The Central Bottling Co. (Coca-Cola Israel), which exclusively markets Coca-Cola products in Israel, has been dealt a major blow and will have to pay hundreds of millions of shekels to the Israel Tax Authority. The Tel Aviv District Court has dismissed appeals filed by the company against the tax assessment issued by the Tax Authority on the Central Bottling Company's tax liability for royalties it paid for using the intellectual property rights of Coca-Cola worldwide.
These were payments made to the global Coca-Cola company in the years 2010-2017 as part of the exclusive marketing agreements between the companies. The ruling was handed down on August 29 but has been banned from publication until now due to a gag order issued at the request of Coca-Cola Israel.
The publication of the main points of the decision was made after a request submitted by "Globes" to the district court to allow the publication of the main points of the ruling. The Central Bottling Company did not object to "Globes" request and the Tax Authority said that as long as the Central Bottling Company does not object to Globes' request, then neither would the Tax Authority. A gag order remains on the full ruling at this stage.
Tax assessment appeals are held as a rule and by law behind closed doors, but the judge has discretion on whether to publish the ruling in full or in part, while taking into account commercial secrets that the petitioner has and which appear in the decision. "Globes" was represented by Adv. Orian Eshkoli Yahalom.
In the agreements between the Central Bottling Co. and Coca-Cola there is no mention of royalty payments, even though Coca-Cola granted the Israeli company the right to use its trademarks and intellectual property. However, the court accepted the Tax Authority's view that part of the payments should be classified as consideration for the license to use Coca-Cola's trademarks and intellectual property in marketing Coca-Cola drinks in Israel. "In exchange for such a strong trademark with an accepted global reputation, it is customary to pay royalties," it was determined.
The Tax Authority's victory means Coca-Cola Israel will be charged hundreds of millions of shekels in tax for 2010-2017, and another estimated tens of millions of shekels in future taxes every year. The Central Bottling Co. will appeal to the Supreme Court, so the dispute is not yet over.
Tax Authority: The company developed a 'method' for reducing corporate tax
The dispute between the Tax Authority and Coca-Cola Israel was first revealed by "Globes" in 2017, when it was found that the Tax Authority was demanding NIS 150 million in tax for 2010-2011. In the assessment issued to the company, the Tax Authority claimed that Coca-Cola Israel has developed a 'method' for avoiding tax on payments it was transferring to the international company in the US for 'royalties.'
After years of discussions with the Tax Authority, the dispute reached the district court, when the Central Bottling Co. filed appeals against tax assessments for 2010 to 2017. The appeals were heard by Judge Magen Altuvia.
The dispute revolved around the classification and the obligation to deduct tax at source for payments by Coca-Cola Israel according to exclusive bottling and marketing agreements with the international Coca-Cola company. The assessor classified some of the payments as royalties for use of Coca-Cola's intellectual property rights, which require tax deducted at source. The royalties were transferred by the Israeli company to an authorized factory of the US company in Ireland, without any apparent authority or justification, according to the Tax Authority.
Since 1968, the Central Bottling Co. has held distribution rights for the soft drinks sold in Israel under the "Coca-Cola" trademark, through agreements with Coca-Cola. To market and sell the drinks in Israel, the Central Bottling Co. buys extracts from an authorized Coca-Cola supplier, prepares the drinks by adding ingredients, bottles and transports them to the marketing and sales points.
The assessments issued by the Tax Authority uncovered creative tax planning, according to the Authority, which Coca-Cola has been carrying out for decades.
According to the agreements, the Israeli company buys extracts from Atlantic Industries, a company incorporated in Ireland, although the Central Bottling Co. does not have any agreement with the Irish company. The invoices sent to the Israeli company from Ireland show it is a company incorporated in the Cayman Islands.
The Tax Authority claimed that as part of the assessment procedure, it became clear that in practice, all of the Central Bottling Co.'s contracts were with the Coca-Cola Co., including both oral and written agreements, reports, audits, current instructions and financial accounting.
The tax assessor also determined that the consideration classified as royalties constitutes income from royalties paid by a company resident in Israel, and accordingly was produced in Israel and taxable in Israel subject to tax deducted at source (from payments classified as royalties to the Irish branch).
Central Bottling Co." Change in the position of the Tax Authority has no factual basis
The Central Bottling Co. appealed these decisions, claiming that it was buying a finished product, with Coca-Cola's reputation attached, and in this situation, the law states that the marketer should not be required to pay royalties.
It further claimed that preparation and bottling of the drinks using the extracts it bought from an authorized Coca-Cola supplier, are done according to instructions by the international company to ensure that the drinks distributed in Israel will be produced by Coca-Cola only, in accordance with the standards and quality of the global company, "So it will be identical in quality and taste to the products of the Coca-Cola Group worldwide."
According to the Central Bottling Co., this method of operation is widespread in many countries, since the supply of the extract reduces the weight of water and sugar accessible to each bottler in their country, thus significantly reducing transport costs of Coca-Cola drinks.
It was further argued that if it had purchased the product "when it is packaged and ready for sale", the transport costs would have been so high that the sale of Coca-Cola drinks would have become financially unprofitable.
The Central Bottling Co. added that this commercial operating model has been led by Coca-Cola for over 120 years in 200 countries through 300 bottlers, and is accepted by most companies operating in the soft drinks market. Therefore, it is claimed, this is not an operation model that is driven by considerations of tax avoidance or reduction, but rather a commercial operation model that has existed for decades.
The company also claimed that over the years the Tax Authority had conducted assessment audits and deductions, and the issue of royalties had been examined, and in all those years the assessor accepted its position that it was not a royalty payment, and stated unequivocally that it did not consider part of the payment for the extracts to be royalties for the use of Coca-Cola's intellectual property.
It was only in 2014 that the tax assessor decided to change its longstanding status and deduct tax at source for the payment of conceptual royalties. The change of position, it is claimed, is arbitrary, has no factual basis and violates the principle of certainty and the company's authority.
The judge ruled: an economic asset of considerable power
Judge Magen Altuvia dismissed the Central Bottling Co.'s arguments that it had bought a 'finished product' from Coca-Cola and said, "Even if I assume in favor of the petitioner and Coca-Cola that the method of operation of Coca-Cola vis-à-vis the manufacturers and distributors in the various countries, including Israel, is intended to reduce the need to transport a large amount of sugar and water in order to save on the production costs of Coca-Cola drinks - this does not change the conclusion that the production of the final drinks extracted from Coca-Cola and the additional ingredients requires the operation of large numbers of machines and workers."
In the circumstances, the judge ruled that the Central Bottling Co. produces the drinks from ingredients provided by Coca-Cola and according to its instructions. In view of the conclusion that the company manufactures the drinks in Israel, and not by buying a finished product, the conclusion was that marketing beverages using the reputation and trademarks of Coca-Cola, constitutes an economic asset of considerable power, and requires the payment of royalties for their use. "This is customary and accepted when the owner of the brand gives the manufacturer and marketer a license to use their trademarks and reputation for marketing and selling the product produced by the manufacturer," stated Judge Altubia.
The judge also noted that considering the power relations and strength of Coca-Cola in the soft drink market at least in Israel, it is likely that Coca-Cola was dominant in designing the deal between it and the main company, and in the process knew that in the marketing of the drinks the marketer relied on its reputation, and therefore could have expected that the payments paid to it would be considered partly as payment of royalties.
The judge also dismissed Coca-Cola Israel's claim that it relied on the Tax Authority's position for decades by which it should not be taxed for the royalties."
Response
The Central Bottling Co said, "The ruling accepts the Tax Authority position on the tax liability in Israel of international companies known in Israel, through local companies that market their products in Israel, under international brands. Accordingly, it was ruled that local companies are required to deduct this tax at source. It should be noted that this is the first ruling in this dispute between the Tax Authority and international companies and it will be brought to the Supreme Court for a ruling."
Published by Globes, Israel business news - en.globes.co.il - on September 12, 2024.
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