18 December 2018 Israeli Tax Authority requires filing of restated tax returns following recent Israeli Supreme Court ruling on inclusion of stock-based compensation in cost base for transfer pricing Following the Israeli Supreme Court ruling published recently in Kontera Technologies Ltd (Kontera) and Finisar Israel Ltd (Finisar) cases,1 which confirmed that expenses incurred by an Israeli Research and Development (R&D) subsidiary of a United States (US) parent relating to employee stock option plans should be included in the cost base for calculating the cost plus remuneration, the ITA published a letter addressed to the Israeli professionals who represent the companies in front of the ITA (the Representatives), in which it presented its view that restated tax returns should be filed in order to reflect the Supreme Court ruling for the relevant historical years (the Letter). In its Letter, the ITA makes it clear that in the absence of the relevant restated tax returns, audit procedures would be taken, during which a higher Transaction Price – according to the median of the interquartile range, in relation to the reported Transaction Price, might be determined. In addition, in certain cases, penalties might also be levied. On 22 April 2018, the Israeli Supreme Court ruled on two appeals made by Kontera and Finisar and counter appeals by their assessing officers, where both cases addressed the Israeli tax treatment of stock-based compensation (SBC) expenses in contract R&D arrangements, which are typically remunerated on a cost-plus basis. The Israeli Supreme Court ruled in favor of the ITA for the inclusion of expenses relating to employee stock option plans in the cost base for calculating the cost-plus remuneration, notwithstanding the fact that such expenses were specifically disallowed as a tax deduction for Israeli tax purposes. Moreover, according to the Supreme Court ruling, the adjustment to the price of services provided by the Israeli subsidiary (additional consideration) should have created an intercompany balance, which should bear arm's-length interest, taxable by the Israeli company. Lastly, the Supreme Court accepted the ITA's appeal to the District Court decision and determined that in the case of deviation, where the adjustment leads to tested party results outside the range of comparable company results, the markup should be adjusted to the median according to Section 2(c) of the Israeli transfer pricing regulations. On 13 December 2018, the ITA circulated a letter to the Representatives, in which it expressed its view that, following the Kontera and Finisar cases, companies that issued their employees with compensation which is settled in capital instruments, but that did not record income for tax purposes for the cost of such SBC issuance, whether or not the corresponded expenses were deducted, should include such income and report it in their tax returns, including through restated tax returns filings. Based on this statement, the ITA clarifies that it expects companies to restate their tax returns, as required, and that in the absence of such filings, the ITA will initiate audit actions against such companies, during which it might determine that a higher Transaction Price, based on the median of the interquartile range, should have been recorded. In addition, in certain cases, penalties will also be levied. In order to mitigate controversy risks and avoid imposition of penalties, multinational groups that operate R&D centers (or other service centers) in Israel on a cost-plus basis should closely review the Israeli Supreme Court decision together with the ITA Letter, and evaluate their potential impact on previous tax return filing, including any required restatements. 1 See EY Global Tax Alert, Israeli Supreme Court rules stock based compensation to be included in cost base for transfer pricing, dated 2 May 2018.
Document ID: 2018-2508 |
