A district court recently ruled that a sale of foreign intellectual property by an oleh [new immigrant] to his own Israeli company is “artificial or fictitious” and the 10-year tax Israeli exemption does not apply (Sephira & Ofek Ltd and Amram, 2995-03-17 etc. August 16, 2021). So, is Zionism tax evasion?
Main facts
In 1999, a French individual set up a successful French company (Sephira SAS) to combine hardware and software to transmit financial data from medical smart cards to central servers needed by insurance companies to pay health providers. It grew to around 150 employees, serving 33,000 health professionals – 20% of the French market.
In 2003, the individual migrated from France to Israel and set up an Israeli company to conduct research and development and operate a call center in Israel.
In 2010, he withdrew around NIS 5 million from the Israeli company to help pay for five apartments in Jerusalem.
In 2011, to cover this debt, the individual sold his personal share (81%) of the relevant trademark to the Israeli company for NIS 41m., payable over 28 years without interest.
The Israeli company began charging the French company royalties for use of the trademark of €300,000-1,000,000 per year. It also charged for R&D at cost plus 50%-60%, around 40% more than justified by a transfer pricing study.
The Israeli company claimed tax breaks for a “preferred enterprise” and amortized the trademark under rules for goodwill, resulting in low Israeli taxation.
Main issue
Was the individual’s trademark sale, using his aliyah 10-year exemption for foreign source gains, an artificial or fictitious way of covering his debt to the company? If so, the Israel Tax Authority could impose tax the royalties and cash withdrawals as personal dividend or salary income (45%-50% tax) and impose negligence fines.
Court decision
The court ruled the trademark sale to the Israeli company was indeed artificial or fictitious – i.e. tax evasion – under Israel’s general antiavoidance rule (ITO Sec. 86).
The court disagreed with the taxpayers’ reasons for the sale. Therefore, it lacked a proven fundamental commercial rationale.
The court ruled there was no indication that the Knesset intended the capital gains tax 10 year exemption to apply to an asset sold to an Israeli company set up by the oleh, even if the price was arm’s length (Para. 123).
Also, the -8 year trademark payment period was ruled to be unreasonable (regardless of cash flow). And the individual never charged royalties before the trademark sale.
The court rejected claims that the trademark sale was necessary for limited liability, to provide a business structure for collecting royalties or to facilitate a possible future exit.
Therefore, the court ruled the trademark sale could be disregarded and the ITA could tax the oleh on deemed dividend and salary income and impose negligence fines.
And excess R&D charges were ruled to be taxable at regular, not preferred, company tax rates under rules for reclassifying transactions not properly presented.
Comments
This seems a nasty case and many comments arise.
First, the trademark definitely existed and was registered in France.
Second, olim often transfer business interests to their Israeli companies for Zionist reasons. This decision means such action, if structured as a sale, is now artificial or fictitious, apparently.
But the court ruled that an asset sale to an unrelated party is acceptable, so is a tax deferred transaction under Section 104 of the Income Tax Ordinance.
Third, if the court disagrees with a taxpayer’s reasons for selling IP, the reasons don’t exist?
Fourth, a French court case in 2009 forced the French company to accept union representation. (That apparently gives the union the right to attend board meetings and block important decisions such as M&A deals). Isn’t that a legitimate reason for transferring IP to an Israeli company?
Fifth, In France, much of the R&D charge was recorded as management fees, according to a parallel French tax audit. It seems the Israeli and French tax authorities were cooperating. One might query whether the ITA was doing French bidding.
Sixth, the court mocks the individual for being “unavailable” to charge royalties to the French company “for some reason or other!” (Paras. 122 and 125). The ITA also mocked the taxpayer, saying a 5% royalty isn’t hard to calculate. The fact that the individual was busy scaling up the activity and the employee headcount from 40 to around 150, post aliyah, did not count at Sephira.
It remains to be seen whether the case will be appealed. Let’s hope so; Zionism is not tax evasion.
As always, consult experienced tax advisers in each country at an early stage in specific cases.
leon@h2cat.com
The writer is a certified public accountant and tax specialist at Harris Horoviz Consulting & Tax Ltd.