In a recent court ruling, the Israeli District Court sided with the tax authorities in a case involving eBay Marketplace Israel Ltd., an Israeli service entity, and approved the Israeli Tax Authority's (ITA’s) decision to replace the taxpayer’s cost-plus method to a method based on turnover, which is suitable for a distributor.
The decision would have a significant impact on the Israeli entity’s profits, to the extent that the group’s turnover in Israel is significant; therefore, conducting a thorough examination for purposes of adapting the pricing model as part of the preparation of market research is recommended.
In 2005, the Israeli service entity was indirectly acquired by a U.S. entity that was part of a group of foreign companies (through an Israeli holding entity) whose main activity is the development and promotion of a platform that connects buyers and sellers for the purpose of conducting online sales transactions (eBay Group/eBay abroad).
According to the Israeli service entity, the business model of the eBay Group is based on the collection of fees from sellers only (not from buyers). Fees are collected according to a certain percentage of the sale price; according to the group’s policy, there are two types of sellers on the platform: “managed” sellers and "unmanaged" sellers. Managed sellers receive services related to more efficient use of the platform from their “customer account” managers.
In 2012, the Israeli service entity established a business department that was intended to provide services to a foreign entity in the eBay Group (eBay Switzerland), including marketing consulting, conducting surveys and research on the Israeli market, organizing conferences and training to promote awareness of the platform in Israel, and providing guidance and support to Israeli sellers. Payment for the services provided by the business department was charged to eBay Switzerland via the cost-plus method.
According to the Israeli service entity, its activities should be compared to those of a supplier providing marketing services that carry low risk. To make the case, it argued that the business department is small (only four to 12 employees), that the services were provided to managed sellers only, whereas unmanaged sellers were referred to eBay abroad, and that most Israeli customers were using the platform even before the establishment of the business department. Moreover, the Israeli service entity said, the employees of the business department lacked professional credentials and were not rewarded based on sales in Israel, eBay Switzerland funded the portal in Hebrew, and the business department did not reduce fees for sellers or raise the sellers’ ratings. The business department did not engage in advertising, but only in characterizing the needs of the managed sellers. In addition, the Israeli service entity was not involved in negotiations regarding contracts signed with customers and was not authorized to decide who would become a managed seller or to intervene in the terms for approving a managed seller, as these were written by eBay Switzerland. The Israeli service entity was not involved in designing the platform and did not benefit from exclusivity in the market. The Israeli service entity emphasized that eBay abroad determined the commission rates payable by the sellers, as well as the terms of engagement with them, and that the terms of the contracts with the sellers were concluded with eBay abroad without the involvement of the Israeli service entity.
Conversely, the ITA argued that the activities of the Israeli service entity were comparable to the of the activities of a distributor regarding the managed sellers (and initially, the ITA thought that the profit split method should be applied). The ITA argued that the business department’s activities should be classified as low-risk distribution activities because the goal of the business department was to increase the use of the platform and the turnover of sales for the multinational eBay Group from activities carried out in Israel.
The ITA contended that the platform’s users were the ones creating the added value; that Israel is the place where the profits should be taxed, even though indicators such as physical presence, equipment, tangible assets, and the salary of the local entity’s employees are less relevant when it comes to the digital economy. The Israeli service entity, the ITA said, was the one that presented the service provided to Israeli customers and was in contact with them regarding everything related to the platform. It would be reasonable to assume that the Israeli customers saw the Israeli entity as the sole local representative responsible for the activities in Israel on behalf of the eBay Group. The Israeli service entity was even responsible for characterizing the needs of all customers- managed sellers, unmanaged sellers, and buyers. The business department was involved in increasing the “sales boundaries” at least since 2014 and was also involved in deciding to turn a “regular” seller into a “managed” seller. In the relevant years, the business department even approved the granting of discounts to customers. The business department conducted surveys and research on the Israeli market for eBay Switzerland and met with dealer representatives at e-commerce conferences held on its behalf.
In addition, the ITA argued that a secondary adjustment should be made.
Regarding the performance of functions, the court found that eBay abroad was responsible for determining a global business marketing strategy, for using the group’s assets, and for developing and improving intangible assets, as well as for protecting them. The Israeli service entity was primarily entrusted with the practical implementation of the local strategy. The business department worked to create a “connection” between eBay abroad and local economic factors.
In term of assets, the court found that eBay abroad was the one that held the platform’s technology and the intellectual property assets, such as brand reputation, whereas the Israeli service entity did not hold any intangible assets at all.
eBay abroad also bore most risks, including marketing risks, risks related to the development of the platform, legal risks, regulatory risks, and more. The Israeli service entity bore only market and foreign exchange risks, and even then, only partially and together with eBay abroad.
Because a benchmark was performed only for years 2012-2014, the court did not receive its implication for the year 2015 (for which apparently the ITA did not present a specific benchmark).
Given the court’s decision, companies with Israeli affiliates should reconsider the use of the cost-plus method.
Amit Shalit
BDO in Israel
The decision would have a significant impact on the Israeli entity’s profits, to the extent that the group’s turnover in Israel is significant; therefore, conducting a thorough examination for purposes of adapting the pricing model as part of the preparation of market research is recommended.
Background
The Israeli service entity -- eBay Marketplace Israel Ltd. -- was established in 1997 as a private Israeli resident entity engaged in the development of technologies for use on the internet that, among other things, help consumers compare products, prices, and marketers online while referring users to sellers’ websites to make purchases.In 2005, the Israeli service entity was indirectly acquired by a U.S. entity that was part of a group of foreign companies (through an Israeli holding entity) whose main activity is the development and promotion of a platform that connects buyers and sellers for the purpose of conducting online sales transactions (eBay Group/eBay abroad).
According to the Israeli service entity, the business model of the eBay Group is based on the collection of fees from sellers only (not from buyers). Fees are collected according to a certain percentage of the sale price; according to the group’s policy, there are two types of sellers on the platform: “managed” sellers and "unmanaged" sellers. Managed sellers receive services related to more efficient use of the platform from their “customer account” managers.
In 2012, the Israeli service entity established a business department that was intended to provide services to a foreign entity in the eBay Group (eBay Switzerland), including marketing consulting, conducting surveys and research on the Israeli market, organizing conferences and training to promote awareness of the platform in Israel, and providing guidance and support to Israeli sellers. Payment for the services provided by the business department was charged to eBay Switzerland via the cost-plus method.
Service Model v. Distributor Model
The ITA contended that the profits allocated to the Israeli service entity were not commensurate with the functions performed, assets used, and risks assumed by the entity.According to the Israeli service entity, its activities should be compared to those of a supplier providing marketing services that carry low risk. To make the case, it argued that the business department is small (only four to 12 employees), that the services were provided to managed sellers only, whereas unmanaged sellers were referred to eBay abroad, and that most Israeli customers were using the platform even before the establishment of the business department. Moreover, the Israeli service entity said, the employees of the business department lacked professional credentials and were not rewarded based on sales in Israel, eBay Switzerland funded the portal in Hebrew, and the business department did not reduce fees for sellers or raise the sellers’ ratings. The business department did not engage in advertising, but only in characterizing the needs of the managed sellers. In addition, the Israeli service entity was not involved in negotiations regarding contracts signed with customers and was not authorized to decide who would become a managed seller or to intervene in the terms for approving a managed seller, as these were written by eBay Switzerland. The Israeli service entity was not involved in designing the platform and did not benefit from exclusivity in the market. The Israeli service entity emphasized that eBay abroad determined the commission rates payable by the sellers, as well as the terms of engagement with them, and that the terms of the contracts with the sellers were concluded with eBay abroad without the involvement of the Israeli service entity.
Conversely, the ITA argued that the activities of the Israeli service entity were comparable to the of the activities of a distributor regarding the managed sellers (and initially, the ITA thought that the profit split method should be applied). The ITA argued that the business department’s activities should be classified as low-risk distribution activities because the goal of the business department was to increase the use of the platform and the turnover of sales for the multinational eBay Group from activities carried out in Israel.
The ITA contended that the platform’s users were the ones creating the added value; that Israel is the place where the profits should be taxed, even though indicators such as physical presence, equipment, tangible assets, and the salary of the local entity’s employees are less relevant when it comes to the digital economy. The Israeli service entity, the ITA said, was the one that presented the service provided to Israeli customers and was in contact with them regarding everything related to the platform. It would be reasonable to assume that the Israeli customers saw the Israeli entity as the sole local representative responsible for the activities in Israel on behalf of the eBay Group. The Israeli service entity was even responsible for characterizing the needs of all customers- managed sellers, unmanaged sellers, and buyers. The business department was involved in increasing the “sales boundaries” at least since 2014 and was also involved in deciding to turn a “regular” seller into a “managed” seller. In the relevant years, the business department even approved the granting of discounts to customers. The business department conducted surveys and research on the Israeli market for eBay Switzerland and met with dealer representatives at e-commerce conferences held on its behalf.
In addition, the ITA argued that a secondary adjustment should be made.
Court’s Decision
The court ruled that the ITA was mistaken in its function, assets, and risk (FAR) analysis of the Israeli service entity, because contrary to its approach, the main functions, assets, and risks related to the activities of the business department in the tax years in question were located in eBay abroad. However, the court accepted the ITA’s approach regarding the distributor model, but only in relation to the activities of the managed sellers.Regarding the performance of functions, the court found that eBay abroad was responsible for determining a global business marketing strategy, for using the group’s assets, and for developing and improving intangible assets, as well as for protecting them. The Israeli service entity was primarily entrusted with the practical implementation of the local strategy. The business department worked to create a “connection” between eBay abroad and local economic factors.
In term of assets, the court found that eBay abroad was the one that held the platform’s technology and the intellectual property assets, such as brand reputation, whereas the Israeli service entity did not hold any intangible assets at all.
eBay abroad also bore most risks, including marketing risks, risks related to the development of the platform, legal risks, regulatory risks, and more. The Israeli service entity bore only market and foreign exchange risks, and even then, only partially and together with eBay abroad.
Technical insights regarding a benchmark
The court raised some points regarding the benchmark (distributor model) prepared by the ITA, including that some of the companies included in the benchmark were not comparable to the Israeli service entity. The court said the ITA should have considered different characteristics, such as the number of employees.Because a benchmark was performed only for years 2012-2014, the court did not receive its implication for the year 2015 (for which apparently the ITA did not present a specific benchmark).
Given the court’s decision, companies with Israeli affiliates should reconsider the use of the cost-plus method.
Amit Shalit
BDO in Israel