Executive summary

The Israeli Tax Authority (ITA) recently released a circular, dated 1 November 2018, on business restructurings in multinational groups (the circular). The circular discusses the circumstances surrounding business restructuring, as well as indications for such an event.

The circular comprehensively sets forth the ITA's positions on the main issues related to business restructuring, the required disclosures, and the possible tax implications arising from such a restructuring. It suggests that a business restructure, from the ITA's perspective, is perceived as a capital gain transaction.

Detailed discussion

By way of background, over the past two decades, Israel has become a prominent hub for acquisitions of technology companies, in many cases by US multinationals. In this context, the ITA has presented in the circular most of its positions regarding a typical case of business restructuring, in which an Israeli company's shares are acquired by a multinational company. Such an acquisition is followed by a change in the composition of functions, assets, and risks (FAR) in Israel, through allocation among related parties within the multinational group, which is interpreted by the ITA as a transfer of FAR. Such business restructurings are often subject to scrutiny by the ITA, and the circular was released against the backdrop of the first Israeli court case (Gteko Ltd.¹), to rule on this topic in June 2017, which set significant precedents on various taxation aspects related to business restructurings and valuations.²

In addition to setting forth the ITA's relevant positions, this circular also aims to define the ways of identifying and characterizing a business restructuring, as well as offering acceptable methodologies by the ITA for valuation of the FAR transferred, ceased or eliminated. Some of the main issues covered in detail by the draft circular are:

• Interpretations of significant elements of restructurings, such as intangible assets, goodwill, going concern value, group synergies, and assembled workforce
• Instructions on how to determine the arm's-length conditions through a functional analysis, examination of legal agreements, and the alternatives practically available to the company
• Interpretations of the tax treatment of certain aspects in a restructuring, including legal vs. economic ownership of intangibles and sale vs. license transactions
• The relevant transfer pricing methodologies for evaluating transferred business activity
• Other tax implications that could arise from a restructuring, including secondary adjustments and impact on tax incentives in Israel
• The information and documents to be provided to the ITA by the buyer and seller

Implications

The circular discusses circumstances and indications of business restructuring. According to the circular, a transfer of FAR is perceived by the ITA as a tax event classified as capital gain. Therefore, business restructuring should be identified, valuated and reported accordingly.

The ITA's approach will have implications on controversy assessments related to both past and present acquisitions in Israel. It will also have implications on structuring and future acquisitions of Israeli companies. Therefore, these companies should closely review the circular and consider its impact, in light of the many requirements presented by the ITA.

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ENDNOTES

¹ Israeli court ruling 49444-01-13 Gteko Ltd. vs. Kfar Saba Tax Assessor (6.6.2017).

² See EY Global Tax Alert, First Israeli court case on IP valuation ruled primarily in favor of Tax Authority, dated 13 June 2017.

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CONTACTS

For additional information with respect to this Alert, please contact the following:

EY Israel, Tel Aviv

• Sharon Shulman
  sharon.shulman@il.ey.com
• Lior Harary-Nitzan
  lior.harary-nitzan@il.ey.com
• Eyal Gonen
  eyal.gonen@il.ey.com

Ernst & Young LLP, Israel Tax Desk, New York

• Lital Haber
  lital.haber1@ey.com

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ATTACHMENT

PDF version of Tax Alert 2018-2239