Israel issues tax circular to address Intercompany Recharges for Capital Instruments

 The Israeli tax authorities recently issued its 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 cost base for transfer pricing purposes. Since said ruling did not address intercompany allocation of capital instruments, Circular 1/2021 is issued to clarify the Israeli tax authorities’ stance on such. Since employees of a company are often compensated with stock-based payments from a related party, the question arises as to how to properly allocate recharge agreements of the related company that grants the capital instrument to the related company, which is employing the individual employee. Circular 1/2021 addresses this matter and specifies the ITA’s position as to under what 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):

 

In order for a payment to be considered as recharge and not as a dividend, it must be only for the vested equity instruments, based on value recorded in financial statements, due by virtue of a recharge agreement and expense thereof included in 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 would be classified as a dividend or, certain cases, 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 Authorities’ website.