Israel's proposed tightening of transfer-pricing rules – opinion

To prevent shenanigans, the TP policies applied within multinational groups in Israel and most other countries should be set on arm’s-length (market) prices and terms.

Calculating taxes (photo credit: INGIMAGE)
Calculating taxes
(photo credit: INGIMAGE)
The Israeli government has just published proposed legislation and regulations to tighten up Israeli transfer-pricing rules in line with OECD requirements. This is important for all multinationals with a link to Israel.
Transfer pricing (TP) refers to the price of goods and services charged between related companies in multinational groups. Much international trade is conducted via multinational groups. For example, a US supplier might have an Israeli subsidiary staffed by Hebrew speakers who know the local Israeli culture.
To prevent shenanigans, the TP policies applied within multinational groups in Israel and most other countries should be set on arm’s-length (market) prices and terms.
Israeli TP regulations are a hybrid between OECD transfer-pricing guidelines and US regulations according to Section 482 of the Internal Revenue Code.
In 2015, the OECD published a report known as “Action 13: Transfer Pricing and Country by Country Reporting,” which aimed to tighten up TP rules internationally. Now Israel is proposing to add elements of the recommendations in Action 13 to its own TP regulations. Israel joined the OECD in 2010.
In the last few years, the Israel Tax Authority (ITA) has been reviewing the transfer pricing of multinationals and has even initiated litigation, e.g. regarding intellectual property (IP) stripped out newly-acquired Israeli companies. What’s in the latest Israeli transfer pricing proposals?
Files and reports
The Israeli TP rules are being amended to fit in with OECD rules that want to see: a local file regarding operations at the local Israeli level; a master file regarding the group as a whole in more general terms; and for larger Israeli groups a Country by Country (CbC) report.
In particular, the ITA wants TP studies (which check transactions are on arm’s-length terms) to reveal information with tax-planning significance. In practice, some of this information is already provided because TP studies are international in nature and other countries already require it.
SUCH INFORMATION would include the following.
At the local Israeli level:
• Description of the organizational structure
• Details of position holders to whom the Israeli company reports
• Actual or anticipated changes in ownership and control
• Main competitors
• The “background for doing” international related-party transactions
At the international level:
• Ownership
• Drivers of growth in the international group
• Supply chains accounting for more than 5% of group revenue
• Inter-company service agreements
• Value contributed by each entity in the group
• Changes in ownership and control
• IP development and holding policy, IP inter-company agreements and inter-company IP transfers in the year concerned
• Inter-company finance activities and services
• Description of the policy for “steering business activities” of the group
• Group financial statements
• Tax rulings issued to group entities;
Israeli companies will now be required to provide TP studies and information “upon demand” rather than within the 60 day period stipulated until now.
Country by Country (CbC) reports
To make it even easier for the ITA to know what a multinational has or does outside Israel, it is proposed to require larger groups to file copies of CbC reports filed by ultimate parent companies, if they are not already available under international information sharing arrangements.
These reports are identical to the CbC report contained in the OECD’s Action 13 report. And Israeli groups with annual revenue over NIS 3 billion will be required to file such CbC reports in English for the ITA to read and share with other tax authorities.
It remains to be seen what is finally enacted and when. Nevertheless, multinationals are advised to prepare now. Transfer-pricing loose ends can lead to double taxation.
A key issue is in what circumstances the ITA is allowed to make transfer-pricing adjustments to reported income. This issue emerged in the recent Broadcom case.
The draft legislation proposes that if the taxpayer has submitted to the ITA documents, reports and data as required by the TP regulations, the ITA bears the onus of proof if it wants to assess differently from the amounts agreed between the (related) parties.
The proposed regulations also clarify that broad TP documentation will need to be prepared annually and available upon demand by the ITA. Until now, this was not always done annually, and was often only a “mini study.”
The ITA may be expected to focus on IP and finance arrangements, to make sure that income is taxed where value is generated by people, not offshore, for example.
New OECD proposals regarding automated digital operations and e-commerce trade over the Internet are apparently not addressed in the proposals. The OECD is also thought to be developing tougher CbC rules.
As always, consult experienced tax advisers in each country at an early stage in specific cases.
The writer is a certified public accountant and tax specialist at Harris Horoviz Consulting & Tax Ltd. [email protected]