By Jacky Houlie, JH & Co. Law Office, and Shlomo Hubscher, JH Consulting Ltd., Tel Aviv-Yafo
The Israeli tax authorities recently issued their first tax circular of the year, Income Tax Circular 1/2021, “Payment to a Parent Company for the granting of Capital Instruments to Employees of Subsidiary (Recharge Agreement) for Intercompany Transactions” (Circular 1/2021).
In 2018, the Israeli Supreme Court ruled that stock-based compensation must be added to the cost base for transfer pricing purposes.
Since the ruling did not address intercompany allocation of capital instruments, Circular 1/2021 is issued to clarify the Israeli tax authorities’ stance.
Company employees are often compensated with stock-based payments from a related party. The question arises, therefore, about how to properly allocate the recharge agreements of the company that grants the capital instrument to the related company employer.
Circular 1/2021 addresses this matter and specifies the Israeli tax authority’s position as to the conditions the recharge would be classified as a recharge cost in relation to grant of the stock-based instrument by the related party (and not as a dividend or capital reduction).
The circular provides that a payment will be considered a recharge and not a dividend if it is only in exchange for vested equity instruments, based on the value recorded in financial statements, due by virtue of a recharge agreement and expense thereof included in the cost base, pursuant to the aforementioned Supreme Court ruling and consistent with Section 85A of the Tax Ordinance.
If the payment does not meet the criteria outlined above, it is classified as a dividend or, in certain cases, as a capital reduction.
It should be noted that the issue of deductibility of the expense for tax purposes by the employer is not directly addressed in the circular.
Additional details can be found (in Hebrew) at the Israeli tax authority website.
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