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Transfer pricing methods
Which transfer pricing methods are used in your jurisdiction and what are the pros and cons of each method?
Customary Organisation for Economic Cooperation and Development (OECD) methods.
Preferred methods and restrictions
Is there a hierarchy of preferred methods? Are there explicit limits or restrictions on certain methods?
This is in line with customary OECD recommendations.
In general, the best-method rule set forth in the Israeli regulations requires that the arm’s-length result of a controlled transaction be determined under the method that, given the facts and circumstances, provides the most reliable measure of an arm’s-length result. The application of the best-method rule thereby establishes an arm’s-length range of prices or financial returns with which to test the controlled transactions. The following hierarchy should be employed while implementing the best-method rule.
The primary methods to be used are those based on comparison between the group's transactions with unrelated parties. These methods are similar to the comparable uncontrolled price/transaction methods. If these methods cannot be used due to lack of similar comparable transactions, then one of the following methods should be employed:
- a comparison between the mark-ups on direct expenses in the tested and comparable transactions (similar to the cost-plus method);
- a comparison between the gross profit margin of the seller in the tested and comparable transactions (similar to the resale price method); or
- a comparison between profit level indicators (PLI) established in the tested and comparable transactions (similar to the transactional net margin method or the comparable profits method). The PLI selected should be in accordance with the regulations.
Where none of the above can be applied, the most suitable method can be used. However, this should be justified both economically and legally, and the application of a different method cannot normally be justified when one of the aforementioned methods is applicable.
What rules, standards and best practices should be considered when undertaking a comparability analysis?
Customary OECD recommendations should be considered. However, due to insufficient information regarding Israeli comparables, a global benchmark (focused mainly on EU and North American companies) is acceptable.
Are there any special considerations or issues specific to your jurisdiction that associated parties should bear in mind when selecting transfer pricing methods?
Services (mainly R&D but also marketing and others) should be carefully examined and the right transfer pricing method should be adopted. The Israeli Tax Authorities (ITA) may try to impose a profit-split method where appropriate, instead of the transactional net margin method. In addition, contemporaneous documentation is important; although no formal fines are set in the current legislation, the ITA may reject any non-contemporaneous documentation. Moreover, an Israeli company involved in an intercompany transaction subject to transfer pricing regulation should file a separate Form 1385 annually, together with its tax return, in which it states (in the form of an affidavit signed by an officer of the company) that it abides by the transfer pricing legislation.
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