A precise definition of business services was recently at the core of a dispute between the Israel Tax Authority and eBay Marketplace Israel Ltd., a subsidiary of the multinational eBay Group. The district court litigated this dispute, deliberating, among other things, the nature of the relationships between related companies in a multinational group.
The relationship between related companies in a multinational group is a complex legal, economic and fiscal issue. It involves numerous implications and aspects, such as the division of legal responsibility, choice of law, applicable taxes, transfer pricing, and profit sharing. When establishing such a relationship, the parties should analyze the aforementioned aspects. They should create a precise commercial and legal relationship that on the one hand will meet the requirements of the group, while on the other hand, providing as much certainty as possible regarding the aforesaid aspects.
Relationships Between Subsidiaries in a Multinational Group
The court ruling in the case of eBay Marketplace Israel Ltd. is the first in Israel to focus on classifying transactions between related companies in a multinational group based on an analysis of the functions and activities of the local company in Israel.
The ruling indicates that the Israel Tax Authority and other entities and authorities will derive most of the answers to the legal and tax questions about companies in a multinational group from the definition of the business activities taking place between them, as well as the actual implementation of such activities. We emphasize that authorities will derive this definition from the nature of the actual business activities, rather than relying on official or contractual definitions..
Transfer Pricing in a Multinational Group
In multinational groups, pricing of transactions between related parties is typically based on the fair market value. Assessing the real fair market value often involves comparing engagements between related parties to those between unrelated parties. This comparison helps establish whether the engagement was conducted at arm’s length or influenced by other factors.
In its circulars, the Israel Tax Authority specified various criteria for accurately classifying services being provided between related companies in a multinational group as well as for predefining the profit for these services. The Israel Tax Authority’s three main criteria when analyzing the nature of the activities are Functions, Assets and Risks (“FAR”). Analyzing the division of the FAR among the companies in the group will enable to accurately define the nature of the activities and the services, as well as the appropriate transfer pricing method.
The dispute in the eBay case concerns the business relations between the business department of eBay Marketplace Israel Ltd. (“eBay Israel”) and another company in the eBay Group – eBay Switzerland. eBay Israel’s business department provided various services. These included marketing advice, market surveys, conferences, and support for Israeli sellers, which is divided into managed sellers and unmanaged sellers.
The business department focused primarily on the managed sellers and eBay Switzerland paid eBay Israel a consideration for its work performed for the interest of the managed sellers at the amount of the business department’s expenses plus a fixed margin of 7%.
eBay Israel reported the transaction with eBay Switzerland as an “international transaction” according to the Israeli tax reporting requirements. The transaction was reported based on the cost-plus basis (cost+ 7%), similar to comparable transactions they considered to be at arm’s length, under the assumption that eBay Israel was acting as a marketing service provider.
The Israel Tax Authority’s Position
The Israeli tax authority disagreed with eBay Israel’s classification of its business department’s services as marketing. Instead, they suggested classifying eBay Israel as a low-risk distributor (LRD). Consequently, the Israeli tax authority proposed an alternative transfer pricing method, and accordingly issued tax assessments to eBay Israel, assuming the services provided were not at fair market value.
At the outset of the legal proceedings, the Israeli tax authority argued for eBay Israel’s remuneration based on the “Profit Split” method. However, they later neglected such argument and claimed that the pricing method shall be based on eBay Group’s sales turnover in Israel.
The Court Ruling
After careful examination of the business department’s operations, the court made a critical distinction between its activities concerning “managed sellers” and those concerning “unmanaged sellers” and buyers. The court determined that the support provided to buyers and “unmanaged sellers” resembled marketing activities, warranting the use of the cost-plus method, as eBay Israel had reported. However, the court found that the activities related to “managed sellers” surpassed typical marketing functions. Consequently, it categorized eBay Israel with respect to these operations as a distributor, suggesting the pricing method should align with eBay Group’s sales turnover in Israel. This ruling reflected the court’s nuanced understanding of the department’s varied roles and impacts on different segments within eBay.
Implications of the Ruling
The ruling suggests that creating certainty regarding applicable taxes for intercompany services/activities requires careful design of relationships between the group’s companies. The transfer pricing method used to determine profits and taxes will depend on these relationships. Hence, optimal design of these relationships is crucial.
Precise advance planning of the division of activities between related companies can save future tax expenses. Companies of a multinational group, exchanging services, should analyze legal and tax implications at the activity’s outset.
When an Israeli company intends to provide services to a foreign related company, the key consideration when designing the nature of the activities will obviously be the commercial needs of the parties. However, there may be instances when there are several alternatives for dividing the FAR among the related companies and, in these instances, the companies should analyze the various legal and tax implications.
[View source.]
