Authored by Ofir Levy and Ofir Paz
The Tel Aviv District Court recently issued a ruling in the tax case of the Central Bottling Company (Israel) Ltd (the “Central Company“), interpreting Israel’s transfer pricing rules in a broad and unprecedented manner. According to the court, these rules may apply not only to affiliated companies (i.e., those from the same group of companies), as was the common practice until now, but also to companies which are not related or affiliated.
Key Facts
The Central Company was incorporated and began its activity in 1968. Since then, it has held the distribution rights for light beverages sold in Israel under the trademarks and/ or brand of “Coca-Cola”, by virtue of exclusive bottling and marketing arrangements signed with the Coca-Cola Company (“Coca-Cola“) from time to time. These agreements do not include any specific reference or obligation on the Central Company to pay Coca-Cola royalties or any other payments for the use of trademarks or intellectual property rights belonging to Coca-Cola. It is also important to note that the two companies are not part of the same group (i.e. they are not related or affiliated).
For the purpose of marketing and selling Coca-Cola beverages in Israel, the Central Company purchases Coca-Cola extracts from a licensed Coca-Cola supplier, and uses it, along with other ingredients, to prepare the Coca-Cola beverages. It then bottles the beverages and transports them to marketing and sales locations.
The Tax Dispute
The Israeli Tax Authority (the “ITA“) argued that part of the payments made by the Central Company to Coca-Cola during the tax years 2010 – 2017 constituted royalties for the use of Coca-Cola’s intellectual property rights, and were thus subject to withholding tax at source. The Central Company, on the other hand, argued that it purchased a finished product from Coca-Cola (which carries with it Coca-Cola’s goodwill), rather than rights to use Coca-Cola’s intellectual property, and therefore the ITA’s position should be rejected.
The Court Decision – Broad Interpretation of the Term “Special Relationship”
The District Court rejected the Central Company’s appeal and upheld the ITA’s assessment.
The court relied on Section 85A(a) of the Income Tax Ordinance which states that, where an international transaction involves a “Special Relationship” between the parties, resulting in the determination of a price or other condition such that the transaction produces less profits than would a transaction between parties with no such “Special Relationship”, that transaction must be reported according to the market terms, and taxed accordingly. According to the District Court’s approach, this tax provision provides the ITA with the authority to intervene in the agreement between the Central Company and Coca-Cola, and to classify part of the payments as royalties for the use of Coca-Cola’s trademarks and intellectual property rights, even though the agreement does not explicitly include an obligation to pay royalties.
It is interesting to note that, in order for the court to rely on the aforementioned tax provision, it determined that there was a “Special Relationship” between the Central Company and Coca-Cola, despite the fact that they are not part of the same group (i.e. they are not related or affiliated). The court concluded that, due to the transaction between the two companies, a “Special Relationship” of mutual involvement and connection in the manufacturing and marketing of the Coca-Cola beverages in Israel was created, akin to a “joint venture”. As evidence of this, the court pointed to the fact that Coca-Cola “guides and/or obligates the appellant to act in a certain way at all stages, from the procurement of the raw materials, through the manufacture, advertising and marketing of the Coca-Cola beverages, and as sales increase, both parties profit more”.
Reflections on the Court Decision
Although it is possible to find some support for the court’s approach in the OECD Model Convention and its Commentary, we believe that a narrower interpretation of the Coca-Cola decision can be considered. It may be argued that a broad interpretation of the term “Special Relationship” should only apply to exceptional cases where the interests of the supplier and the distributor converge.
So, in this case, a convergence of interests between the two parties was created over many years, due to the long-term relationship between them (over 50 years), in the course of which the Central Company was involved in the manufacture of the products and not just in their distribution, Coca-Cola guided and/or obligated it to act in a certain way at all stages of its operations, and the payment was calculated based on the product sales.
In contrast, in cases where the distributor operates independently and according to its own discretion (even though it may take the supplier’s guidelines into account), our view is that the condition of “Special Relationship” is not necessarily met and therefore, the transfer pricing rules should not apply.
This publication is provided as a service to our clients and colleagues, with explicit clarification that each specific case requires individual examination and discussion in writing.
The information presented here is of a general nature and is not intended to answer the unique circumstances of any individual or entity. Although we strive to provide accurate and available information, we cannot guarantee the accuracy of the information on the day it is received, nor that the information will continue to be accurate in the future. Do not act on the information presented without appropriate professional advice after a comprehensive and thorough examination of the specific situation.
