Israel: Tax authority’s claim of deemed taxable transfer of functions, assets, and risks upheld (court decision)

The Central-Lod District Court on 1 June 2023 upheld the tax authority’s claim of a deemed taxable transfer of functions, assets, and risks (FAR) pursuant to a post-acquisition royalty arrangement and research and development (R&D) contract.

The case is: Medtronic Ventor Technologies Ltd vs Kfar Saba Assessing Office

Read the decision (Hebrew) [PDF 624 KB]

In 2008, a U.S. company acquired a minority interest in an Israeli company that had developed transcatheter heart valve technologies for the treatment of aortic valve disease. In 2009, the U.S. company acquired all of the interests in the Israeli company for approximately U.S. $325 million.

Post-acquisition, the companies implemented a royalty arrangement allowing the U.S. company the use of the Israeli company’s intangible property (IP), as well as contract for R&D services for which the Israeli company was compensated on a cost plus basis. The Israeli company’s activities subsequently ceased around 2012.

The tax authority claimed that the Israeli company’s activities had essentially become an extension of the U.S. company’s interest in the Israeli company, and under the U.S. company’s direct management and supervision. Accordingly, the tax authority claimed that the Israeli company had effectively transferred its FAR to the U.S. company and thus recognized taxable capital gain with respect to the value of the overall business.

The court upheld the deemed taxable FAR transfer, broadly in line with the acquisition value of U.S. $325 million (although the court’s decision does not mention specific assessment numbers).

Among others, certain key points were central to the court’s decision:

• The relevant intercompany agreements were not put in place contemporaneously, but signed in 2011 retroactive to 2009.
• The business was not run in a manner to maintain and further the Israeli company’s standalone economic interests.
• Separation was not maintained between the Israeli company’s IP and group IP and value components.
• Eight patents developed by the Israeli company (out of 185) were assigned to the U.S. company in the United States, and insufficient information was provided to explain that process or the claimed insignificance of those patents.
• The Israeli company ceased to have any material value within a few years of the acquisition.

The court also discussed whether the acquisition value of the Israeli company may be reduced by a “control premium.” The court did not categorically reject the notion, but suggested it would be difficult to establish a control premium short of an actual analysis at the time of the acquisition comparing standalone projected income to the acquisition price. The court also suggested that, in any event, control premiums must be treated similarly to acquisition synergies and included in the asset values (in line with the Gteko decision in 2017 by the same judge).

Post-acquisition business restructuring is a topic that comes up frequently in controversy with Israeli tax authorities and IP planning. Recent court decisions in Israel had seemed to make tax authority claims of a deemed FAR transfer more difficult to sustain. Although this case and decision are fact-specific, it will be an important precedent in favor of the tax authority.
 

For more information, contact a tax professional with the KPMG Global Transfer Pricing Services practice in Israel:

David Samson | +(972) 3 684 8970 | dsamson@kpmg.com

Itay Falb | +(972) 3 684 8908 | itayfalb@kpmg.com