment.

This case also reflects broader challenges in navigating Israel’s tax and legal systems. Some taxpayers and their advisors reportedly prefer to settle disputes with the ITA to avoid protracted litigation, which can be unpredictable.

Ultimately, the Schwarzbaum case serves as a cautionary tale for individuals dealing with ESOP-related tax matters to retain all relevant documents carefully, seek expert advice early, and understand that pursuing multiple court actions with new evidence may backfire.