Microsoft to Pay $28.2 Million in Israeli Taxes in Precedent-setting Ruling

Israeli court rules against U.S. company in connection with acquisition of Israeli startup a decade ago

Microsoft
Tomi Setala/Bloomberg

In a precedent-setting ruling that could have wide implications for Israel’s high-tech industry, a court ruled on Wednesday that Microsoft owes 100 million shekels ($28.2 million) in taxes connected with its acquisition of the startup Gteko more than a decade ago.

The case pitted Gteko, now a subsidiary of the giant American tech company, against the Israel tax Authority about how to classify part of the acquisition Microsoft made and how to value it.

Judge Shumel Bronstein of Central District Court ruled in favor of the tax authority, saddling Microsoft with the tax bill and setting a precedent that could leave other multinational companies buying Israeli startups with larger tax bills in the future, too, lawyers said.

“However, it could be an incentive for foreign companies that are buying Israeli companies to leave the intellectual property, or at least part of it, in Israel,” Eldar Ben-Ruby told the Calcalist daily. “That is in line with the new Law for Encouraging Capital Investment, which provides benefits for IP staying in Israel.”

At issue was Microsoft’s 2006 acquisition of Gteko, a maker of networking and support software solutions for the digital homes, for $90 million. The U.S. company bought Gteko’s stock and hired the startup’s entire staff, including its manager. Less than a year later, Microsoft paid another $26.6 million for Gteko’s IP, and it was this deal that caught the tax authority’s attention.

Gteko argued in court that the second transaction was a simple sale of IP, while the share sale represented not only the value of the company but a premium Microsoft expected from the synergies that would be generated from the acquisition.

But the Israel Tax Authority said otherwise and contended the IP sale was a full-fledged sale of its business operations. It told the court that the $90 million sale accurately reflected the market value of Gteko and that by the time Gteko sold its IP, as a unit of Microsoft it was no longer acting as an independent seller but putting its parent company’s interest first.

“My conclusion is that in a substantive (or ‘functional’ sense) the transaction that the parties conducted was far more extensive than the deal described by them in the IP transaction,” Bornstein said in his decision.

By the time Gteko has sold its IP it was no longer in business, but the judge said the value of the company does not “evaporate” when a business ceases operations, and that the tax should fully reflect the value of its assets that were discharged from the company.

As a result, he said the IP transaction, minus some costs amounting to $9 million, should be valued the same as the share transaction and taxed accordingly.