Written By Alexander F. Peter
A bottler is liable for withholding tax on deemed royalties to Coca-Cola abroad because the Israeli Company used Coca-Cola’s intellectual property, a Tel Aviv court has ruled, echoing a decision in a similar Australian case regarding Pepsi.
In The Central Bottling Co. for the Production of Soft Drinks Ltd. v. Tax Assessor, dated August 29 and seen by Tax Notes, the Tel Aviv District Court upheld an assessment by the tax authorities. They had considered the taxpayer and the Coca-Cola group related parties, making the taxpayer liable for withholding tax on deemed arm’s-length royalties for the use of Coca-Cola’s IP.
“The liberal construction of the term ‘special relationship’ under the Israeli transfer pricing rules by the Tel Aviv District Court even in the absence of a corporate shareholding between the relevant entities could potentially draw in many companies into the transfer pricing arena,” Boaz Feinberg of the Tel Aviv office of Arnon, Tadmor- Levy told Tax Notes. “The referenced Israeli Supreme Court decision in Silverbaum in this regard, in my opinion, was interpreted too broadly by the district court.”
The plaintiff, Central Bottling Co., purchases beverage concentrate from an authorized Coca-Cola supplier, prepares the Coca-Cola sodas by adding additional ingredients, and dispenses the beverages into bottles, which it then transports to sales points. The plaintiff also owns another Israeli entity, Central Sales and Distribution Co. Ltd., which markets and sells the Coca-Cola beverages in Israel. The agreements between Central Bottling Co. and unspecified Coca-Cola entities do not require license payments for the use of IP.
Central Bottling Co. rendered payments to the Cayman Islands branch of an Irish Coca-Cola company. It has not remitted any withholding tax to the Israeli tax authorities. Although this was not challenged in previous years — Central Bottling Co. has had the distribution rights since the 1960s — for 2010 to 2017, the Israeli tax authorities assessed withholding tax on deemed royalties in amounts of up to 25 percent. The actual figures are redacted in the decision. However, according to media reports, the tax authorities could demand more than ILS 150 million ($40 million at today’s exchange rate) from Central Bottling Co.
More Than $40 Million Potentially Due
After Central Bottling Co. and the tax authorities failed to agree on a resolution, the company filed an appeal with the Tel Aviv District Court. The plaintiff claimed that singling it out from other companies that are not required to pay licenses under similar circumstances is discriminatory.
Central Bottling Co. argued that it does not maintain a special relationship with Coca-Cola as required by the Israeli Supreme Court’s 2015 decision in Silverbaum Holdings Ltd. v. Tax Assessor (CA 780/14). It explained that it buys a finished product, to which Coca-Cola’s reputation is attached. It is in the Coca-Cola group’s own interest that the over 300 independent bottlers around the world operate according to Coca-Cola’s instructions, upholding the brand’s reputation. The bottlers are not the sole beneficiaries of using Coca-Cola’s trademark and therefore should not pay royalties. Further, Central Bottling Co. claimed, additional license payments are not required for distribution rights under the OECD transfer pricing guidelines.
Regardless, the value of the IP was not correctly appraised by the tax authorities, said the plaintiff, which submitted its own valuation report. The license rate of 12.5 percent was taken from a noncomparable transaction, since it dealt with a finished beverage, unlike in its case, the plaintiff said.
Judge Magen Altuvia disagreed with the taxpayer and held that Central Bottling Co. and Coca-Cola maintain a special relationship, according to the controlling Supreme Court decision in Silverbaum. Therefore, the tax authorities could adjust the agreed pricing to the arm’s-length amount under section 85A of the Israeli Income Tax Ordinance, he said.
Central Bottling Co. purchases only a raw material, the concentrate, which it turns into a finished product in Israel by adding sugar and water and bottling and transporting it to customers in a consumable state, Altuvia said. That requires a significant amount of machinery and workforce, he said.
The marketing of the final product would not be possible without using Coca-Cola’s global reputation and strong trademark, which are powerful economic assets, Altuvia added. Their usage would not be allowed free of charge, he said, adding that it is customary to pay license fees in such cases.
Pepsi Case Looms Large
Altuvia also followed the valuation of the tax authorities, including their license rate determination. These parts of the decision are largely redacted. However, in several places, the decision quotes the tax authorities and their adjustments to the royalty rate, with which Altuvia agreed without weighing the arguments of the parties. He notably cited the witness for the tax authorities, who testified that it is difficult to find two sufficiently similar transactions that do not necessitate adjustments.
“The publicly available discussion of the arm’s-length royalty amount — assuming one goes along with the judge about the existence of a special relationship — does not, in my view, do justice to the expert witnesses’ statements,” Feinberg said. “Additionally, there was no real discussion about which company — an Irish or a Cayman Islands entity — was the actual seller, which would have affected the withholding tax rate.”
Altuvia also briefly mentioned that the tax authorities in February applied to have the Federal Court of Australia’s decision in PepsiCo Inc. v. Commissioner of Taxation, [2023] FCA 1490, considered in the Israeli litigation. Altuvia said he found no obstacle to the motion but saw no need to rely on the determinations of the Australian court. The 2023 single-judge decision was overturned by Australia’s full Federal Court in June ([2024] FCAFC 86) and is now pending at the Australian supreme court.
Central Bottling Co. will appeal to the Supreme Court. How and whether the Israeli Supreme Court will take the Australian decision into account will be interesting to see, Feinberg said. “In my opinion, there’s a good chance that the Supreme Court will remand this case to the district court for further fact finding before ruling on the legal issues,” he added.
The taxpayer in The Central Bottling Co. for the Production of Soft Drinks Ltd. v. Tax Assessor (16567-07-17 et seq.) was represented by Goldfarb Seligman.
Published in www.taxnotes.com
INTERNATIONAL NEWS | HIGHLIGHTS & DOCUMENTS, VOLUME 107, WEDNESDAY, SEPTEMBER 18, 2024
