Tax Update | January 2021

New Tax Circular – Recharge Agreement

On January 27th, 2021 the Israeli Tax Authority (“ITA”) published Tax Circular 1/2021 which specifies ITA’s position regarding the classification for tax purposes of inter-company payments made under a Recharge Agreement with respect to capital-based compensation granted by a parent company to its subsidiary’s employees (the “Circular”).



It is a common practice to grant employees of one company (the “Employing Company”) options, stocks or other capital-based instruments (the “Capital Compensation”) of parent company or of an affiliated company (the “Granting Company”). In some cases, the Employing Company and the Granting Company enter into a Recharge Agreement, according to which the Employing Company is charged by the Granting Company for the Capital Compensation granted to the Employing Company’s employees. In accordance with the Israeli Supreme Court’s ruling in the famous Kontera case, the cost of such Capital Compensation must be taken into account for the purpose of calculating the cost-plus consideration which the Employing Company is entitled for. However, the court did not address the question of how to treat the inter-company charges resulting from Recharge Agreements.


Recharge Agreements – Compensation or Dividend?

According to the Ruling, payments made by the Employing Company to the Granting Company for Capital Compensation granted by the Granting Company to the Employing Company’s employees under a Recharge Agreement, may be considered, from the Granting Company’s perspective only,  as compensation for payroll expenses incurred by it, or as a dividend distributed to it.

In order that such payment shall be classified as compensation for payroll expenses for tax purposes, the following conditions must fulfill:

  1. The payment must not exceed the actual payroll expenses recorded by the Employing Company in its financial statements with respect to the grant of the Capital Compensation to its employees, and it must be final and unconditioned;
  2. The payment must be for the Capital Compensation’s portion which has already vested;
  3. The payment for each Capital Compensation granted to an employee must reflect fair market value at the date of grant (as recorded in the financial statements based on GAAP);
  4. The Granting Company is entitled to the payment by virtue of a Recharge Agreement entered into by the partied prior to the grant of the Capital Compensation;
  5. All expenses incurred with respect to the Capital Compensation were included in the cost base for purpose of Section 85A of the Income Tax Ordinance (“ITO”) and in accordance with the Kontera case.

Payments that do not fulfill all the aforementioned conditions shall be considered as dividend paid by the Employing Company to the Granting Company – whether or not the Granting Company is the Employing Company’s parent or an affiliate.The Circular further clarifies that an Employing Company which entered into a Recharge Agreement with a Granting Company and the payments thereunder fulfill all the relevant conditions under the Circular, shall be exempt from reporting under reportable position 70/2019 (which classifies such payments as dividend in general).

Please note, the tax position as set forth in the Circular may not be in line with the tax implications in the Granting Company, transfer pricing methodology and cross border payments, therefore, we recommend that prior to adopting and/or taking any tax position you are urged to consult with your tax advisors on that matter.


For further information, please contact Adv. Oren Biran, Partner, Head of Tax Practice at Gross Law Firm 

Gross & Co. (GKH) is one of the leading law firms in Israel, with over 170 attorneys. GKH specializes, both in Israel and abroad, in various fields of law including Mergers and Acquisitions, Capital Markets, Technology, Healthcare and Life Science, Banking, Real Estate, Project Finance, Litigation, Antitrust, Energy and Infrastructure, Environmental Law, Intellectual Property, Labor Law and Tax. This alert is prepared as an informational service to clients and colleagues of Gross & Co. (GKH) and the information presented is not intended to provide legal opinions or advice. Readers should seek professional legal advice regarding the matters about which they are particularly concerned.

Oren Biran

Phone +972-3-6074547

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