Introduction
On October 28, 2025, the Tel Aviv District Court (Honorable Judge Yardena Sarusi) published its judgment in the tax appeal filed by Hexadite Ltd (the “Appellant“), which was represented by our firm.
The judgment deals with the method of determining the value of assets sold to a related party as part of a business model change transaction, which was carried out shortly after a share purchase transaction of the selling company. In particular, the judgment addresses two issues with dramatic implications for international M&A transactions: whether the valuation should reflect the expected tax arising from the sale of the assets, and whether deferred payments that are contingent upon continued employment at the company after the transaction should also be taken into account.
The Court ruled in favor of the Appellant determining that the Appellant’s position should be accepted, according to which the expected tax should not be embedded in the valuation of the transferred assets. Conversely, the Court rejected the Appellant’s position that the contingent consideration should not be taken into account in determining the value of the transferred assets. The Court also accepted the Appellant’s position regarding the interest rate applied in the secondary adjustment made following the increase in the value of the transferred assets.
This client memorandum briefly presents the facts of the case, the key determinations of the Court, and the potential implications arising from the ruling.
Summary of the Facts
The Appellant, a private Israeli company, engaged in research and development in the field of cybersecurity, was founded by three founders. In June 2017, the shareholders of the Appellant entered into an agreement with the Microsoft Group for the sale of it’s the entire share capital of Hexadite, for total consideration of USD 75 million. It was agreed that approximately USD 9.3 million of this amount, payable to the three founders of the Appellant, would be held back and its payment would be conditional upon their continued employment with the Microsoft Group for a period of three years (the “Holdback“).
Shortly after the closing of the share purchase transaction, the Appellant entered into three additional agreements with the Microsoft Group, under which it sold to the group its intellectual property and the remaining assets and functions it owned (the “Transferred Assets“) for total consideration of USD 65.4 million. The amount was determined based on the consideration paid in the share purchase transaction, after deducting the Holdback component.
The Israel Tax Authority (the “ITA“) did not accept the asset value as reported by the Appellant and determined in its assessment that the value of the assets amounted to USD 95.933 million. According to the ITA, the Holdback component should be included as part of the consideration paid in the share purchase transaction, and the valuation should also reflect the tax that would be imposed on the Appellant in respect of the Transferred Assets’ sale. In addition, since in the ITA’s view the Appellant did not actually receive the full consideration for the sale, it determined that the difference between the value reported by the Appellant and the value determined by the ITA should be regarded as an interest-bearing loan, and that the Appellant should be taxed on deemed interest income at a rate of 2.2%, compounded annually (It should be noted that during the court proceedings, the ITA, on its own initiative, reduced the interest rate on the secondary adjustment to only 1.01%).
Both the Appellant and the ITA agreed that the appropriate valuation method for determining the value of the Transferred Assets was the Comparable Uncontrolled Price (“CUP“) method, which is based on the share purchase price, subject to the necessary adjustments.
As noted, the Court accepted the majority of the appeal, dividing its decision into two main questions: whether the future tax liability arising from the sale of the Transferred Assets should be reflected in the valuation, and whether the Holdback component, which was conditioned upon the founders’ continued employment with the Microsoft Group, should be taken into account in the valuation of the Transferred Assets as of the stock acquisition closing date.
First Issue – The Tax Gross-Up Issue
The Appellant argued that no tax gross-up should be applied in determining the value of the Transferred Assets, as this contradicts the ITA’s policy as reflected in its written guidelines and actual conduct, as well as the OECD Transfer Pricing Guidelines, which do not include any requirement to apply a tax gross-up under the CUP method. According to the Appellant, this method is based on an actual transaction between unrelated parties that inherently reflects all economic considerations of the parties, including tax considerations. The Appellant further claimed that the ITA had changed its policy on this matter without any official publication or legislative amendment, in violation of administrative law principles, and that the issue was first raised at the second phase of the audit without affording the Appellant a proper opportunity to present its arguments.
The ITA, on the other hand, argued that according to the OECD Transfer Pricing Guidelines, which provide that the impact of taxes on the transaction price should be taken into account, the tax gross-up must be included when determining the value of the assets. In its view, this did not constitute a change in policy but rather a correction in the way the guidelines were implemented. The ITA further argued that its published guidance referencing an adjustment for a “tax asset” naturally includes an adjustment for a prospective tax liability.
The Court accepted the Appellant’s position and held that a tax gross-up should not be included in determining the value of the Transferred Assets. The Court distinguished between valuations based on the CUP method and those based on the Discounted Cash Flow (“DCF“) method. Based on the OECD Guidelines, the Court determined that only under the DCF method should future taxes be taken into account, since this method relies on theoretical forecasts, as opposed to the CUP method, which is based on an actual transaction between unrelated parties that reflects all economic considerations.
The ruling further held that the tax gross-up requirement is not anchored in law or in the ITA’s guidelines, and that the ITA acted contrary to its own published guidance.
Second Issue – The Holdback Issue
The Appellant argued that the Holdback component should not be included in determining the value of the Transferred Assets, since it constitutes a payment that is conditional upon the continued employment of the founders after the transaction. Accordingly its nature is that of a retention bonus or payment for services performed following the completion of the acquisition transaction. According to the Appellant, the primary condition for receiving the payment was the employment condition, and therefore the payment has mixed characteristics of ordinary income and capital gain. The Appellant further argued that this position is supported by the precedent established in the Gteko case, which held that such conditional payments should not be regarded as part of the value of the transferred assets. In addition, the Appellant claimed that the ITA erred by failing to discount the value of the Holdback to the date of the transaction closing, since it was a deferred payment contingent upon the fulfillment of future conditions, which should be discounted to reflect both the risk and the time value of money.
The ITA, on the other hand, argued that the Holdback component should be included in determining the value of the Transferred Assets, as it formed an integral part of the share consideration paid to the founders under the share purchase agreement, and not a separate payment for future services. According to the ITA, the entitlement to the payment derived from the founders’ status as shareholders, while the condition of continued employment was intended to ensure the implementation of the transaction and the preservation of the value of the Transferred Assets, without changing the capital nature of the payment. The ITA also noted that the amounts were deposited in trust for the benefit of the founders and invested in instruments of their choice, and therefore there was no justification for discounting their value. Furthermore, the ITA argued that the circumstances of this case differed from those in the Gteko case, where the Holdback funds remained under the purchaser’s control until payment, whereas in this case they were immediately transferred to a trust, which in its view indicated that they formed part of the acquisition consideration.
The Court accepted the position of the ITA and held that the Holdback component should be included in determining the value of the Transferred Assets, distinguishing between a payment that is conditional upon continued employment and a payment in consideration for continued employment. The Court clarified that while a payment for employment represents compensation for services rendered or to be rendered and is therefore not part of the asset value, a payment that is conditional upon continued employment may reflect a commitment designed to ensure the implementation of a transaction and may therefore be regarded as part of the consideration for the transaction. Accordingly, and based on the share purchase agreement, the Court held that the Holdback did not constitute salary or a retention bonus, but rather a payment intended to secure the founders’ commitment to continue working at the company, and was therefore paid to them in their capacity as shareholders and not as employees. The Court further held that there was no basis for discounting the Holdback amount, since the funds were deposited in trust for the benefit of the founders and invested in financial instruments of their choice, and therefore no economic yield was lost.
Secondary Adjustment
With respect to the secondary adjustment, the Appellant argued that an imputed interest charge on amounts that were not actually paid results in economic double taxation, and that the ITA has no legal basis authorizing it to impose tax on such an adjustment. The ITA, on the other hand, relied on the precedent established in the Kontera case, which held that when the full consideration in a related-party transaction is not reported, the unreported amount should be regarded as an interest-bearing debt. The Court rejected the Appellant’s position, holding that the Kontera case is binding, but noted that the question of the ITA’s authority to impose tax on a secondary adjustment warrants further examination. However, the Court accepted the Appellant’s arguments regarding the applicable interest rate and the method of calculation, and determined that the interest rate would be 0.175% derived from the interest rates set in loan transactions between Microsoft Group companies, with respect to which the ITA had not issued an assessment, and that the method of calculating the interest (simple or compound) would likewise be determined in accordance with those intra-group loan transactions.
The Hexadite judgment clarifies key points in valuation of assets in business restructuring transactions and emphasizes the importance of a thorough examination of the transaction structure and the agreements executed as part of it, particularly those that include components contingent upon continued employment. The judgment also provides important clarifications regarding the status of the ITA’s written guidelines and the circumstances under which deviation from published guidance may lead to the rejection of the ITA’s position in judicial proceedings.
Our Tax Department has extensive experience and expertise in these matters, both in the planning stages of transactions, business restructurings, and the agreements executed as part thereof, and in representing clients before the ITA in audit proceedings, mutual agreement procedures, APAs and in court. We remain at your disposal and would be pleased to provide advice regarding the issues discussed above and the potential implications of the judgment for our clients.
Hexadite was represented by Adv. Dr. Yuval Navot (Tax Partner), Adv. Ofer Granot (Head of Tax Litigation), Adv. (CPA) Amir Cooper (Tax Partner), and Adv. Chen Ben David (Tax Associate).
For your convenience, here is a link to the judgment.
