eBay’s Development Unit in Israel Owes $43.5 Million in Back Taxes

There has been a lot of conversation about taxes when it comes to eCommerce.

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In the U.S., the U.S. Supreme Court is trying to decide the fate of Quill Corp. v. North Dakota, a 1992 landmark sales tax case that currently sets the rules for collecting sales tax across state lines.

And in Europe, multinational companies are fighting attempts by various member states to collect taxes based on the location of revenue activity versus location of EU offices. Now Israel seems to be getting into this spat as well.

eBay operates a development unit in Israel as many other multinational tech companies do a well. Sometimes, a multinational corporation will set up a division, other times it will purchase a small Israeli company and fold the operation into their business.

Waze (now part of Google), Wix, and Viber may be some of the better known Israeli startups that operate out of Silicon Wadi, Israel’s Silicon Valley.

During the late 60s, Israel realized it needed to develop its own technology sector as sanctions during that time made it more difficult to obtain Western technology for its security needs.

Born out of the necessity to supply its military and security services, the country invested in science and technology. Today, most kids already start to learn about computers in preschool.

With most Israeli citizens over 18 required to enlist in the military, many are exposed to high-level technology in their military service. The security and intelligence services of Israel rely heavily on technology advances to defend the country.

Also, Israeli culture values high educational standards with nearly half of adults obtaining post-secondary diplomas (university degrees) and English proficiency is a core requirement in public education with many jobs requiring fluency in English.

While the security needs launched the tech sector, it wasn’t until the shift to software services that the commercial tech sector started to boom.

Many advanced technology startups may work closely with Israel’s defense establishment, but entrepreneurs in Israel have launched everything from crowdsourced bra buying (Brayola) to image identification (Cortica).

Especially technology dealing with cybersecurity, augmented reality, virtual reality, image processing, drone technology and large volume data analytics have special interests in eCommerce.

Major U.S. tech multinationals such as eBay, Amazon, IBM, Motorola, Intel, CA Technologies, Google, Red Hat, Apple, Facebook, and many more either acquired Israeli startups or operate development divisions in the country.

For Israeli workers, there is an added benefit that engineering salaries at divisions owned by multinationals can be 2 to 3 times higher than working for local or startup firm.

Back to eBay’s Taxes

But development divisions have an inherent problem with taxation. They generally do not generate market-driven revenues that result in traditional profit taxation.

And this issue is the heart of the dispute between eBay and the Israel Tax Authority.

The Israel Tax Authority claims that eBay’s Israeli unit should have reported 903 million shekels ($250 million) in revenue over a five year period generated from other overseas income.

Because development centers do not have actual revenues, they often work on a cost-plus system.

In a cost-plus system, other divisions of the multinational company pay for the R&D services based on a cost of the R&D services plus 10 percent profit. This profit is ordinarily taxed at 23 percent.

The remaining profit is paid back to the parent company (the owning multinational) in the form of a dividend.

Because eBay Israel is a development unit, not a regular profit-seeking enterprise, it must receive court approval to pay the dividend after confirmation from the Israel Tax Authority (ITA) that all taxes have been paid.

The ITA appears to claim that eBay undervalued the R&D services and reduced the taxable burden and the government claims that eBay still owes 156 million shekels ($43.5 million) in back taxes.

eBay Israel plans to challenge this claim in Tel Aviv District Court and until a resolution is found, the dividend payment cannot proceed.

Globalization brings interesting challenges to small businesses, multinationals companies, and governments.

At all levels, sales tax, import duties, and even foreign R&D divisions, governments are trying to find valuations to assess tax burdens.

While this story doesn’t impact eBay sellers in any meaningful way, it demonstrates the complexity of global taxation today in an ever changing technologically driven world.

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