Court Restrains Tax Authority in Cybersecurity Case

Introduction

In The Hexadite Case, the Tel Aviv Jaffa District Court Tax Authority in Cybersecurity case issued a significant judgment concerning the valuation of assets transferred following Microsoft’s USD 75 million acquisition of Hexadite Ltd., an Israeli cybersecurity company. Shortly after the share purchase, Hexadite transferred its intellectual property, personnel, and business functions to Microsoft group entities. The Tax Authority challenged the reported valuation of these transferred assets, seeking to increase the value by adding hypothetical tax effects and arguing that a USD 9.3 million holdback payable to the founders only upon three years of continued employment should be included in full as part of the asset deal consideration.

In brief:

• Tax effects cannot be added under the Comparable Uncontrolled Price method.

• The holdback was part of the acquisition consideration, not employment income.

Tax Effects in CUP Valuation: Clear Limits Confirmed

The judgment draws a clear methodological line. The Court held that tax gross-up is not permitted under the Comparable Uncontrolled Price Method (CUP) because CUP replicates observable market pricing, whereas the Discounted Cash Flow Method (DCF) which is a cash-flow based valuation method relies on theoretical forecasts.

• CUP relies exclusively on the price agreed in an actual arm’s-length transaction, which already reflects the economic expectations and tax considerations of independent parties.

• Paragraph 46 distinguishes CUP from DCF: CUP reflects real pricing, while DCF measures projected cash flows, including tax effects, based on assumptions and forecasts.

• Forecasted tax liabilities cannot be added to CUP without transforming it into a DCF analysis.

• The Tax Authority relied solely on OECD sections 6.157 which states that then determining the transfer price the impact of taxes on transaction must be taken into account, provision which apply only to DCF valuations, not to CUP.

• OECD section 6.153 confirms that cash-flow valuation such as the  techniques apply only when no reliable comparable transaction exists; in this case, a real acquisition price was available and undisputed.

Building on these principles, the Court further noted that the acquisition price already embedded the parties’ expectations regarding future tax liabilities, as independent buyers and sellers naturally account for such factors when negotiating a real transaction. Any additional tax gross-up would therefore amount to double counting and artificially inflate the value of the transferred assets. Introducing projected tax effects into a CUP analysis would collapse CUP into a cash-flow valuation, contradicting the OECD framework and distorting the method’s purpose.

Ultimately, the Court concluded that hypothetical tax effects cannot be incorporated into the CUP method. The acquisition price negotiated between unrelated parties must remain the proper basis for valuing the subsequent asset transfer. Any deviation from this principle would undermine the integrity of the CUP method and introduce speculative and unjustified adjustments into the valuation process.

Founder Retention and Deferred Consideration: Substance Over Form

The Court reaffirmed that deferred consideration linked to continued employment must be evaluated according to its true economic purpose, not its conditionality. The USD 9.3 million holdback arose from the founders’ status as shareholders and was intended to secure the value transferred in the acquisition, not to remunerate employment.

This distinction is particularly relevant in cybersecurity acquisitions, where founders’ continued involvement often protects the operational value of transferred assets such as algorithms, detection engines, and response systems. The ruling confirms that when deferred consideration secures technological value, it is correctly attributed to the business rather than to labour.

Strategic Insight

The Court’s judgment reinforces that valuation must remain anchored in actual market behaviour, not administrative reconstruction. For multinational groups acquiring high-value technology or cybersecurity targets, the decision confirms that:

• Acquisition prices offer reliable CUP anchors.

• Founder retention mechanisms may form part of the asset value.

• Hypothetical tax effects cannot inflate valuations.

How MCORE Can Help

MCORE LAW supports clients throughout cross-border acquisitions and post-acquisition restructurings. Services include: Developing defensible FAR valuations grounded in arm’s-length evidence.

1. Designing founder-retention and deferred-consideration structures aligned with commercial and tax objectives.

2. Preparing transfer pricing documentation consistent with OECD guidance.

3. Identifying exposure areas in asset deal planning and integration.

4. Managing disputes involving valuation methodology, deferred consideration, and secondary adjustments.