Beware Of No-Interest Loans

The District Court has ruled that large interest free loans from a US parent corporation to an Israeli subsidiary company are not okay (eBay Israel Holdings Ltd Vs. Netanya Assessing Officer, civil appeal 51066-03-20, of December 5, 2023). But the judgment has many twists and turns and some Hebrew write-ups appear to have missed the point.

Main facts:

In 2005, eBay Inc. (US parent corporation) set up an Israeli company (eBay Holdings Ltd or the taxpayer) to buy and hold all the shares in a successful Israeli hitech company for $685 million.

To finance the deal, the parent corporation invested $45 million in the equity share capital of eBay Holdings Ltd and lent it a further $635 million (Comment: this adds up to $680 million….). This loan was repayable upon demand after no fixed period, and no interest was due. The loan was received on August 30, 2005.

After two years, eBay Holdings Ltd repaid the US parent Corporation $133 million of the loan. It also made a tax-free repayment of $110m of the share capital. (Comment: it is not clear from the judgement how $110m of capital was repaid if the capital invested was only $45m).

The Israeli Tax Authority allowed these payments to be made to the US parent corporation without withholding tax, then changed its mind saying the loan should have borne interest at the “arm’s length” market rate under Section 85A of the Israeli Income Tax Ordinance (ITO).  Section 85A deals with “transfer pricing” of international intercompany transactions where one company controls 50% or more of any means of control of the other, directly or indirectly.

In 2018 $230m of the loan was repaid and the rest was turned into an interest free “capital note” for a period of at least 5 years. The Israeli company eBay Holdings applied regulations allowing dollar-based tax reporting.

The Issue:

The issue in this case was whether the ITA could insist on arm’s length interest on the intercompany loan from eBay Inc to its Israeli subsidiary eBay Holdings Ltd. This is an important question for multinational groups. Interest free loans can be repaid without tax or withholding tax. By contrast, dividends out of profits are subject to withholding tax (up to 25%), so is interest, if it exists.

The ITA didn’t want $635m of profits to be paid to the US parent corporation under the guise of loan repayments rather than dividends and interest.

Meandering discussion:

In the judgement, the Court said the dollar tax regulations changed nothing. The taxpayer initially argued that loans repayable upon demand count as capital notes and there was no need to recognize interest on them. The Court disagreed saying repayable upon demand pre-2018 did not meet a 5 year minimum term required under various Israeli tax laws and part of the loan was repaid after only 2 years in 2007.

The Court ruled that Section 85A was the wrong section, it only became effective in Israel in 2006, after the loan was made. This would have implied no interest need be recognized.

So the ITA changed its mind again, saying that interest may be deemed at an annually prescribed rate of interest under Section 3(j) (“Shalosh Yud”) of the Income Taxed Ordinance. The Court agreed, partly because it said the taxpayer had no right to appeal if it was forced to record more expenses (the interest at issue) under ITO Section 152(b).

To sum up, the Court allowed the ITA to recognize deemed interest expense under Section 3(J), and presumably levy withholding tax on that deemed interest.


Subject to any appeal, the ITA may apparently collect up to 25% withholding tax on deemed interest over many years.

Questions arising include:

(1) Will fines also be imposed for lateness?

(2) Will the US Internal Revenue Service grant a foreign tax credit?

(3) Will VAT of 17% also be imposed? Methods of avoiding this exist, but time limits and conditions apply.

Assuming the above figures are correct, the debt:equity group financing of eBay Holdings Ltd was initially perhaps around 93%:7%.

Israel lacks “thin capitalization” rules restricting actual interest expense deductions where a high level of leverage exists – banks are unlikely to finance 93% of anything.

Israel has a general antiavoidance rule against artificial or fictitious transactions (Section 86), but it wasn’t used in this case.

The case did not deal with the taxation of e-commerce, which is fast becoming another hot issue in Israel.

As always, consult experienced tax advisors in each country at an early stage in specific cases.

Next Steps:

Please contact us to discuss any of the above matters further, or any other matter.

As always, consult experienced legal and tax advisors in each country at an early stage in specific cases.

[email protected]

(c) Leon Harris 2024

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