All questions

Filing requirements

Taxpayers engaged in cross-border controlled transactions are required to include a separate form (Form No. 1385) in their annual tax return, in which they declare that their international transactions between related parties are conducted at arm's length and specify details such as the volume of the transactions, transaction types, terms and conditions and the parties thereto, the implemented TP method, the profitability rate used and whether the transactions are reported based on the new safe harbours set forth in Tax Circular 12/2018. Form No. 1385 is signed personally by an officer of the company (usually the company's CFO), and although no personal liability has yet been claimed by the ITA in cases where the form was inaccurate, the ITA is reviewing its position on this matter and may extend the statute of limitation to audit already closed tax years. For inter-company finance, Form 1485 has to be filed.

In practice, this means that taxpayers in Israel are expected, and in fact required, to hold up-to-date transfer pricing documentation, including (at a minimum) a transfer pricing study and an inter-company agreement relevant for the fiscal year end.

Full documentation includes the following:

  1. a transfer pricing study that includes:
    • a description of the parties involved in inter-company transactions, including a description of the management structure of the parties and functional organisational charts;
    • a description of the inter-company transactions, including value chain analysis depicting where value is created;
    • a description of the business environment and the economic circumstances in which the parties operate;
    • a functional analysis of the parties involved in the inter-company transactions (including functions performed, risks assumed and resources employed);
    • selection of the pricing method or methods and the reasons behind the selection;
    • an economic analysis (determination of arm's-length prices); and
    • the conclusions that may be derived from the comparison to uncontrolled comparable companies; and
  2. additional documents that corroborate the data described above, such as:
    • inter-company contracts;
    • any disclosure made regarding the controlled transactions to any foreign tax authority, including any request for an advance pricing agreement (APA);
    • a transfer pricing policy, if applicable;
    • any differences between the prices reported to the foreign tax authority and the prices reported in the Israeli tax returns; and
    • any opinion from an accountant or lawyer, if one was given.

It is recommended to update the transfer pricing study on an annual basis. Where the facts of the transactions under review have not changed materially (or at all), the entire transfer pricing study can remain the same except for the benchmark results, which should be updated every year. It is best practice to perform a new search every three years and update the results of the original search on an annual basis.

The ITA is entitled to demand full transfer pricing documentation within 60 days of a request of this type (it is expected to be updated to 30 days during 2022). Penalties may be imposed on a taxpayer for not preparing and submitting transfer pricing documentation on time or at all. In addition to preventing penalties and fines, holding a transfer pricing study in most cases shifts the burden of proof to the ITA and enables the taxpayer to maintain an arguable position regarding any determination made by the ITA concerning transfer pricing adjustments.

On 12 May 2016, Israel signed the Multilateral Competent Authority Agreement (MCAA) for the automatic exchange of CbCRs, which allows all participating countries to bilaterally and automatically exchange CbCRs with each other. It is important to note that the CbCR in itself could not alone be used by the ITA for determining transfer-pricing adjustments.

Proposed legislation – new documentation requirements

In recent years, the ITA together with the Israeli Ministry of Finance published a draft amendment to the Ordinance as well as to the Regulations, which aim to implement the master file and CbCR concepts and reporting obligations in Israel. The proposed amendments introduce a new reporting obligation, which is expected, for master files, to have a 150 million shekel revenue threshold, according to which any group of companies, comprising two or more entities, one of which resides outside of Israel, will have to file a master file. In addition, an Israeli taxpayer that serves as the ultimate parent of a multinational group whose consolidated turnover exceeds 3.4 billion shekels will be required to submit a CbCR as well.

In light of this proposed legislation, the burden of transfer pricing documentation will grow as taxpayers will be required to submit further documentation, reports and data to comply with the new documentation requirements.

Presenting the case

i Pricing methods

The Regulations incorporate both the OECD Guidelines and Section 482's approach towards the determination of the correct analysis methods for examining an international transaction between related parties. As such, the Regulations require 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, where there is a preference for transactional transfer pricing methods over profit-based transfer pricing methods.

According to Section 85A, the preferred method is the comparable uncontrolled price or transaction (CUP/CUT) methodology because this method can produce the most accurate and reliable arm's-length results. When the CUP/CUT cannot be used, then one of the following methods should be employed:

  1. resale price method (RPL);
  2. cost plus;
  3. profit split methods (comparable or residual); or
  4. transactional net margin method (TNMM, similar to the comparable profits method (CPM) in Section 482).

If none of the above methods can be applied, other methods should be used that are most suitable under the circumstances. However, this should be justified both economically and legally, and the application of a different method cannot normally be justified when one of the above-prescribed methods is applicable.

When applying a certain transfer pricing method, an adjustment is sometimes required to eliminate the effect of the difference derived from various comparison characteristics between the controlled and comparable uncontrolled transactions.

According to the Regulations, a cross-border controlled transaction is considered to be at arm's length if, following the comparison to similar transactions, the result obtained does not deviate from the results of either the full range5 of values derived from comparable uncontrolled transactions when the CUP method is applied (under the assumption that no comparability adjustments were performed), or in the interquartile range when applying other methods.

The adoption of post-BEPS measures has been formalised in part in Israel, including guidance concerning restructuring and low-value-adding services, and measures related to the digital economy; other post-BEPS measures are under consideration by the ITA.

Financing transactions

The Israeli transfer pricing regulations do not provide specific guidelines for evaluating the arm's-length nature of inter-company financing transactions and thus follow a broader transfer pricing approach provided under the OECD Guidelines and Section 482.

Specifically, for inter-company loans, the evaluation of the arm's-length nature is carried out by establishing an arm's-length interest rate based on those applied in comparable third-party transactions. According to the OECD Guidelines and Section 482, the transfer pricing methodology usually used when setting arm's-length interest rates is the CUP method, applying internal or external CUP analysis. The approach preferred by the ITA is the external CUP method, which is, in fact, a market-valuation method, as it relies on market yields of publicly traded corporate bonds that are comparable to the assessed inter-company loan in terms credit-rating and loan terms when establishing the arm's-length interest rate.

Application of profit split

The Regulations incorporate the OECD Guidelines' approach towards the application of the profit split method. In general, the employment of the profit split method in documentation is quite limited. However, the profit split can be a method of choice for dispute resolution.

The Regulations stipulate two profit split methods:

  1. the comparable profit split method; and
  2. the residual profit split method.

The Regulations do not contain specific guidance for the application of the profit split method. Nevertheless, this method is generally acceptable to tax administrators when it is used in cases where both entities contribute or own significant intangibles, and it has recently been advocated by certain officials of the ITA. The profit split method is most often applied in the context of global value chains, where global operations of a multinational corporation are significantly integrated.

In this regard, the ITA places great emphasis on business or economic substance when analysing value chains and transactions involving the transfer or use of intangible properties. This means that functions contributing to the creation of value (e.g., R&D, marketing and management), as well as where people are located, constitute important criteria when determining the appropriate attribution of profits among group members in multinationals. Consequently, there is an increasing trend of challenging cost-plus models (under TNMM and CPM) and recharacterising as profit splits by the ITA.

The ITA implements a people-orientated analysis when conducting tax audits, and therefore can, in certain cases, determine management services as being a non-routine activity for purposes of profit splits.

With respect to R&D services, the ITA will soon publish a tax circular presenting its view when there are indications of 'economic ownership' of intangible assets or strategic roles fulfilled by the Israeli R&D centre, justifying the application of a profit split method over cost-plus method.

Factors indicating economic ownership of intangible assets in Israel are as follows:

  1. the intangible asset is sourced in Israel and its activity commenced in Israel;
  2. in addition to the R&D activities, the Israeli company conducts additional activities;
  3. the headquarters of the foreign multinational group, including the R&D centre, is located in Israel;
  4. the R&D centre in Israel bears some of the significant risks relating to the R&D activity; and
  5. the activities of the R&D centre provide a unique and valuable contribution to the foreign multinational group.

Factors indicating non-economic ownership of intangible assets in Israel are as follows:

  1. the Israeli R&D centre was established following an initiative by a foreign multinational company;
  2. decisions relating to intangible assets are concluded by employees of the foreign multinational company's headquarters from outside of Israel;
  3. the Israeli R&D centre does not bear any business risks relating to the R&D activity;
  4. the Israeli R&D centre does not have the financial capability to finance the R&D activity that would establish economic ownership over the intangible assets;
  5. the Israeli R&D centre does not have accumulated losses for tax purposes resulting from the R&D activity; and
  6. the Israeli R&D centre does not provide a unique and valuable contribution to the foreign multinational company.
Application of the cost-plus method

The cost-plus method compares gross margins of controlled and uncontrolled transactions. The cost-plus method is most often used to assess the markup earned by a service-providing entity that engages with related parties.

The arm's-length price is measured by adding an appropriate gross profit (i.e., markup) to the controlled taxpayer's cost of producing the services involved in the controlled transaction.

The cost-plus method applies where internal data is available, in which a service renderer provides the same or similar services to both controlled and uncontrolled parties and where it provides detailed information concerning comparable transactional costs.

In practice, this method is usually not applicable for evaluating the arm's-length nature of intra-group services, mainly because external data (i.e., transactions between two third parties) found on public databases cannot be reliably used when applying this method. This is due to inconsistencies between companies' financial data, arising from the fact that companies allocate their costs using different accounting methods.

The degree of consistency in accounting practices between the controlled transaction and the uncontrolled comparables materially affects the gross profit markup and the reliability of the result.


When performing comparability analysis, the goal is to reach the most accurate pool of potential comparable companies. In doing so, the search process usually includes a quantitative screening followed by a qualitative screening.

It is first essential to apply Standard Industrial Classification (SIC) codes, NACE (Nomenclature des Activités économiques dans la Communauté Européenne) codes, or both, as well as specific industry classifications employed by certain databases, which classify companies by the type of economic activity in which they are engaged and the types of products or services that they sell.

Following the application of the aforementioned industry codes, additional screening criteria are also applied, including geographic location, company status (i.e., active companies), company type, exclusion of operating subsidiaries from the search, years of available accounts and limitations regarding operating losses.

Depending on the nature of the tested transaction under review, in certain cases, additional quantitative screening criteria are also applied to yield a more accurate set of comparables. This mainly includes the application of different financial ratios such as R&D expenditure sales, intangible-asset sales, inventory sales, or property, plant and equipment sales.

The next step is a qualitative screening, which focuses on examining the business descriptions of all remaining companies and then establishing a set of comparable companies.

The Regulations do not provide a reference to a specific number of comparables required for the establishment of interquartile range results. In our opinion, between 10 and 20 comparables should suffice, with the minimum being around five.

Regarding the locations of selected comparables, local (Israeli) comparables are preferred but are not often available. Practice has shown that the use of European or US comparables is also accepted by the ITA, as well as global benchmarks, as long as applicable adjustments were made (when required). However, this is examined on a case-by-case basis.

ii Authority scrutiny and evidence gatheringTax scrutiny

There is a dedicated Transfer Pricing Department (TPD) within the ITA, which is responsible for performing audits and economic analyses to determine the arm's-length price for a taxpayer's transactions. Furthermore, the TPD has been given full authority to review (and tax) previously approved assessments and to reopen final assessments that were approved up to three years before their inspection. The TPD also gives guidance and instructions to local tax AOs to screen and initiate audits on a wider level. In the event of an audit by a local tax AO, certain disagreements may be handed over to the TPD.

In Israel, the tax authorities' transfer pricing unit audits both Israeli subsidiaries of multinational enterprises (MNEs) and local corporations in all matters related to transfer pricing. Taxpayers can dispute the proposed transfer pricing adjustments of the tax authorities by means of appeals, courts and through the use of treaties (where relevant).

Signing the MCAA for CbCR may indicate the ITA's intention to implement a global tax position when assessing profit attribution among companies in a multinational corporation.

Owing to the nature of the Israeli market, the ITA gives special attention to R&D services provided by Israeli subsidiaries and matters relating to intangibles, which may also involve governmental support. The ITA also focuses its audits on the restructuring of FAR and on the distinction between marketing services and distribution activities carried out in Israel by MNEs.

Evidence-gathering process

The ITA does not usually interview persons outside the company undergoing an audit, although this is not prevented by legislation. It is common, however, to allow the professionals, who act as consultants to the company, to be interviewed by the ITA with regard to their work and to present them to the ITA as part of a 'hearing' held for the company. These meetings occur both prior to and following the issuance of a transfer pricing tax assessment.

With regard to intra-group information requirements, the ITA may request intra-group information even if it is held outside Israel. If the company fails to present the requested information, it is likely to be viewed negatively throughout the process, including (potentially) in court, thereby preventing the company from providing the information at a later stage.