Money cash Shekels currency 521.
(photo credit: Reuters)
In 2012, the government spent NIS 39 billion more than it took in, mostly
because the slowing economy meant fewer tax revenues. This was double the
expected deficit. Now the general election is over, and the new government must
produce a budget for 2013 that benefits the people but balances the books. This
is a tall order; can it be done? It will be tempting to mortgage the expected
future gas-tax revenues.
Another way of raising state revenues
prudent approach might be to take a look at Britain, which has its own deficit
and has pinpointed one of the root causes.
According to the British
Parliament’s website, MP Margaret Hodge, chair of the Committee of Public
Accounts, said on December 3: “Corporation tax revenues have fallen at a time
when securing proper income from taxes is more vital than ever... The
inescapable conclusion is that multinationals are using structures and
exploiting current tax legislation to move offshore profits that are clearly
generated from economic activity in the UK... We consider that paying an
appropriate amount of tax in the country in which profits are made is not only a
matter of basic economics. It is also a matter of morality... there is a moral
case on top of the basic economic case that taxation of economic activity should
transparently reflect where that activity occurs.”
And British Prime
Minister David Cameron reportedly told the G-8 earlier this month: “We all have
a common interest in being able to tell our taxpayers, who work hard and pay
their fair share of taxes, that we will make sure others do the
The importance of transfer pricing
The above brings us to a
subject known as “transfer pricing.”
Most international trade is done via
For example, if an US corporation wants to sell
widgets to Israelis, it will do well to set up an Israeli subsidiary corporation
that employs Israelis to sell the widgets to other Israelis. They will share the
same language and culture and be on the same time line.
But first the US
producer must sell the widgets to the Israeli subsidiary at a “transfer price”
that is a market-based “arm’s-length” price. This is a theoretical requirement
in most countries’ tax laws that applies to most global trade.
But it is
easier said than done as many factors affect market pricing, such as quality,
credit terms, functions needed in each country, whether a premium is due for
know-how or use of a brand name, inventory risks, currency risks,
How are transfer prices arrived at?
In practice, a multinational
corporation will from time to time conduct a “transfer-pricing study” to
determine what is a fair transfer-pricing policy. This involves seeing what
other corporations charge and/or how much profit they make from comparable
transactions. If the multinational corporation applies Israeli transfer-pricing
rules, it is allowed to use any transfer price falling within a range of prices
from comparable transactions, but it must merely ignore the top 25 percent and
the bottom 25% of those comparable transactions. (This is known as the
“interquartile range.”) So transfer pricing is more of an art, not a statistical
science, and there is a lot of wiggle room. Most multinationals will set their
transfer prices in a way that: (a) optimizes their tax planning, and (b) avoids
trouble with tax authorities that are awake and alert to these possibilities
(for example, the United States).
So Britain has just woken up to
transfer pricing, but Israel has not. The transfer-pricing unit at the Israel
Tax Authority has a handful of personnel who can only do what they can do. Few
know they even exist.
How much tax is at stake?
There is little
information on how much is at stake, but it is possible to make a rough
estimate. Israeli exports totaled $90 billion (not shekels), and imports totaled
$93b. in the year to September 2012, according to the latest data from
the Central Bureau of Statistics. So Israel’s trade with the rest of the world
amounts to about $183b. a year.
Suppose, hypothetically, the transfer
prices could have been on average 25% more in Israel’s favor applying Israeli
transfer-pricing tax rules (anecdotal evidence suggests this might be possible).
That would imply additional Israeli-source corporate profits of $45b., liable to
25% company tax in many cases, resulting in $11.4b., or NIS 42b., more tax for
Israel. Hey Presto! This is only an estimate subject to assumptions.
Nevertheless, even some of that would go a good way toward painlessly plugging
Israel’s budget deficit, until the gastax revenues arrive and
If your business has an international
dimension, make sure you have a transfer-pricing study in case you are asked
about your pricing policy.
As always, consult experienced tax advisers in
each country at an early stage in specific cases.
Harris is a certified public accountant and tax specialist at Harris Consulting
& Tax Ltd.