Overview of Coca-Cola Ruling: Central Company vs. Gush Dan Tax Officer
The Tel Aviv District Court recently mandated that the central company for soft drink production Ltd. (“Coca-Cola Israel”), the official distributor and seller of Coca-Cola in Israel, is liable for an additional tax in the hundreds of millions of shekels. This ruling has significant implications for the field of transfer pricing.
Background to the Decision
Coca-Cola Israel operates in the marketing and sales of Coca-Cola products within the country. The business model involves Coca-Cola Israel purchasing concentrates from the global Coca-Cola company, producing the beverages, and subsequently selling them within Israel. The agreement between Coca-Cola Israel and the global Coca-Cola company relates to the payment for concentrates and does not explicitly cover payment for the use of intangible assets.
This decision follows the Tax Authority’s policy shift after nearly two decades. This shift pertains to the royalties for using Coca-Cola’s intellectual property. Previously, the Tax Authority did not view Coca-Cola Israel’s payments to the global company as inclusive of a royalties component, seeing them instead as merely for the beverage concentrate.
However, the Tax Authority now contends that these payments also encompass a royalties component, arguing that the concentrates themselves incorporate the value of Coca-Cola’s intangible assets beyond just the cost of the material (since these concentrates are not available from competitors, and it is evident that the cost of the physical material alone is not substantial). This shift has substantial tax implications for Coca-Cola, potentially increasing its tax burden by hundreds of millions of shekels, and affects other companies in the industry as well.
Court’s Determination
The court ruled that while the payment agreement between Coca-Cola Israel and the global Coca-Cola company does not explicitly include royalties, there exists an exception in Section 85A of the Income Tax Ordinance. According to this, if there are special relationships between the companies, the tax officer is empowered to intervene in the agreement and adjust the pricing. Therefore, if special relationships exist between Coca-Cola Israel and the global Coca-Cola company, the tax officer can modify the transaction in such a way that it incurs additional tax payment.
Understanding ‘Special Relationships’ in Tax Law
The framework of the term ‘special relationships’ as outlined in Section 85A of the Income Tax Ordinance is an “open weave” requiring an examination of the entirety of circumstances and relationships between the parties to determine if ‘special relationships’ indeed exist between them. This definition of special relationships includes relationships between relatives, control of one party over another in the transaction, or control by one person over the parties involved, directly or indirectly, alone or together with others, and is not a closed definition. An analysis of the relationships between the parties can lead to a determination that they indeed share special relationships.
Indeed, the court analyzed the nature of the relationships between the parties and determined that special relationships exist, noting the transactional arrangement that has been woven between the appellant and Coca-Cola, which creates ‘special relationships’ of connection and mutual involvement between the two companies in the production and marketing of Coca-Cola beverages in Israel, akin to a ‘joint venture.’
Consequently, the judge established that since there are special relationships between the companies, Coca-Cola Israel is obliged to pay additional tax for the royalties to the global Coca-Cola company. This determination leads to additional tax payments amounting to hundreds of millions of shekels.
Conclusions from the Legal Decision – Defining Special Relationships in Section 85A
Key Insights from the Ruling
The main conclusions include attention to an exception in the law that allows the tax officer to intervene in the nature of the transaction and reclassify it. Generally, the tax officer must respect the agreement forged between two parties. However, as stated in the judgment, there are exceptions in the law. The relevant exception for our matter specifies that the tax officer is authorized to disregard the provisions of the existing agreement between the involved parties and establish new provisions in their place. For the tax officer to employ this exception, the international transaction must occur between parties that maintain “special relationships,” and the terms of the transaction must be less profitable compared to a deal that would occur between parties without such relationships.
Application of the Exception
To activate this exception, special relationships must exist between the parties tied to the agreement. The classic interpretation of ‘special relationships’ is aimed at relationships between companies related in a corporate structure, such as subsidiary and parent companies or sister companies.
Despite the fact that there is no corporate structure relationship between Coca-Cola Israel and the global Coca-Cola company, the judge determined that special relationships exist between them. The judge based his ruling on the terms of the agreement negotiated between the parties and the mutual involvement forged between them, which, among other things, relied on the method of accounting.
Implications of the Broad Definition of Special Relationships
This determination highlights that the definition of ‘special relationships’ in Section 85A of the Ordinance is not a closed one, but a broad definition that can also include transactions between parties not linked in the simple sense. It is important to consider such issues when conducting international transactions with parties that might be claimed by the Tax Authority as related, potentially altering the transaction.
Global Judicial Decisions on Similar Tax Issues
It’s important to note that the Israeli Tax Authority is not the only tax body worldwide that has deliberated on this matter. Similar issues have been discussed in both Australia and Spain. Moreover, the debate is not exclusive to Coca-Cola; the Australian court also addressed a similar claim by the Tax Authority against Coca-Cola’s main competitor, PepsiCo.
The Israeli Tax Authority even utilized the Australian court decision to strengthen its case. According to the Israeli authority, the Australian judgment concerned a company performing similar operations to Coca-Cola Israel, and it was determined in the decision that the payments made by this company for beverage concentrates included a component of royalties. The judge noted that while this foreign ruling could be used, he saw no necessity to rely on it for his determination, which was analogous to the Australian court’s decision.
However, after the proceedings in Israel, the Australian judgment reached the Federal Court, where the ruling was reversed. The Federal Court in Australia ruled that the payments received by the company did not include a royalties component. This reversal could significantly assist the central company in altering the decision of the district court.
A similar case also occurred in Spain, where the court made a decision similar to the one in Israel. Thus, it appears that other legal systems around the world have not yet settled the issue, which could potentially cost international companies hundreds of millions in tax payments.
These cases illustrate the significant power that tax officers have in intervening and reclassifying the nature of a transaction when dealing with related parties, even if they are not connected in the straightforward sense of the definition. Therefore, it is necessary to consult with relevant experts in the field to regulate the relationships between parties as precisely as possible. Our firm specializes in Israeli and international taxation and offers our clients a professional package in the field of transfer pricing. For an initial consultation with a representative from our firm, click here.
