The District Court of Tel Aviv ("Court") recently held that the cost of grants of options to purchase shares in a parent company ("Options") pursuant to Section 102 of Israel's Income Tax Ordinance were to be considered "costs" under an intercompany Research and Services Agreement entered into by the subsidiary and its parent company, pursuant to which the parent company paid the subsidiary on a "cost+" basis.
Based on the specific facts of the case, the Court held that the cost of the Options were best classified as "costs expended in the production of income", as the purpose of granting the Options was to motivate the subsidiary's employees. The Court also mentioned that the result was notwithstanding the fact that the subsidiary was not entitled to deduct the value of the Options as an expense for reasons related to the terms of the Section 102 Option plan benefiting the employees. The Court reached a similar decision with respect to other social benefits provided by the subsidiary, such as employee pensions, holding that as an objective of these benefits was to motivate employees, they should also be considered part of production costs and included in the "cost+" calculation under the Research and Services Agreement.
The Court rejected the argument that as an employee receiving the Options could classify income from the Options as capital income on tax filings, the same capital income classification should be applicable to the subsidiary with respect to the Options. The Court pointed to case law holding that there is no requirement that payments be classified in the same manner by both payor and payee, or in this case, by both employer and employee.
Finally, the Court also held that the fact that the parent company (and not the subsidiary) had de facto granted the Options to the subsidiary's employees was irrelevant, as the options had been granted in order to motivate the employees of the subsidiary.
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