Tax Aspects of Business Restructuring – New Tax Circular
Recently, the Israel Tax Authority published a circular discussing business restructuring in multinational groups.
In this circular, the ITA presents its position on the ways to identify and characterize business restructuring. It also presents what it considers the accepted methodologies for evaluating the restructuring, which largely involves transfers of FARs (functions, assets, and risks) within the group. In addition, the circular addresses tax aspects pertaining to business restructuring.
The ITA’s position in the circular is based mainly on the OECD guidelines for transfer prices and on the judgment in the Gteko case, which was handed down by the Central District Court in June 2016 and constitutes an important precedent, inter alia, as it pertains to business restructuring.
In a nutshell, the circular discusses a change in the business model. Two typical examples of restructuring are mentioned: an Israeli company owning a business activity (in the technology sector, for the most part) is acquired by a multinational group and, subsequent to the acquisition, (1) companies in the group are restructured, which results in the Israeli company becoming an R&D center providing R&D services to a foreign company in the group; or (2) all of the company’s employees are relocated to the buyer company and, at that point, a situation may be created of a transfer of know-how and/or intellectual property during the restructuring, which could be a taxable event.
Inter alia, the following points are raised in the circular:
1. The ITA’s definition of “restructuring” is broad and encompasses any transfer, or even discontinuance, of an existing business activity or of FARs to related parties in a multinational group, as well as any material change in the pre-existing arrangements in the multinational group.
2. Any change in the contractual framework among companies in the group involving a transfer of rights among related companies (whether formal or not), or any change in the contractual or commercial terms between companies in the group, which eventually affect the distribution of profits and/or risks in the group’s companies, may be considered a “business restructuring,” thereby creating a taxable event of a capital gain in the original company.
3. There are many instances of international groups migrating various functions among companies in the group as part of the business trends and changes transpiring over a period, and these changes do not necessarily indicate the creation of a tax event in respect of asset transfers. Each case will be examined on its merits.
4. Inter alia, the circular emphasizes that even in instances when a legal transaction does not materialize, aspects of the economic ownership of intangibles must be analyzed in order to ascertain whether a “transaction” has occurred.
5. When evaluating the transaction and setting the transaction price, third-party indications should be taken into account, such as the price of acquiring the company itself, significant capital inflows just prior to the business restructuring, and whether the changes are intended to be included in the value of the operations, such as liabilities, transaction costs, employee stock options, etc.
6. Components that should be taken into account in the valuation include goodwill, control premiums, and valuable group synergies and their impact on the transaction price.
7. A transfer of an assembled workforce may lead to a transfer of intangible assets, such as know-how, and when a transfer of an assembled workforce occurs, it should be included in the analysis of the business restructuring in order to define a suitable transfer price that reflects the value of the right to use this know-how.
8. Besides the questions that arise in relation to business restructuring, it is important to consider the implications of the entitlement to tax incentives by virtue of the laws encouraging capital investments. This being the case, the classification of the company’s revenues, plants, and tax benefits it is receiving should also be examined.
9. A list of requirements is forwarded to the taxpayer in any instance whereby the question of a business restructuring is being examined, such as company valuations, transfer price evaluations, minutes, purchase price allocations, intercompany agreements, financial statements, and the like.
Considering the complexity of this subject and the potential tax implications likely to derive from business restructuring or any activity that may be deemed business restructuring, it is highly recommended to obtain professional advice in this regard. Our firm’s Tax Department is, of course, always at your service.