Dear Clients,
We are pleased to bring to your attention two recent judicial decisions concerning the taxation of employee benefits and compensation arrangements.
As set forth below, the rulings underscore the importance of examining the economic substance underlying employee compensation and benefit arrangements. Accordingly, we recommend that our clients contact us for a review and consultation regarding these matters, including, inter alia, dividend distributions, withholding tax at source, compensation policy planning, and the assessment of existing exposures.
Supreme Court 4077/23 Rehovot Tax Assessor v. Conduit Ltd. (March 19, 2026)
Conduit Ltd. allocated shares to its employees through a trustee, under the capital gains track, pursuant to Section 102 of the Income Tax Ordinance (the “Ordinance”). The company distributed dividends to its shareholders, including employees whose shares continued to be held by the trustee.
Since the dividend was distributed from profits derived from a Benefited Enterprise and a Preferred Enterprise, the company withheld tax at source at a reduced rate of 15%-20% in accordance with the Law for the Encouragement of Capital Investments (the “Encouragement Law”). The Tax Assessor issued an assessment, asserting that with respect to dividends distributed to employees the company was required to withhold tax at a rate of 25% pursuant to Section 102 of the Ordinance, rather than at the reduced rates under the Encouragement Law.
The company appealed the assessments to the District Court, and its position was upheld. The District Court held that Section 102 of the Ordinance does not govern the tax rate applicable to dividend distributions, and therefore the reduced rates set forth in the Encouragement Law apply.
In a judgment published recently, the Supreme Court reversed the District Court’s decision. The Supreme Court adopted the position of the Tax Assessor and held that the applicable withholding tax rate is 25%, in accordance with Section 102 of the Ordinance.
The Supreme Court held that the Encouragement Law is intended to encourage capital investment in companies and to facilitate capital raising. Against this background, an employee receiving shares pursuant to Section 102 of the Ordinance is not comparable to an investor investing their own funds, since the shares are allocated as part of the consideration for the employee’s work. Accordingly, no actual capital investment is made, and the incentive purpose underlying the Encouragement Law is not fulfilled. In addition, the Supreme Court clarified that Section 102 of the Ordinance constitutes an exhaustive, unique, and specific arrangement governing the taxation of share allocations to employees, and that it prevails over other arrangements addressing dividend taxation.
In accordance with the Supreme Court’s determination, a dividend is a right deriving from the shares, and when it is transferred to the employee rather than retained by the trustee, this constitutes a realization of part of the shares, subject to tax at a rate of 25%.
District Court (Tel Aviv) 60005-01-23 SAP Labs Israel Ltd. v. Tel Aviv 5 Tax Assessor (March 11, 2026)
SAP Labs implemented a deferred compensation arrangement for its senior employees. Under this arrangement, a portion of the employees’ salary and bonus components was reduced, and the reduced amounts were deposited on their behalf into private insurance policies (which are not approved pension funds). SAP did not withhold tax at source at the time of the deposits into the policies and reported the amounts as severance pay only upon termination of the employment relationship.
The Tax Assessor issued assessments to the company, determining that the deposits made by SAP constitute, in substance, employment income at the time they are made, since depositing amounts for the benefit of the employee grants the employee an irrevocable right and constitutes “use of income” similar to a cash payment. Accordingly, the Tax Assessor held SAP liable for the tax that should have been withheld at source at the time of the deposits.
SAP appealed the assessments to the District Court, arguing that the deposits remained under its ownership and control and were exposed to its creditors, and therefore that the taxable event crystallized only upon the employee’s actual receipt of the funds.
The District Court dismissed SAP’s appeal and held that a deposit into a policy for an employee’s benefit is equivalent to a cash payment, and therefore tax must be withheld at source at the time the deposit is made. The court held that although SAP was the formal owner of the policies, in substance the funds were designated exclusively for the employees. The court further held that an employee’s election to direct part of their salary to savings constitutes “realization of income”, as if the employee had received the amount in cash and deposited it themselves into the policies. The court also noted that the arrangement constitutes a “bypass route” to the statutory caps under the pension laws and may be viewed as an “artificial transaction” under Section 86 of the Ordinance.
As stated above, we recommend that our clients contact us for a review and consultation regarding the matters addressed in this circular, and in particular for a substantive (and not merely formal) review of employee compensation and benefit arrangements. We note that an appeal to the Supreme Court may be filed with respect to the SAP decision, and therefore it is important to continue monitoring developments on this matter.
This memorandum is provided for general informational purposes only and does not constitute legal advice and/or a legal opinion. This memorandum is provided as a service to our clients. In any specific case, individual consultation is recommended.
