05 June, 2023

New Israeli Tax Court Ruling on Post-Acquisition ‘Change of Business Model’

A new judgment in the case of Medtronic was recently issued by the Israeli District Court which accepted the ITA’s views and arguments. The latest court decision follows three District Court decisions from recent years on post-acquisition business restructuring and transfer pricing changes – Gteko, Broadcom and Medingo.

In many cross-border transactions, multinational purchasers acquire Israeli target companies, mainly in stock sale transactions in consideration for cash or a mix of cash and stock of the purchaser. In many cases, following the closing of the transaction, the acquirer will change the structure of the business for business reasons, including the intercompany transactions between the Israeli target company the new parent company or its’ affiliates, and set a new post-acquisition transfer pricing arrangement (sometimes referred to as a “Change of Business Model”). Over the years, the ITA has audited many acquired companies on their post-acquisition reorganizations with respect to such Change of Business Model and tax assessments issued in such cases are estimated to total billions of US dollars. The ITA argues that the Change of Business Model should be treated as if the intellectual property, know how and other intangibles (“IP”) of the Israeli target company were sold to the acquirer or its afiliates, which results in a significant capital gains tax liability for the Israeli company. In such cases, the ITA tends to assign a large portion of the acquisition price to the value of such IP. In certain cases, ITA has asserted that all or substantially all of the acquisition price should be attributed to the value of the post-acqusition transferred IP.

In the Medtronic case, a US multinational acquired the shares of an Israeli target company, Venture Technologies Ltd., which was the owner of the IP in Med Products, for USD 325M. Post-acquisition, the transfer pricing arrangement was amended and the Israeli target company commenced providing R&D services to the acquirer and/or its affiliates and also provided a license to use its IP. The ITA argued that this Change of Business Model should be deemed as a sale transaction by the Israeli target company as the de-facto IP and all FAR (Functions, Assets and Risks) were transferred outside of Israel to the acquirer Medtronic and its affiliates. The Israeli target company argued that the transactions were structured for business purposes, and accordingly, tax evasion and/or avoidance of tax were not relevant to this case. In addition, the lack of intention to sell the IP and the intercompany agreements supported such arguments.

Prior to the Medtronic court decision, the Israeli courts issued rulings in three tax cases in which the ITA argued that the Change of Business Model should be deemed a sale transaction – the Broadcom, Medingo and Gteko cases. In Gteko, the court ruled against the taxpayer, while in Broadcom and Medingo the court ruled for the taxpayer. After an analysis of the facts and circumstances, the court determined that the Medtronic case is more similar to the Gteko case rather than to the other cases. The court ruling is based, among others, on the facts that the IP license period was de facto for the entire effective life of the IP, patents post-acquisition were registered in the name of the parent company, the Israeli company lost its control over the R&D, IP and the employees and the inter-company agreements were not in place, and were executed late and not in a real time. The court accepted the ITA’s arguments that the FAR were transferred post-acquisition and based its decision on the OECD guidelines.

As can be inferred from the above, the Israeli courts have now ruled in four cases on the Change of Business Model based on different facts and circumstances. Acquirers of Israeli target companies should be aware of such rulings and should carefully consider the tax risks and exposures involved with entering into new intercompany transactions and amending transfer pricing post-acquisition.

This tax memo has been prepared for discussion purposes only and does not constitute tax advice.

For further information please contact:

Adv. Oren Biran, Co-Head of the Tax Department

Adv. Yaron Sever, Co-Head of the Tax Department

The content in this communication is provided for informational purposes only and is not intended to be comprehensive. It does not serve to replace professional legal advice required on a case by case basis. The firm does not undertake to update the information in this communication or its recipients about any normative, legal or other changes that may impact the subject matter of this communication.