In a recent decision, a district court in Israel ruled in favour of Broadcom Semiconductor Ltd and rejected the Israeli Tax Authority's (ITA's) claim that Broadcom Semiconductor was required to pay additional taxes of NIS100 million due to the deemed sale of its main functions and assets to affiliated companies. In its decision, the court ruled that a change of a company's business model would not necessarily be deemed as a sale of its assets (and, in particular, a sale of its intellectual property).
Broadcom Semiconductor, an Israeli company engaged in developing, manufacturing and selling router components, was acquired in 2009 by Broadcom Corporation, a US company traded on NASDAQ. Following this acquisition, Broadcom Semiconductor entered into three intercompany agreements with Broadcom Corporation and its affiliates (Broadcom Group), including an agreement to provide marketing services to Broadcom Singapore and an agreement to provide development services to Broadcom Corporation, both on a cost-plus basis. The third agreement was between Broadcom Semiconductor and Broadcom International, granting it the use of Broadcom Semiconductor's intellectual property in connection with Broadcom International's products.
According to the ITA, the agreements materially changed Broadcom Semiconductor's business activities, as they resulted in it exclusively engaging in the provision of development services for the benefit of Broadcom Corporation; therefore, the agreements constituted a business restructuring, which should be classified as a deemed sale of Broadcom Semiconductor's functions, assets and risks (FAR) (a capital gain taxable event) and should be taxed accordingly. The assessor stated that such approach aligns with the Organisation for Economic Cooperation and Development (OECD) guidelines.
Broadcom Semiconductor argued that the agreements were not artificial and reflected real business transactions. Further, if such a business restructuring had in fact occurred, the result should have been the dissolution of Broadcom Semiconductor's business activities. In contrast to the similar matter in Gteko v ITA, the agreements increased Broadcom Semiconductor's operations, workforce, revenue and profit and did not result in it becoming a "corporate shell without any content". Broadcom Semiconductor also argued that it was authorised to license its intellectual property while retaining its ownership and while also providing research and development services relating to future intellectual property.
The court accepted Broadcom Semiconductor's position, emphasising that not every change in the FAR of a company justifies the reclassification of such transaction as the sale of an intangible asset.
The court emphasised that the Israeli Tax Ordinance does not preclude the reliance on the OECD's FAR test for classifying or valuating a transaction. However, the reclassification of a transaction following a change of a company's functions and business model does not automatically result in a taxable event. The court held that analysing the change in Broadcom Semiconductor's business model led to the conclusion that the agreements had real economic substance (in contrast to the ITA's position) and the court held that Broadcom Semiconductor had not sold all of its assets and functions to the Broadcom Group.
The court also distinguished between the Broadcom case and the Gteko case and ruled that each should be examined in accordance with its specific facts to determine whether the changes in potential FAR should be considered as a business restructuring and as a result a deemed sale of such company's assets.
In its decision, the court ruled that there are two main tests to determine whether a business restructuring has occurred:
- the changes in the value of a company's FAR; and
- whether the intercompany transactions were conducted at arm's length.
In the case at hand, the court stated that, as of the execution date of the agreements, Broadcom Semiconductor's financial results had improved (which was evidenced by its hiring of additional employees and the expansion of its offices), and there were no indications that a deemed sale following a business restructuring had occurred.
In its decision, the court established that as each case should be analysed according to its specific circumstances, a business restructuring carried out through intercompany agreements following an acquisition will not necessarily be treated as a sale of assets.
Considering the above, acquisitions and intercompany agreements should be carefully planned, structured and priced, taking into consideration not only the ITA's approach, but also the takeaway from the decision in the Broadcom case.
This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.
