The Central Bottling Company (Coca-Cola Israel), which exclusively markets Coca-Cola products in Israel, has been dealt a severe blow and will be forced to pay hundreds of millions of shekels to the Israeli Tax Authority. The Tel Aviv District Court rejected the company’s appeals against the tax assessment issued by the Tax Authority regarding the Central Bottling Company’s tax liability for royalties it paid for using Coca-Cola’s intellectual property rights around the world.
The payments were made to Coca-Cola International between 2010 and 2017 as part of exclusive marketing agreements between the companies. The ruling was handed down on August 29, but has been blocked 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 came after Globes filed a request with the district court to allow publication of the main points of the ruling. Central Bottling Company did not object to Globes’ request, and the IRS said that as long as Central Bottling Company did not object to Globes’ request, the IRS would not object either. The publication ban on the full ruling remains in effect at this stage.
Tax assessment appeals are generally held behind closed doors by law, but the judge has discretion as to whether to publish the ruling in full or in part, taking into account the trade secrets owned by the petitioner that appear in the decision. Globes was represented by attorney Orian Eshkoli Yahalom.
The agreements between the Central Bottling Company and Coca-Cola made no mention of royalty payments, even though Coca-Cola granted the Israeli company the right to use its trademarks and intellectual property rights. However, the court accepted the Tax Authority’s view that part of the payments should be classified as consideration for licensing the use of Coca-Cola’s trademarks and intellectual property rights in marketing Coca-Cola beverages in Israel. The court ruled that “in return for such a strong brand with an acceptable worldwide reputation, it is customary to pay royalties.”
The Tax Authority’s victory means that Coca-Cola Israel will pay hundreds of millions of shekels in taxes for the period 2010-2017, as well as tens of millions of shekels more in future taxes each year. The Central Bottling Company will appeal the ruling to the Supreme Court, so the dispute is not over yet.
IRS: Company Developed ‘Method’ to Reduce Corporate Tax
The dispute between the Tax Authority and Coca-Cola Israel was first revealed by Globes in 2017, when it emerged that the Tax Authority was demanding NIS 150 million in taxes for the years 2010 and 2011. In the assessment issued by the company, the Tax Authority claimed that Coca-Cola Israel had developed a “method” to avoid tax on payments it was transferring to the international company in the United States in exchange for “royalties.”
After years of discussions with the IRS, the dispute reached the District Court, when Central Packing filed appeals against tax assessments for the period 2010 to 2017. The appeals were heard by Judge Magen Altovia.
The dispute centered on the classification and obligation of Coca-Cola Israel to deduct tax at source on payments made by the company under exclusive bottling and marketing agreements with Coca-Cola International. The assessor classified some of the payments as royalties for the use of Coca-Cola’s intellectual property rights, which require deduction at source. The Israeli company transferred the royalties to a licensed factory of the American company in Ireland, without any clear authorization or justification, according to the Tax Authority.
Since 1968, the Central Bottling Company has held the rights to distribute soft drinks sold in Israel under the Coca-Cola brand, through agreements with The Coca-Cola Company. To market and sell the drinks in Israel, the Central Bottling Company purchases extracts from a supplier approved by The Coca-Cola Company, prepares the drinks by adding the ingredients, bottling them and transporting them to marketing and sales points.
The assessments issued by the IRS revealed innovative tax planning, the agency said, which Coca-Cola has been doing for decades.
According to the agreements, the Israeli company buys extracts from Atlantic Industries, a company registered in Ireland, although Central Bottling Co. has no agreement with the Irish company. Invoices sent to the Israeli company from Ireland show that it is a company registered in the Cayman Islands.
The IRS alleged that as part of the assessment procedures, it became clear that in practice, all of the Central Bottling Company’s contracts were with Coca-Cola, including oral and written agreements, reports, audits, current instructions and financial accounting.
The tax assessor also determined that the consideration classified as royalties constitutes royalty income paid by a company resident in Israel, and therefore was generated in Israel and is taxable in Israel taking into account the tax withheld at source (from the payments classified as royalties to the Irish branch).
Central Packing Company: Change in Tax Authority’s position has no factual basis
The Central Bottling Company appealed these decisions, claiming that it was purchasing a finished product, with Coca-Cola’s reputation attached to it, and in this case, the law states that the marketer should not be required to pay royalties.
It also claimed that the preparation and packaging of the drinks using extracts purchased from a Coca-Cola Company-approved supplier is carried out in accordance with the global company’s instructions to ensure that the drinks distributed in Israel will be produced by Coca-Cola only, in accordance with the global company’s standards and quality, “and therefore will be identical in quality and taste to Coca-Cola Group products around the world.”
According to the Central Bottling Company, this method of operation is widely used in many countries, as the supply of extract reduces the weight of water and sugar available to each bottling company in its country, thus significantly reducing the transportation costs of Coca-Cola beverages.
The company also claimed that if it had purchased the product “when it was packaged and ready for sale,” transportation costs would have been so high that selling Coca-Cola beverages would have become financially unprofitable.
The Central Bottling Company added that this business operating model has been led by Coca-Cola for more than 120 years in 200 countries through 300 bottling companies, and is accepted by most companies operating in the soft drinks market. Therefore, it claims that this is not an operating model driven by considerations of tax avoidance or tax reduction, but rather a business operating model that has been in place for decades.
The company also claimed that the IRS had over the years conducted audits, assessments and deductions, and the issue of royalties had been examined, and in all those years the assessor had accepted its position that it was not a royalty payment, and had 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 his long-standing position and deduct tax at source to pay the notional royalties. He claims that the change of position is arbitrary, has no factual basis and violates the principle of certainty and the authority of the company.
Judge’s Ruling: An Economic Asset of Great Power
Judge Magen Altovi rejected the arguments of the Central Bottling Company that it purchased a “finished product” from Coca-Cola and said: “Even if we assume in favor of the plaintiff and Coca-Cola that the way Coca-Cola operates towards manufacturers and distributors in various countries, including Israel, is aimed at reducing the need to transport a large amount of sugar and water in order to save the costs of producing Coca-Cola beverages – this does not change the conclusion that the production of the finished beverage extracted from Coca-Cola and additional ingredients requires the operation of large numbers of machines and workers.”
Under these circumstances, the judge ruled that the Central Bottling Company produces the beverages from ingredients supplied by Coca-Cola and in accordance with its instructions. In light of the finding that the company manufactures the beverages in Israel, and not by purchasing a finished product, the conclusion was that marketing the beverages using the Coca-Cola brand name and reputation constitutes an economic asset of great power, requiring the payment of royalties for its use. Judge Altopia stated: “It is customary and acceptable when a trademark owner grants a manufacturer and marketer a license to use its trademarks and reputation to market and sell the product produced by the manufacturer.”
The judge also noted that given the power relations and strength of Coca-Cola in the soft drinks market at least in Israel, it was likely that Coca-Cola was dominant in designing the deal between itself and the parent company, and in the process knew that the marketer relied on its reputation to market the drinks, and therefore could have expected that the payments made to it would be considered in part as royalty payments.
The judge also rejected Coca-Cola Israel’s claim that it relied on the Tax Authority’s decades-long position that it should not be taxed on royalties.
answer
The Central Bottling Company said: “The decision accepts the position of the Tax Authority regarding the tax liability in Israel of global companies known in Israel, through local companies that market their products in Israel under global brands. Accordingly, it was decided to oblige local companies to deduct this tax at the source. It should be noted that this is the first ruling in this dispute between the Tax Authority and global companies and it will be presented to the Supreme Court for a ruling.”
This article was published in Globes, Israeli Business News – en.globes.co.il – on September 12, 2024.
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