Cisco Israel asks to distribute $175 million as dividend

After laying off 1,000 out of 1,500 employees in Israel in the past four years, Cisco wants to transfer more than half of its Israeli branch’s assets abroad. The board of directors of Cisco Systems Israel, a subsidiary, recently decided to distribute NIS 570 million (about $175 million) as dividends, the company’s entire equity, to its sole owner - Cisco Systems Netherlands.

This move essentially is the transfer of more than half of the Israeli company's assets abroad, which as of January 31 amounted to NIS 970 million (just below $300 million). Cisco will finance the dividend, including through the conversion of loans granted to related companies in favor of Cisco Netherlands.

Cisco Israel, which develops computer communication technology and marketing support for the global company, reported last week to the local tax authority that it has turned to the courts to authorize the payment of the dividend.

Applying to court is required by law because the dividend distribution does not meet the required “profit test.” The Israeli company has only NIS 40 million (about $12.5 million) in distributable profits, while it wants to distribute more than 14 times that. Because of this, the company must convince the court that it has the ability to repay future commitments.

Cisco Israel approached the Tax Authority to present its position as a possible creditor of the company regarding future solvency. According to tax experts, an event in which a global company seeks to withdraw from a subsidiary all its equity can be considered by the authority as an actual sale of the company. Such a move may affect the final tax rate, which under certain conditions can reach 23% of the NIS 530 million (about $162 million) in additional capital distributed in addition to the profits, which will amount to an additional NIS 120 million ($38 million) in taxes. If the Authority will not consider the equity withdrawn as a sale of the company, a dividend tax is expected to be imposed in accordance with the agreement signed between Israel and the Netherlands, of between 5% and 10%.

Cisco USA, which owns through its proxy 100% of Cisco Israel, is one of the 50 largest companies in the world, traded on Nasdaq at a value of $226 billion. The global company specializes in managing internal corporate communications, and it has previously performed several acquisitions in Israel, valued at several billion dollars.

Cisco Israel currently employs 500 people in Netanya, Caesarea, and Tel Aviv. In the past, it also had R&D centers in Haifa and Jerusalem that were shut down. According to the agreement between Cisco Israel and the global company, in exchange for its local services, Cisco Israel is compensated for its costs plus 10%, that is, for each of its expenses. For example, when it wins a tender, the Israeli company receives the costs of the project plus 10% from the parent company. This type of agreement characterizes Cisco’s relationships with dozens of its subsidiaries around the world and is a model used by most multinational companies.

According to Cisco Israel’s 2020 financial reports, which were obtained by Calcalist, recorded revenues of NIS 500 million (more than $150 million) from the services it provided to the American company, a drop from NIS 558 million (more than $170 million) in 2019. During the first half of 2021, revenues from the global company amounted to NIS 237 million (about $72 million).

The operating profit grew

Cisco Israel's largest item of expenditure revolves around R&D, mostly in salaries, which amassed to an average of 70% of the revenues during 2019-2020. It is followed by marketing expenses, with an average of 20%, and the administrative and general expenses item, which stands at 5%.

The Israeli company’s 2020 operational profit was NIS 22 million ($6.75 million), which constituted about 4.5% of total revenues. It is also a small increase compared to 2019’s NIS 19 million ($5.8 million), which constituted about 3.5% of revenues. In the first half of 2021, Cisco Israel recorded an operational profit of NIS 15 million ($4.6 million), which constitutes approximately 6% of revenues.

However, a large inflow of funds from Cisco Global helped Cisco Israel to reach a NIS 150 million ($46 million) profit after taxes in 2020. The boost came to offset tax payments resulting from the shares awarded to Israeli employees between the years 2013-2016. In other words, the global company, according to the agreement with the Israeli branch, bears the tax payments on the shares received by the Israeli workers, and therefore it transferred that amount.

NIS 11 million in tax in 2020

According to the information in the report, the Israeli company's income is subject to corporation tax of 23%, while under the Investment Encouragement Law the tax rate is 16%. In 2020, it paid NIS 11 million in tax (just below $3.5 million), and in 2019 it paid NIS 12.5 million ($3.8 million). In September 2020 the company signed an agreement with the Tax Authority for the years 2013-2016, and accordingly, it was determined that it would pay an additional tax of approximately NIS 65 million (almost $20 million).

In light of the dividend distribution, the company can expect an additional income tax claim. According to attorney and accountant Simon Yaniv, who specializes in international taxation, according to the taxation treaty between Israel and the Netherlands, the tax authority is entitled to deduct tax from the dividend at a 10% rate in relation to exempt profits or those that were previously taxed at a lower rate, and 5% of the rest of the amounts handed out.

According to Yaniv, the reduction in capital that Cisco Israel wants to make has tax implications.

“The Tax Authority is expected to claim that by reducing its capital, Cisco is relinquishing its assets in essence, and therefore the Authority will ask to tax the company on the capital level,” he added. “In 2018 the Tax Authority published information that makes a distinction between the distribution of dividends from excess profits that can be distributed, and a dividend that reduces the company's capital."