Executive summary

On November 1, 2018 the Israeli Tax Authority (the “ITA”) published a circular on the matter of Business Restructuring in Multinational Groups (the “Circular”).

In this Circular, the ITA addresses its approach towards change of business model following the acquisition of an Israeli company and relates, mainly, to the principles of valuation of the Intellectual Property (“IP”) of the acquired company.  In addition, the Circular relates to related matters associated with the Israeli incentives legislation and to the issue of documents request and the taxpayers’ response to it.


Acquisition of Israeli technology companies by non-Israeli multinationals has become a well-known phenomenon in the last two decades.  Typically, these multinationals are looking at the technology developed by such companies and are seeking to take advantage of their human capital.  Following these motivations, in many cases such multinationals migrate the technology outside Israel after the acquisition and integrate it with their other technologies; while the Israeli company usually becomes an R&D center, or merged into the multinational’s existing R&D center in Israel.

The issue of transfer of technology from the Israeli company abroad – which gives rise to either a capital gains tax event, or a royalty transaction – has been in the midst of numerous tax audit discussions, where the ITA challenged the value allocated to the technology.  The ITA’s typical claim has been that given that the most substantial asset of a technology company is its IP, the value allocated to it should, in principle, be close to amount paid for the shares.

The ITA’s preliminary approach towards business restructuring has been addressed in an ITA Circular that was published in July 2010.  Based on the experience it obtained since the publication of the previous circular, and in relation to the court’s verdict in the Gteko case (see below), the ITA has now published this extensive circular.

The Gteko case (Tax Apeal 49444-01-13 Gteko Ltd. vs. The Tax Assessing Officer of Kfar Saba)

In this case – the only one, so far, on this matter – that was published in June 2017, the district Court ruled mainly in favor of the ITA.

The court held that the Acquisition Price Method is the valid methodology to evaluate the sold IP, and upheld the ITA’s position that the value of synergies should be integral to the value of the company’s assets sold.  In addition, under the case’s facts, the court upheld the ITA’s arguments to re-characterize the transfer of the specific technology IP as a sale of the entire business activity, including the value of the workforce in place.  The court also identified those items that should not be included in the identified assets of the company such as hold back payments and retention bonuses, and it was agreed that the tax value of the company’s net operating losses (NOLs) should be deducted from the purchase price.  The Court identified Control Premium as a value that does not reflect the underlying assets’ value.

The current Circular

Supported by the Giteko case, the ITA published its approach, which relates to the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration (2017). The Circular addresses the methods for identification and characterization of business restructuring and suggests methodologies that are accepted by the ITA for valuation of Functions, Assets and Risks (FAR) that have been transferred or dismissed.

Based on the OECD guidelines, the ITA provides that there is a general notion that goodwill and the value of going concern cannot be separated from the other business assets.  The ITA provides its position that consideration for FAR should include also elements that were classified as goodwill or going concern.

Based on the Gteko case, the ITA addresses its approach that group synergy is not held by a certain party to the transaction and therefore it does not substantiate an intangible asset for transfer pricing purposes.  Accordingly, group synergy does not substantiate an asset in and for itself.  Rather, it affects the value of the intangible assets.

In relation to workforce, the ITA’s approach is that transfer of skilled workforce can sometimes be treated as transfer of intangibles (such as know-how), or as a right to provide service.  This issue should be considered carefully by companies who integrate the workforce of their newly acquired company into the existing R&D center they have in Israel (a similar approach was taken by the court in the Gteko case).

The Circular provides that in cases where the tax inspector believes that the substance of a transaction is somehow different than the way it was presented to him, the burden of proof would be on the taxpayer to prove that there was no other transaction.

With respect to legal ownership, as opposed to economic ownership, the ITA’s approach is that even if the legal ownership has not been transferred as part of a business restructuring, this fact alone should not affect the determination of market conditions for the transaction, where transfer of FAR should be examined, regardless of whether legal ownership has been transferred.

The Circular provides certain characteristics for classification of a transaction as a sale, or as provision of a right to use. It addresses certain characteristics that would not be decisive for classification of a transaction.  These are the contractual arrangement and the payment method.

Where the business restructuring is preceded by acquisition of shares, as in most of the acquisitions, then the total purchase price should be sought.  The Circular addresses certain elements (such as payments to employees) that should be added to the purchase price.  The value allocated to the sold intangibles is typically derived from this purchase price (this approach was accepted by court in the Gteko case).

The ITA’s approach is that valuation of FAR should relate to the total purchase price of the shares, where no subtraction should be made with respect to synergy or control premium.  It should be noted, though, that this approach aligns with the court’s ruling at the Gteko case with respect to synergies, but it is opposed to the court’s clear statement with respect to control premium.

Certain reference is provided to documents request as part of an audit procedure.  The Circular provides an annex with the ITA’s generic information request and provides that even though some of the documents are held by the Israeli taxpayer while other may be held by non-Israeli group companies, all of them are required for valuation.  The ITA provides that non-provision of such documents should not prevent the audit of the transaction.


The circular addresses the ITA’s approach, as was addressed in numerous tax audit procedures in cases of business restructuring.  It aims at setting clear guidelines on how should tax payers valuate their intangibles in such cases and provides a relatively rigid position on some of the issues.

Having stated that, these guidelines are not binding and taxpayers are allowed to take other positions, where appropriate.  Therefore, taxpayers should relate to these guidelines and should build their case accordingly, in preparation for a future tax controversy process.

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