The Israeli Supreme Court on 22 April 2018 issued a judgment in proceedings concerning the tax treatment of cross-border services involving private Israeli subsidiaries of private U.S. companies that maintained equity-based (option) compensation programs for their Israeli employees and that implemented a markup on costs (“cost plus”) as the model of payment for intra-group services rendered by the Israeli affiliates.
The Supreme Court held that the expenses associated with the employee options (i.e., the value of the options) must be included in the markup cost base. The Supreme Court accepted the position of the Israel tax authority that the transactions were subject to a higher markup because the taxpayers’ failure to include the value of the options in the cost base resulted in a deviation from the acceptable range of markup in the transfer pricing benchmark analysis.
The cases were appealed to the Supreme Court from a lower district court. The central issue on appeal related to accounting expenses (i.e., the value of the options) associated with options granted by the U.S. parent companies to their respective Israeli subsidiaries’ employees. Specifically, at issue was whether such expenses would be regarded as part of the overall cost (“cost base”), as being representative of the Israeli subsidiaries’ rendered services, that in turn would then be marked-up to achieve the appropriate taxable profit within their “cost plus” arrangements.
An additional issue on appeal was, in the event the value of the granted options must be included in the cost base, whether the associated options expense would be considered deductible for tax purposes.
The main points of the Supreme Court’s judgement are as follows:
To conclude, the Supreme Court rejected the taxpayers’ arguments on appeal and held that the expenses associated with the options (i.e., the value of the options) granted to the employees must be included in the marked-up cost base. Further, the Supreme Court found that deductibility of the options expense was not dependent on the inclusion of the options within the cost base, and was to be determined entirely under the relevant tax law provision (section 102 of the ITO). In addition, the Supreme Court accepted the position of the Israel tax authority that the transactions were subject to a higher markup (the median) because the failure to include the value of the options in the cost base resulted in a deviation from the accepted range of markup results achieved in the transfer pricing benchmark analysis.
Read a May 2018 report (Hebrew) [PDF 99 KB] prepared by the KPMG member firm in Israel
For more information, contact a tax professional with KPMG’s Global Transfer Pricing Services practice in Israel:
David Samson | +97 236 84800 | firstname.lastname@example.org
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