Israel: The Israeli Tax Authority Issued New Circulars On Transfer Pricing

Last Updated: 10 January 2019
Article by Oren Biran

Transfer pricing tax matters relate to the examination of pricing transactions between parties that maintain special relations, as stated in Section 85A (herein: "Related Parties") to the Income Tax Ordinance (New Version), 1961. When a transaction is made between unrelated parties, the difference in interests results in the price and the conditions of the transaction reflecting the market conditions. A fundamental principle in the field of transfer pricing is the "Arm's Length Principle" for determining market conditions between Related Parties. The terms of the "Arm's Length Principle" between Related Parties will be examined best by comparing the terms of the transaction between Related Parties to the terms of a similar transaction between unrelated parties.

The issue of transfer pricing is becoming more acute as Israeli companies enter into transactions with foreign companies, including subsidiaries and/or parent companies, under intercompany agreements and/or distribution agreements.

On September 5, 2018, the Israeli Tax Authority issued two new circulars on the subject of transfer pricing applying to multinationals operating in Israel. The first, Circular 11/2018 titled "Determination of the Appropriate Transfer Pricing Method for Activities relating to Distribution, Marketing and Sales of a Multinational Enterprise in the Local Market"; the second, Circular 12/2018 titled "Transfer Pricing – Profitability Levels and Ranges in certain Transactions" (Shall be referred to together as: the "Circulars"). In publishing the Circulars, the Israeli Tax Authority wishes to create certainty regarding the pricing determination of international transactions between Related Parties.

The First Circular: 11/2018

This Circular discusses the issue of activity related to sales, marketing and distribution, carried out through an Israeli entity of a multinational group. According to the Circular, the local entity's activity will be determined following a functional analysis using the appropriate transfer pricing method in order to determine the arm's length price and probability, according to the OECD guidelines.

The Circular particularizes the FAR (Functions, Assets, Risks) analysis in order to examine the division of activities and responsibilities between the multinational and its local entity in Israel in order to classify such distributer as a full-fledged distributor, a low-risk distributor or as marketing services.

The Circular provides details on the appropriate transfer pricing method for each of the following cases: For a full-fledged distributor the Circular suggests that the most appropriate transfer pricing methods are the resale price method, the transactional net margin method and the profit split method; for a low-risk distributor the Circular suggests the transactional net margin method and for marketing services the cost plus method or the transactional net margin method.

Additionally, the Circular reviews some of the accepted transfer pricing methods in Israel.

The Second Circular: 12/2018

The Circular presents the position of the Israeli Tax Authority which provides a safe harbor in a number of different services. Certain safe harbor probability ranges would exempt taxpayers from the documentation requirement to prepare the analysis part of the transfer pricing study.

The Circular provides safe harbors for three types of services:

  • The first, low-value services such as legal, HR or IT services, with respect to which the Circular refers to the OECD guidelines and suggests a safe harbor of cost + 5%.
  • The second, marketing services, for which it provides a safe harbor of operational profitability of cost + margin of 10%-12%.
  • The third, a low-risk distributor for which it establishes a safe harbor of operational profitability of 3%-4% of the sales with respect to which the Israeli entity renders distribution services.

It should be noted, that the Israeli Tax Authority emphasizes, that the Circulars and safe harbors do not impact the analysis of whether a foreign entity engaged in intercompany transactions with the Israeli affiliate might have a permanent establishment in Israel and do not apply to the digital economy (internet activities)1 and to R&D services (the development centers in Israel).

The Circulars include extensive and complex details of accepted transfer pricing methods, and determination of transactions prices between Related Parties in multinationals. A review of this bulletin does not replace the full review of the provisions of the Circulars. Furthermore, we highly recommend multinationals which have activity in Israel to review their relevant intercompany agreements and evaluate the applicability of the safe harbors to their circumstances and whether their transfer pricing documentation and selection of transfer pricing method are aligned with the position of the Israeli Tax Authority as reflected in the Circulars.

Footnotes

1 Please see Circular 4/2016: Activity of foreign corporations in Israel via the internet.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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