On September 17, 2024, the Israeli Tax Authority (ITA) amended the existing rules governing employee share plan offerings in Israel, effective January 1, 2025. As part of these new rules, the ITA will reactivate dormant reporting obligations for employee share plan offerings in Israel and has also adopted new requirements and procedures for establishing share plan offerings with trustee arrangements. Join Baker McKenzie and Israeli Firms Herzog, Fox & Neeman and Phoenix – ESOP for a…
I hope most of you have seen our client alert on the recent Israeli Supreme Court ruling that confirmed that stock-based compensation has to be included in the cost base of Israeli subsidiaries of multinational companies. As a result of the decision, we have already seen a flurry of activity as many companies are evaluating how to obtain a tax deduction for awards granted to Israeli employees. As a reminder, for companies with a cost-plus…
The Court Case
In December 2015, the Tel Aviv District Court issued a ruling (the “Kontera decision”) that could have significant implications for companies that have a cost-plus structure in Israel and grant equity awards to employees of the Israeli entity. Under a cost-plus transfer pricing method, the parent company (or another entity in the company group) compensates the local entity with a fee that equals its direct and indirect costs related to the service provided by the local entity (the “cost base”) plus a mark-up (usually, a percentage of the cost base). The total fee is treated as taxable income to the local entity. It is therefore critical that all expenses that comprise the cost base are deductible expenses for local tax purposes. If they are, then the taxable income will equal only the amount of the “plus.”
In most countries, companies can determine the amount of their intercompany service fees under the cost-plus approach without including the “cost” of equity awards in the cost base. This is based on the argument that, absent a recharge payment by the local entity, there is no actual cost incurred by the local entity. In this case, the amount of the “plus” is minimized and it is less critical to ensure that the amount of the notional equity compensation “cost” is a locally deductible expense.
However, the Tel Aviv District court rejected this argument in the Kontera decision: in a case where the Israeli entity was being compensated under the cost-plus method, the court ruled that the expense related to the grant of options to employees of the entity had to be included in the cost base. The “cost” to be included was equal to the accounting expense of the options, not the value of the shares issued to employees (minus the exercise price paid by employees).