Practical Lessons from the Q Cyber (NSO) Judgment on the Artificial Transactions when purchasing Israeli IT Companies
Foreword
On July 28, 2026, the Central-Lod District Court (Judge Avi Gorman) rendered its judgment in Q Cyber Technologies Ltd v. Kfar Saba Assessing Officer (ITA 59924-03-22), concerning the acquisition structure designed by the foreign private-equity fund Francisco Partners (the “Fund”) for the purchase of the Israeli offensive-cyber company NSO Group Technologies Ltd (the “NSO”). The court held that the sequence of actions through which over USD 86 million of NSO’s profits was transferred to the Luxembourg parent company (the “Parent”) in the guise of loan repayments constitutes an “artificial transaction” under Section 86 of the Income Tax Ordinance (New Version), 5721-1961 (the “Ordinance”), and dismissed the appeal against the withholding assessments for 2014-2015 and 2017-2018.
The court reaffirmed that leveraged acquisitions are a legitimate commercial practice; the decisive question is whether a substantial commercial rationale, established by contemporaneous evidence, under Section 191A of the underlays the structure chosen. It also cancelled the withholding penalty
Ordinance, signaling that penalties are not to be imposed routinely whenever a taxpayer’s position is rejected.
The Relevant Statutory Provisions, the Dispute and the Court’s Interpretation
The two-stage corporate taxation model and Section 86 of the Ordinance
Israeli tax law taxes companies in two stages: corporate tax on taxable income (Section 126(a) of the Ordinance), and a supplementary tax upon distribution of dividends. To avoid multi-tier taxation along a chain of Israeli companies, inter-company dividends between Israeli-resident companies are excluded from income under Section 126(b) of the Ordinance, deferring the second stage until profits reach the individual or a foreign-resident recipient, at which point the dividend is taxed under Section 125B(5) and withheld at source, subject to any reduced treaty rate.
In parallel, Section 86 empowers the assessing officer to disregard a transaction that is artificial or has an improper reduction of tax as a principal purpose. Under the “two-stage test” consolidated by the Supreme Court “transaction” is construed broadly to cover the entire sequence of actions. The court first classifies the planning as positive, neutral or negative; only negative planning is subjected to the “substantial commercial purpose” test: would the taxpayer have entered into the transaction, as structured, absent the expected commercial purpose? Auxiliary tests examine whether contemporaneous evidence shows that the asserted rationale in fact underlay the transaction; whether the commercial benefit is economically equivalent to the tax benefit; whether a genuine expectation of economic gain existed at the time; and whether real commercial risk was assumed. The assessing officer bears the initial burden of showing an apparent artificial transaction; the burden then shifts to the taxpayer, who holds the best evidence, to prove the commercial considerations underlying the structure.
The Acquisition Structure and the Flow of Funds
In 2014 the Fund acquired NSO through OSY Technologies S.à.r.l. (“OSY”), a Luxembourg-resident company it held. A trust agreement between OSY and the appellant, Q Cyber Technologies Ltd (the “Appellant” or “Q Cyber”), provided that OSY would acquire the NSO shares in trust for Q Cyber. During 2014-2018 the Appellant repaid its loans to OSY out of loans and dividends from NSO, the dividends being exempt under Section 126(b). The funds, exceeding USD 86 million, were in practice transferred directly from NSO to OSY’s bank account and only recorded in Q Cyber’s books.
The Dispute
The assessing officer contended that interposing Q Cyber, an empty shelf company, between NSO and the Parent served no purpose other than tax: had NSO been held directly by a foreign company, its profits would have attracted dividend tax abroad at 10% rate under the tax treaty between Israel and Luxemburg); through the Israeli intermediary, the same profits left Israel as exempt inter-company dividends followed by “loan repayments”.Q Cyber argued that this was a conventional leveraged acquisition; that a local holding company is legitimate and even desirable; that repayment of a loan is not a dividend; and that substantial commercial reasons existed, principally that Q Cyber would hold further Israeli cyber acquisitions and concentrate the group’s marketing, distribution and headquarters functions in Israel, including for defense-export (API) reasons. It also raised reliance arguments based on a 2019 transfer-pricing agreement and challenged the computation and penalty.
The Court Decision
The court stressed that the same structure may be legitimate in one case and artificial in another; the answer is evidentiary. The assessing officer discharged his initial burden by demonstrating a clear tax saving, and the Appellant failed to discharge hers. The tax benefit (approximately USD 8.6 million) stood in marked disparity to the cumulative taxable income of approximately USD 5 million generated by the Appellant’s actual activity. No contemporaneous documents, board minutes, opinions or investment memoranda explained why the NSO shares were to be held through the Appellant, although a USD 100 million investment would ordinarily be preceded by written records. The Fund’s representatives who designed the structure did not testify, and the sole witness, a founder of NSO and today the Appellant’s controlling shareholder, learned of the Appellant’s involvement only after the purchase agreement was signed. Business activity developed only from 2016, and substance created after the fact cannot validate a structure designed in 2014.
Conclusion, Key Takeaways and Practical Recommendations
An Israeli holding company in an Israeli acquisition may well be legitimate where a proven business justification exists; the demand the judgment places on foreign investors and multinational groups is evidentiary. In Q Cyber the tax advantage was clear and quantified while the commercial rationale remained unproven: the case turns on what the taxpayer could not prove.
First, contemporaneous documentation matters more than ever: board and investment-committee minutes, investment memoranda, professional opinions and internal correspondence on the choice of structure may, years later, make the difference between a legitimate transaction and an artificial one. Second, substance must exist from inception: defined management, personnel and operational responsibilities within the group. Third, debt-financed structures require particular care: where repayment of shareholder debt allows Israeli profits to leave untaxed, resembling dividend extraction, heightened scrutiny under Section 86 of the Ordinance should be expected. Fourth, the focus will be on the original purpose and the witnesses able to prove it; later commercial success does not validate the structure.
The judgment thus adds a further layer to the case law delineating legitimate tax planning from artificial transactions, in the context of acquisitions of Israeli companies by foreign companies.