The Israeli District Court has ruled that the Coca Cola’s Israeli bottler should have withheld royalty withholding tax on payments for imported Coke concentrate because of the Coke trade name. Did the Court mis-read OECD guidance? How wide are the ramifications for trade with Israel? Why are passages on 13 out of 26 pages of the judgment blacked out?
This case decision could disrupt Israeli imports more than the Houthis.
Read on for more questions than answers (The Central Soft Drink Production Company vs. Gush Dan Assessing Office, Civil Appeal 16567-07-17, handed down 29.8.24).
Israel and Coca Cola
Israelis have been drinking the Coke beverage for over 50 years. It is shipped into Israel as a concentrate product from Coke’s Ireland plant to an unrelated bottler in Israel who adds water, fizz and other additives, then distributes it in bottles around Israel under the Coca Cola trade name and logo.
Shipping concentrate avoids the cost of shipping water needlessly. In 1990 the bottler and the ITA reached a no-royalty agreement. But starting with the 2010 tax year, the Israeli Tax Authority (ITA) claimed that the price of the concentrate includes a royalty element due to Coke’s trade name and branding. This was partly because the bottler paid additional sales-related payments not for products, so they must have been sales royalties.
The ITA’s deemed royalty rate is 12.5%. Therefore, the ITA said the bottler should have withheld 25% tax at source all those years in the deemed 12.5% royalty (see below).
Israeli District Court's decision
The taxpayer invoked the OECD Model Tax Convention Commentary (Paragraph 10.1 on Article 14) but the Court shot it down. This Paragraph says:
Payments that are solely made in consideration for obtaining the exclusive distribution rights of a product or service in a given territory do not constitute royalties as they are not made in consideration for the use of, or the right to use, an element of property included in the definition.
According to the OECD, these payments, are best viewed as being made to increase sales receipts, would are business profits not royalties.
The OECD says an example would be that of a distributor of clothes resident in one country (e.g. Israel) who pays a certain sum of money to a manufacturer of branded shirts, who is a resident of the other country (e.g. the concentrate plant in Ireland) as consideration for the exclusive right to sell in Israel the branded shirts manufactured abroad by that manufacturer.
In that example, the Israeli resident distributor does not pay for the right to use the trade name or trade mark under which the shirts are sold; he merely obtains the exclusive right to sell in his State of residence shirts that he buys from the manufacturer i.e. no royalty.
The Israeli District Court quoted the bottler as claiming that some production occurred in Israel namely adding water, additives and fizz to the concentrate. So the Court ruled the concentrate wasn’t a finished branded product and the OECD branded shirt example didn’t “help” the taxpayer.
The Court upheld the ITA’s claim that a royalty could be deemed to exist and accepted 12.5% as the royalty rate based on another published transaction between Paul Newman and Drinks America.
Possible appeal
It is understood the decision may be appealed to the Israeli Supreme Court.
It is difficult to understand the Court’s refusal to accept the OECD branded shirt example. The OECD refers to a product, not necessarily a finished product as the Court says. Anyway, the concentrate is a very nearly finished product without water and fizz to save shipping costs.
Moreover, there is no mention of the EU-Israel Association Agreement i.e. free trade agreement. Article 8 thereof says “Customs duties on imports and exports, and any charges having equivalent effect, shall be prohibited between the Community and Israel. This shall also apply to customs duties of a fiscal nature.” That apparently rules out royalty withholding tax?
The judgement does not say what the 12.5% royalty rate applies to – purchases, year-end payments or all sales of coca cola beverages in Israel.
The judgement also does not consider what happens if there is double taxation. Suppose Coke cannot get a foreign tax credit abroad on the royalty deemed to exist in Israel?
Pepsi Cola apparently lost a similar case in Australia .
What can other exporters of branded products glean from this case? Apparently that relatively minor packaging and processing of products in Israel can land them in the same tax trap as Coca Cola.