Israel: Supreme Court / Deduction Of Expenses Of Employee Option Issuances In A Foreign Corporation By An Israeli Subsidiary

Last Updated: 15 August 2018
Article by Yoram Shiv and Alex Berman

In this proceeding an Israeli subsidiary ("Subsidiary"), wholly owned by an US parent company ("Parent"), served as a research and development center for the Parent. The two companies were parties to an agreement pursuant to which the Subsidiary provided the Parent with research and development services on a "cost plus" basis (i.e. payment of the cost of providing the service plus a fixed rate). It was also agreed that the Parent would grant employees of the Subsidiary options to purchase stock of the Parent at a predetermined price. The allotment of the options was made within the framework of the "capital gains track" of Section 102 of the Israeli Income Tax Ordinance. The dispute at hand was whether the "cost" of allotting employee options could be omitted from the Subsidiary's cost base from which the amount payable by the Parent was calculated.

In this ruling, the Israeli Supreme Court ("Supreme Court") noted that international transactions between companies with "special relations" are characterized by a difficulty of estimating the real economic value of the transaction and that there is a risk that income is being improperly channeled to countries with a lower tax rate. The Supreme Court remarked that the accepted criterion for determining the real economic value in "special relations" transactions is the economic value of such a transaction that would be determined between unrelated companies each of which wishing to maximize its profits. This principle is also reflected in the Israeli Income Tax Ordinance, which establishes three cumulative conditions to allow the tax assessor to object to the reported value of a transaction and to impose tax in accordance with market conditions: (i) the existence of an international transaction; (ii) the existence of "special relations" between the parties to the transaction; (iii) out of market price or provisions for the transaction due to the special relations between the parties. The issue in dispute in this case is the existence of the third condition.

The Supreme Court discussed two tests to determine whether the cost of allocating options to the Subsidiary's employees should be included in the cost base according to which the payment by the Subsidiary to the Parent in the cost plus transaction is calculated.

The first and principal test is to examine the nature of employee option expense and whether it should be considered as part of the Subsidiary's costs of providing services to the Parent. The Court concluded that employee options are a method of remuneration and are, by their very nature, expenses incurred in the provision of the service and the generation of the Subsidiary's income. Therefore, the Supreme Court stated that as a rule, this cost should be considered part of the cost base to calculate payments to Parent in a cost plus transaction.

The second test is whether unrelated parties conducting a similar transaction tend to include the cost of allocating employee options as part of the cost base in a cost plus transaction. It was noted by the Supreme Court that most of the comparable companies surveyed in market studies that were filed by the parties to the litigation as part of their filings to the Tax Authority applied American accounting standards in their financial statements that were comparable to the Israeli standards. According to both of these standards, expense in allocating employee options should be recognized as an operating expense in the profit and loss statement in the amount of the value of the options on the date of grant and in accordance with various valuation methods. Therefore, the claim that the cost of allocating the options should not be included in the cost basis of cost plus transactions is inconsistent with the market research studies submitted by the Parent and Subsidiary.

Another issue that was addressed in the ruling is the entitlement of a company to deduct from its income its expenses in an amount equal to the total value of options allotted to a trustee under the capital gains track under Section 102 of the Income Tax Ordinance. The companies' position was that there must be symmetry between the inclusion of the cost of the allocation of options in the cost base and the deduction thereof: if the expense was included in the cost base, the expense should be deductible. However, it was determined that the option expense is not deductible, even though the cost of option allotment constitutes an expense in the production of income. This is due to a section of the Income Tax Ordinance that explicitly prohibits the deduction of an expense in respect of allotment of shares and options under the capital gains track of Section 102 of the Income Tax Ordinance.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions