Taxing authority and tax law
Tax authority: Israeli Tax Authority (ITA)
Tax law: Income Tax Ordinance §85A and Income Tax Regulations (Determination of Market Terms), 2006
Relevant regulations and rulings
The ITA Income Tax Regulations (Determination of Market Terms) were drafted pursuant to §85A of the Israeli Income Tax Ordinance. Final regulations were adopted in November 2006. The Israeli Transfer Pricing (ITP) Regulations apply to all international intercompany transactions. The Regulations apply to all transactions carried out subsequent to their validation on 29 November 2006. The ITP Regulations are based upon a combination of the OECD Transfer Pricing Guidelines and the US Transfer Pricing Regulations.
Taxpayers are required to comply with the proper timing for the submission of documentation (i.e., 60 days from official demand of a tax inspector), which shifts the burden of proof to the tax authority if the prices do not appear to be at arm’s length.
As a transitional provision, for tax years 2007 to 2008, a transfer pricing study documented prior to the publication of the ITP Regulations will be accepted for a period of two years upon their publication provided that the documentation was conducted based on the OECD guidelines or guidelines published by its members (e.g., the US).
The ITP requires that, commencing with tax year 2007, Israeli annual tax returns include a form (Form 1385), specific to transfer pricing, that delineates the intercompany transactions, details of the other party and its residency, the price of the transactions and signatures on declarations that the international intercompany transaction is at arm’s length. According to the tax authority such declaration must be supported by benchmark analysis
OECD guidelines treatment
The ITA considers its transfer pricing rules and regulations to be fully consistent with the OECD guidelines and the US Treasury Regulations under §1.482. For domestic use, the OECD guidelines do not provide support and would not be directly relevant to the application of any pricing methods. However, an arm’s length study documented prior to the publication of the ITA Regulations will be accepted for a period of two years as of the Regulations’ publication provided that the documentation was conducted based on the OECD guidelines or guidelines published by its members.
Priorities/pricing methods
To determine whether an international transaction is at arm’s length terms, the ITP Regulations require the taxpayer to apply one of the following methods in the following hierarchy:
- CUP or Comparable Uncontrolled Transaction (CUT)
- Comparable profitability
- Cost Plus or Resale Price method
- CPM or TNMM
- Profit Split Method
- Other methods
An international transaction is at arm’s length if through the application of an approved method, the result falls within a defined interquartile range. As an exception, the entire range of values will apply when the transfer pricing method applicable is a CUP or CUT, and no adjustments were performed. If the international transaction is outside the range of comparable transactions, the median should be applied as the transaction’s price.
Additionally, the ITP Regulations stipulate the use of several profit level indicators (PLIs) depending on the particular industry and environment. For example, when appropriate, the following PLIs may apply:
- A cost-plus mark-up may be applied to a company’s direct costs
- A gross profit margin may be applied
- The operating profit or loss applicable for comparable transactions
- The profit or loss derived as a proportion of the firm’s assets, liabilities or capital
- Other measures considered appropriate under the circumstances
Transfer pricing penalties
The ITA has not currently specified any penalties with regards to its transfer pricing regulations. However, general tax penalties applied by the ITA, with regards to a tax deficit, will also apply on transfer pricing adjustments.
Penalty relief
No penalty relief regime applicable.
Documentation requirements
A taxpayer is required to file a transfer pricing report with the Tax Assessing Officer, at the Tax Assessing Officer’s request, within 60 days from the application date. Documentation is required to include the following data:
- Details of the taxpayer, including group structure, the parties to the international transaction, their residency and any special relations between the taxpayer and the other transaction parties
- The contractual terms, including specifications of the asset, the service granted, the price paid, the loan and credit terms and related guarantees
- The taxpayer’s area of activity and any relevant developments
- The economic environment in which the taxpayer operates and the related risks
- Details of all transactions entered into by the taxpayer with a related party
- An economic analysis
The taxpayer is also required to attach additional documents that corroborate the data submitted, such as transaction contracts and any other contracts between the related parties and tax returns filed with foreign tax authorities.
Documentation deadlines
A taxpayer is required to file a transfer pricing report with the Tax Assessing Officer, at the Tax Assessing Officer’s request, within 60 days of the application date.
Form 1385 should be attached to the annual tax return. The ITA has published Tax Circular 3/2008 where they stressed their opinion that this form must be backed with a benchmark analysis. Under this interpretation the deadline equals the timetable of the tax return.
Statute of limitations on transfer pricing assessments
The Israeli Income Tax Ordinance has general rules for auditing a tax return. As such, the statute of limitations is usually three years (or four if the commissionaire extends the time period) beginning at the end of the fiscal year tax return was filed.
Return disclosures/related-party disclosures
Commencing with the fiscal year ending 2007, taxpayers must attach to the annual tax returns a specific transfer pricing form (Form 1385), in which the following should be disclosed:
- a short description of the intercompany transaction details of the other party and its residency
- the prices of the transactions
- signatures on declarations that the international transactions were at arm’s length
Audit risk/transfer pricing scrutiny
Medium Risk: The risk of transfer pricing scrutiny during a tax audit has increased exponentially following the issuance of the ITP Regulations and Form 1385. Transfer pricing will now be monitored with greater regularity and with increased ITA experience. In order to cope with the changing transfer pricing climate in Israel, the ITA has established a new division to enforce and regulate the ITP Regulations.
There is a growing emphasis on transactions involved with intangible assets and on July 2010 the ITA published an internal opinion instructing the assessing officers how to deal with post acquisition integration and IP migration following such restructuring.
APA opportunity
Section 85A of the Israeli Income Tax Ordinance, which governs the ITP Regulations, stipulates in article 85A(d) the condition under which an APA may be conducted and delineates the scope of an APA. The process starts with a detailed application filed by the taxpayer that includes all the relevant details. Under the APA process, the ITP must respond within 120 days (though the time can be extended up to 180 days) otherwise the application will be approved automatically, and the intercompany policy will be deemed as providing reasonable arm’s length prices.
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