Do not register Israel owned patents on foreign group companies, unless the group is ready to pay millions of dollar $ in tax
On June 1, 2023, the District Court delivered its’ decision in the dispute of Medtronic Venture Technologies Ltd with the tax assessor.
Nearly two years after the US based Medtronic Inc company had completed the acquisition of full control in Medtronic Israel (in 2009) for approx. 326 M US$, Medtronic Israel had awarded a license to a Medtronic group company in Ireland to use its’ intellectual property, while a second agreement was signed by which Medtronic Israel would provide R&D services to related companies under a cost-plus compensation, taking effect already in 2009. In 2012 the Israeli entity terminated its activities.
The tax assessor believed intercompany agreements in the case at hand in fact signified a transfer of functions, assets and risks (“FAR”) pivotal to the activities of the Israel based company. And therefore, the tax office had deemed the constellation of events a tax relevant sale of business assets and capabilities, not in the least because the company ceased its activities a bit over a year later.
The Medtronic Israel company had filed an appeal to court, arguing inter alia, that the tax assessments should not be upheld under the statute of limitations, that the tax assessor had not (sufficiently) motivated his position and had misrepresented the transactions by wanting to see the fleeing of assets and business functions abroad ~ within the group.
The Court agreed with the tax assessor that under the arm’s-length principles (also of section 85A to the Israel Income Tax Ordinance) and the relevant ‘re-organizations chapter’ of the OECD transfer pricing guidelines, that company had been left a hollow barrel. The facts in this case were different from the Broadcom decision, because no increase of Medtronic’s personnel or capabilities in Israel had materialized after the acquisition and the re-registration of patent ownership on other Medtronic group companies, which patents had previously been registered in the name of the Israeli company proved that industrial know how had been lifted out of Israel and ‘planted’ with Medtronic Inc without any or sufficient payment by the new owners of these assets.
In the previous cases of Broadcom and Medingo, the IP had remained with the Israeli company and continued to have a separate and independent value of its own.
Business dealings without a written agreement contradict how the Medtronic group would interact with third parties, the judge said. This is especially true for a “dinosaur,” as the CEO of Medtronic Israel characterized the large and old Medtronic multinational, he ruled. Medtronic had not succeeded in proving, explained the court, that the intercompany agreements were a mere reflection of group policies and that the late drafting and signing of the relevant intercompany agreements did not plea for proper business behaviour. The court also did not accept a downward adjustment of the income assessed resulting from the “transfers”, and which income had been determined by the tax assessor as a function of the acquisition price of the shares of the company at 326 M US$.
Note that the court, also on this occasion, confirmed the tax authority’s “secondary tax adjustment” (like the court had in the similar Giteck case) by adding interest income on the amount of the underpayment by relevant foreign group companies for the FAR extracted from Medtronic Israel. The reasoning for the interest income addition was that an independent party would have never waived an interest charge on the debt of the relevant companies.
The court dismissed the appeal, upheld the tax assessments and charged the company with NIS 180,000 (US$ 45,000 approx.) for the recovery of expenses run up by the tax authorities (link to the decision).Note that in the case of Medingo, the same court had decided in favor of the local Israel company which – after it had been acquired by the Roche pharmaceuticals multinational – it had properly managed the intercompany relations supported by solid agreements, had shown an increase in turnover and personnel post-acquisition (see here).
There are many suitable ways for both acquiring and shaping the co-operation of a newly acquired Israel technological company with other companies and functions in an international Group.
