Israel's Central District Court has upheld a decision by the Israel Tax Authority that medical device company Medtronic Ventor Technologies, formerly Ventor Technologies, pay hundreds of millions of shekels in capital gains tax. International medical devices giant Medtronic acquired Israeli heart-valve developer Ventor Technologies for $325 million in 2009.
In rejecting Medtronic's petition, the court accepted the Israel Tax Authority's position that Medtronic Ventor had sold its IP and activities to parent company Medtronic, as part of the original sales deal.
What happens to IP after an exit
This is another ruling on the issue known as "business model change" and is one of the most prominent disputes between the Israeli Tax Authority and Israeli companies, especially those that have made exits and been acquired by multinational corporations. The dispute revolves around the question of tax on exits - whether to tax these deals as the sale of the company's activity, i.e. as a "change of business model", which results in capital gains tax as required by the Israel Tax Authority - or to accept the claim of the Israeli companies that their IP remained in their hands at the time of the exit, and that they did not separate it from their activities and assets, so the deal should not be taxed.
Ventor Technologies, which develops medical products, was founded and incorporated in Israeli in 2004. The company's flagship product was an aortic valve, which can be implanted through the chest wall, without the need for open heart surgery. Alongside this, a catheter is opened, through which the valve is transplanted.
US global medical device giant Medtronic bought 8% of Ventor in 2008 and the entire company at a valuation of $325 million the following year. Medtronic had also invested in Ventor's rival company CoreValve. After the acquisition, Medtronic Ventor entered into a number of intercompany agreements with Medtronic and with Medtronic Ireland (a company wholly owned by Medtronic), under which Medtronic Ireland and Medtronic were granted R&D services in return for reimbursement of expenses, plus a margin (cost plus) and licensing agreements in which they were granted license to use Medtronic Ventor's IP.
In the 2010-2014 tax years, Medtronic Ventor reported its revenue from these agreements, when according to its claim, revenue from the R&D agreements began in the 2010 tax year and revenue from the licensing agreements began from the 2013 tax year, after receiving approval for the products from the European regulatory authorities. In 2012 Medtronic Ventor activity was discontinued.
The Kfar Saba tax assessor rejected the company's report and issued it an assessment with the demand for payment of capital gains already from the first deal of the sale of shares in 2008. According to the tax assessor, there was another transaction, "concealed" behind the legal arrangements, in which Medtronic Ventor, in effect, transferred all of its ownership of IP, functions, assets and risks to Medtronic.
According to the tax assessor, the contract between the parties should have been classified as a sale transaction of everything that was owned by the company, which was emptied of its contents, so that at the time of its closure, almost nothing was left.
Medtronic claimed that Medtronic Ventor remained the owner of all IP created by it prior to contracting with Medtronic, and the sale of the shares did not include the transfer of ownership of intangible assets, but only the acquisition of the right of use. According to Medtronic, with the acquisition of the company's shares, Medtronic became the controlling owner of it, but this does not mean that it separated its IP from the ownership.
The court rejected Medtronic Ventor's position and stated that the evidence shows that "Medtronic Ventor gave parent company Medtronic, full and complete right to use its IP, and this for almost its entire economic life. Regarding certain patents, the petitioner even made sure to register them in the name of the parent company, and this without a satisfactory explanation, other than that by doing so Medtronic wanted to secure its hold on the IP or part of it."
Estimates are that Medtronic will be required to pay NIS 800-900 million in tax, representing 80% of the original acquisition price. This is an issue that worries many startups planning a much sought after lucrative exit.
Adv. Oren Biran, Head of the Tax Department at GKH law firm said, "In recent years, we have witnessed that the Tax Authority conducts proactive tax audits immediately after the acquisition of foreign companies that acquire tech companies, and if the Tax Authority identifies indications of a business model change (employee transfer, license agreements, distribution, etc.) as a result of these audits, huge amounts of assessments are issued to these companies. It should be understood that international giants are already aware of this trend and the issue is troubling them, this issue is already arising as part of the negotiations for the acquisition of Israeli companies and it may have an impact on the acquisition price."
Published by Globes, Israel business news - en.globes.co.il - on June 5, 2023.
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