Does the sale price of intellectual property between related parties reflect its market value? The Tel Aviv District Court deliberated this question in October 2022. The ruling it handed down, which concurs with a series of similar rulings in this regard (the Gteko ruling, the Broadcom ruling, and the Medingo ruling), clarified the rules and boundaries during sale transactions of activities and intellectual property when a special relationship exists between the parties.

The Transaction

The Israeli software company CA Software is part of a huge international group of more than 200 software companies and development sites around the world. The ultimate parent company of the group is a foreign company called CA Inc.

In 2010, CA Software sold its intellectual property to the parent company and reported to the Israeli Tax Authority that it had received a consideration of approx. ILS 111 million within the transaction.

Subsequently, the tax assessor claimed the value of the sold intellectual property was significantly higher than the reported value and totaled ILS 667 million. The tax assessor further claimed that since CA Software had not actually received the full consideration in respect of the transaction, the sums not transferred to it shall be deemed as a loan provided to the parent company and that CA Software should be taxed in respect of imputed interest income derived from the loan.

The Appeal

CA Software appealed the tax assessor’s ruling. During the appeal, the court deliberated the question of whether the special relationship between the parties affected the transaction price reported by CA Software. To this end, the court examined if the intellectual property had a long life expectancy (as the tax assessor argued) or a short one (as CA Software argued).

The court ruled CA Software did not present any relevant, real-time documents that could support its arguments regarding the transaction value. It further found that the testimonies presented on its behalf were retrospective testimonies of witnesses who did not hold key positions in the company. Inter alia, the court based its ruling on applications for tax benefits and on reports the company submitted in real time to the Chief Scientist Office (today known as the Israeli Innovation Authority), which indicated high potential future income from the intellectual property.

Furthermore, although the court doubted the justification of imposing tax liability on CA Software in respect of the imputed interest, based on a payment not actually paid to it by the parent company, the court ultimately ruled in favor of the Israel Tax Authority in this regard as well. 

Recommendations in Light of the Ruling

Since a sale of intellectual property carried out between related parties may face scrutiny from the Israel Tax Authority, it is important to prepare in advance and perform various actions to reduce future tax exposure:

1. Hire a reliable external appraiser to perform a real-time valuation of the assets being sold in conformity with the generally accepted methods and principles, including analysis of the value of the functions, assets, and risks (FAR) transferred as part of the transaction.
2. Document the company’s actions and conduct in real time.
3. Ensure the reports and documents the company submits in real time to the various authorities (such as the Israeli Innovation Authority, the Israeli Securities Authority, the Tel Aviv Stock Exchange, etc.) are consistent with the data submitted to the Israeli Tax Authority.
4. Ensure the key functions involved in the transaction will be available to provide answers regarding the transaction in the future.

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