Israeli Transfer Pricing Regime

Dr. Avi Nov, Adv.

April 2009

Section 85A of the Israeli Tax Code provides that every international transaction between related parties must be set according to the arms length principal (the fair market price). Rules introduced in 2006, based on both the OECD 1995 transfer pricing guidelines and the U.S main principals, determine the necessary means for achieving the fair market price of the inspected transactions.

Setting the fair market price

Section 85A of the Israeli Tax Code states that, “[i]n an international transaction where there are special relationships between the parties ... and less profit was derived under the circumstances than if the price or conditions were agreed between unrelated parties (market conditions), the transaction will be reported according to the market conditions.”

Section 85A(b) of the Israeli Tax Code defines "related parties" as:

"[i]ncluding relations between a person (including an entity) and its relative, and the control of one party by the other, or the control of one person by the parties to the transaction, directly or indirectly, alone or with another".

"Control" is defined as "holding, directly or indirectly, 50% or more in one of the indicators of control".

An indicator of control is defined as:

• the right to profits;

• the right to appoint directors or the general manager or other similar positions;

• the right to vote in the general shareholders' meeting;

• upon liquidation of the company, the right to a share in the equity after all debts are paid; or

• the right to determine which party will have one of the above-mentioned rights.

A relative is defined as "a spouse, sibling, parent, parent of a parent, offspring, spouses' offspring and the spouse of each of these".

In order to establish whether an international transaction conducted between related parties is set at a fair market price, research must be carried out whereby the related party transaction is compared to similar market transactions by particular comparison methods.

Transfer Pricing Regulations

The Regulations define an “International transaction", as a transaction that is the subject of the examination and in which all these exist:

(1) The transaction was made between parties all or some of which have special relationships between them;

(2) One or more of the parties to the transaction is a non-resident, or the income from the transaction, in whole or in part, is income that is taxable outside of Israel as well;

The Income Tax Regulations (Assessing Market Conditions) 2006 oblige the taxpayer, who is party to an international transaction, file a form annexed to its annual tax report submitted to the Israeli tax authority (“Form 1385”).

In the 1385 form, the taxpayer must report the execution of the international transaction, its actual conditions and price thereof as well as the conditions and price of the transaction at fair market price.

The 1385 form must be signed by an officer of the company, who declares that the company is compliant with the arm's length principle and that it maintains contemporaneous transfer pricing documentation.

The Regulations do not apply to a one-time international transaction that has been approved by the assessing officer as a one-time international transaction, and the transaction will be reported as if the price or terms, as applicable, had been determined between parties among which special relationships do not exist.

The Israel Tax Authority Guidelines

The Israel Tax Authority published a Circular on Transfer Pricing (Circular 3/2008 of July 14 2008). In this Circular, the Israel Tax Authority states that transfer pricing documentation is required to be prepared to support the arm’s length nature of international related party transactions.

According to the Israel Tax Authority, taxpayers are required to disclose certain transactions that may be regarded as aggressive tax planning. Such transactions include:

• Cross border payments that exceed NIS 2 million for management services provided by a related entity;

• The sale of assets to a related entity that resulted in a loss to the selling entity; and

• Debt relief of over NIS 1 million to a related entity.