Coca-Cola owes Israeli Tax Authority huge sums of money

Coca-Cola failed to convince the Israeli Tax Authority that payments to the Irish company should not be taxed as "royalties."

A logo is seen on a Coca-Cola bottle  (photo credit: REUTERS)
A logo is seen on a Coca-Cola bottle
(photo credit: REUTERS)
Has Coca-Cola been evading billions of shekels in taxes for 30 years, and is this state of affairs about to end? Globes has obtained confidential internal figures revealing what is going on behind the scenes in the recent tax assessment processes for the Central Bottling Company (Coca-Cola Israel), which manufactures Coca-Cola in Israel. Among other things, the figures obtained by Globes reveal the company's agreements with its parent company in the US; the payments transferred by the Israeli company to the parent company's authorized factory in Ireland, apparently with no documentation or justification; the system used for years by Coca-Cola in order to reduce its tax liability in Israel; and the arguments used by Coca-Cola in the matter - why it should not owe taxes on its payments to the Irish company (which the Tax Authority says are royalties) - arguments that the Tax Authority has rejected.
The bottom line arising from a summary of the Tax Authority's tax assessment discussions is that if the tax assessment procedures end with the Tax Authority having the upper hand, Coca-Cola's tax assessment for recent years will amount to hundreds of millions of shekels (15% of the company's annual turnover, going back five years, plus tens of millions of shekels annually in the future). This assumes that Coca-Cola does not find a new creative method of tax planning for avoiding the Tax Authority's tax interpretations in the future. In any case, in view of the amounts at stake, it can be assumed that a long legal contest between the parties will ensue. Coca-Cola has already hired a law firm to appeal its tax assessment.
Purchasing concentrates or paying royalties?
The confidential figures obtained by Globes were compiled several months ago by the Tax Authority's legal department in preparation for the anticipated legal proceedings in the framework of the disputes between the Central Bottling Company and the Tax Authority concerning the Tax Authority's assessment for the company for 2010-2011.The company's assessment included a demand for NIS 154 million in taxes in respect of "royalties" paid by the Israeli company to the Irish company. The Israeli company argued that it had paid the money for "concentrates," and therefore did not owe taxes on royalties.
The dispute between Coca-Cola and the Tax Authority involves two main questions: whether part of the proceeds paid by the Israeli company to the Irish company in the 2010-2011 tax years should be regarded as royalty payments, and how the amount of the royalties should be calculated and distinguished from other payments by the Israeli company.
According to the Tax Authority, the Israeli company's payments to the Irish company are actually revenue from the royalties of the parent Coca-Cola company in the US produced in Israel, and are therefore taxable, both directly through the company with the income that produce revenue in Israel, and indirectly, as was actually done, through tax withholding assessments paid by the Israeli company. Because the Israeli company is allowed to use the parent Coca-Cola company's intellectual property solely in Israeli territory, and the company's revenue results from Israel, the Tax Authority is asserting that even according to the rules in the Israel-US tax convention, Israel can be regarded as the place where the revenue from royalties was produced, and the Israeli company can be assessed for taxes on them.
The second question being assessed is which tax rate will be applied to these royalties: the 15% rate stipulated in the Israel-US convention or the 10% rate set forth in the Israel-Ireland convention.
The Tax Authority's conclusion is clear. The argument by the tax assessor who reclassified part of the proceeds paid by Israeli company to the Irish company for royalties is well founded, and Coca-Cola was justly assessed for NIS 154 million. The figures obtained by Globes also show that the Tax Authority is arguing that Coca-Cola Israel did not give the Tax Authority the full picture during the tax assessment discussions ("the version presented was incomplete"), and that no document was presented justifying the payment to the Irish company ("it is not at all clear why payments were made to a company in Ireland"), rather than to the parent company.
During the tax assessment discussions, the Israeli company gave the Tax Authority an opinion drawn up in August 2015 bearing the title "Memorandum." This opinion is unsigned, but it summarizes the Israeli company's argument that the payments to the Irish company should be regarded as a payment for a brand name "beverages base" (concentrate), not royalties. The company's opinion asserts that the "bottle agreement" does not include any royalty payment. Under the Israeli company's agreement, it has no rights to the US company's trademark or goodwill; it has merely been temporarily authorized to use the trademark for its activity in Israel. The Israeli company is therefore arguing that it cannot actually pay royalties, because royalties are paid for rights to trademarks. The Israeli company also argued that in contrast to royalty agreements, in which the amount of the payment varies according to the license-holder's use of the intellectual property, usually as a percentage of sales, in this case, the price for buying the concentrates is fixed. In various legal rulings and tax conventions, the term "royalties" refers to payments that vary according to the extent to which the asset is used. It is also argued that the royalties argument has no precedent in the global Coca-Cola group, which has never received royalties, did not charge royalty payments for bottles, and was not "exposed" to the classification of its proceeds as royalties. Finally, Coca-Cola Israel argued that a transaction should not be classified in a way not intended by the unrelated parties (the Israeli company and the Irish company) in the framework of the economic relations established between them. In other words, since the parties stipulated that what was involved was a purchase of concentrates, the transaction should not be classed as a royalty payment.
The tax assessor rejected these arguments. Among other things, he ruled that the "bottle agreement" between the Israeli company and the US company does not at all reflect a sale of an absolute and final product in which the seller is separated from the asset, and has no further interest in or influence over the purchaser of the product. On the contrary; the Tax Authority argues that the "bottle agreement" includes many provisions showing the US company's close supervision and constant monitoring of the Israeli company's entire business, and the many restrictions imposed on the Israeli company. According to the Tax Authority, these restrictions can support claims that the transaction between the Israeli company and the Irish company contains a substantial element of use of the US company's rights. The Tax Authority is asserting that because of the use made of the intellectual property owned by the US company, the US company monitors and supervises the Israeli company's activity, has a great interest and absolute influence over that activity, accompanies the entire process of producing revenue, receives regular reports, and does not confine itself to the sale of concentrates as a finished product, as alleged by the Israeli company. The Tax Authority also claims that the economic content of this activity is that of a "use of rights transaction" on which royalties should be paid, not an "absolute sale" transaction in which the seller receives the proceeds and has no connection with the product sold.
As for whether the US or Irish tax rate is relevant, the tax assessor ruled that the tax rate should be set according to the tax convention between Israel and the US (15% for industrial royalties), because the US company is the one that produced the royalties and owns the rights for which the royalties are being paid, even though the Irish company is the one that actually received the royalties. According to the Tax Authority, while the payments were made to the Irish company, as shown by the invoices given to the Israeli company, it is not at all clear why these payments were made to the Irish company. The Tax Authority notes that despite the tax assessor's requests, no agreements were produced showing the Israeli company's obligation to make the payments to the Irish company, instead of to the parent company in the US.