Changes ahead for Israel in TP, master file and country-by-country reporting
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Changes ahead for Israel in TP, master file and country-by-country reporting


Eyal Bar-Zvi of Herzog Fox & Neeman Law Offices explains why the burden of transfer pricing documentation will grow as taxpayers are required to submit further documentation, reports and data to comply with the new documentation requirements.

Israel’s transfer pricing (TP) regime is regulated under Section 85A (Section 85A) of the Israeli Tax Ordinance (the Ordinance), which came into effect on November 29 2006 and applies to corporate tax. Guidance regarding TP is provided in several tax circulars issued by the Israel Tax Authority (ITA).

At the time of writing, several material changes are expected, including regarding adopting the country-by-country reporting (CbCR) and master file concepts, as well as requirements for further information to be included in the study (local file).

The regulations promulgated under Section 85A (the regulations) adhere to the arm’s length principle and incorporate the approach taken in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the OECD Guidelines), issued in 2017, and the approach taken in Section 482 of the US Internal Revenue Code (Section 482) towards determination of the correct analysis methods for examining an international transaction between related parties. It should be noted, however, that certain tax circulars offer a ‘safe-harbour’ mechanism with specific margins.

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 No. 1485 must be filed.

In practice, this means that taxpayers in Israel are expected, and in fact required, to hold up-to-date TP documentation, which includes (at a minimum) a TP study and an inter-company agreement relevant for the fiscal year. The regulations detail the sections that must be included so that a study would be considered compliant.

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 NIS 150 million ($45 million) 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. Finally, it is expected that Form 1385 will be updated to require master file and CbCR related declarations.

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

–Intangible assets – DEMPE

The matter of valuing intangible assets with a focus on DEMPE functions has been ‘on the table’ for the ITA in recent years, mainly with regard to the exploitation of R&D originating in Israel and R&D subsidiaries established in Israel by foreign entities.

According to ITA officials, DEMPE is one of the matters considered by the ITA when auditing a TP case, but not necessarily the only one. Moreover, these aspects were relevant to ITA audits even before BEPS. In addition, on several occasions, the ITA has noted that it intends to adopt the recommendation promulgated under the BEPS Actions 8–10, with respect to intangibles. Therefore, because of the extensive R&D functions carried out by Israeli companies, it is expected that Israeli tax practitioners will conduct their inspections of transactions involving intangibles in accordance with the DEMPE and new hard-to-value-intangibles (HTVI) rules, with greater emphasis regarding the attribution of profits based on value creation. An ITA circular on this topic is expected in the near future.

Recent developments – Israeli Tax Authority Circulars

Expected circulars

The ITA has recently held round-table talks (in which the author’s firm is the only law firm participating) on expected draft circulars, including in the fields of implementation of development, enhancement, maintenance, protection and exploitation of intangibles (DEMPE) analysis; profit split over cost plus for R&D centers; profits associated with management functions and the incorporation of master file and CbCR.

Tax Circular 1/2021

Tax circular 1/2021 addresses the ITA’s views on the tax treatment applicable to recharge payments relating to grants of stock-based compensation (ESOP) in multinational groups. Recharge payments are costs assumed by a foreign issuing company in connection to vested equity compensation that are granted to employees of an Israeli affiliated company (i.e. employing company). These recharge payments are charged by the issuing company to the employing company.

The ITA sets forth in the Circular its views as to when recharge payments should be treated as a dividend (or capital reduction), which is generally subject to tax withholding, and when such payments can be treated as reimbursement of expenses to the issuing company, which are not subject to withholding tax.

Tax Circular 1/2020

In accordance with Tax Circular 1/2020, the filing of a TP study, in and of itself, does not shift the burden of proof from the taxpayer to the ITA in cases where there is a disagreement on the factual background or on the method chosen, or when the submitted TP study is incomplete.

It is important to state that the position of Tax Circular 1/2020 is that where the ITA rejects the TP study filed by the taxpayer based on the foregoing, or where the taxpayer has not filed a TP study at all, the results will be the same, and the ITA can, inter alia, set the tax assessment without the need to provide a complete study on its behalf. While the ITA inspectors cannot set this arbitrarily, they can base such assessment upon their general experience and past assessments, as well as upon estimations. Additionally, the ITA inspectors may impose fines on the taxpayer.

Tax Circular 15/2018

On the basis of the Gteko court ruling (6 June 2017) and the OECD Guidelines, on 1 November 2018, the ITA published Tax Circular 15/2018 dealing with business model restructuring by a multinational enterprise (MNE), and involving the FAR (functions, assets and risks) associated with the Israeli subsidiary of an MNE.

The Circular presents the ITA’s position with respect to business restructuring, defines ways for identifying and characterizing business restructurings, and offers methodologies that are accepted by the ITA for valuation of transferred, ceased or eliminated FAR commonly involved in the course of a business restructuring (e.g. intangibles, skilled work force). With regard to each FAR transferred in a business restructuring, the Circular sets guidelines for the characterisation of a FAR transfer as a sale transaction or a ‘grant of temporary-usage permit’ transaction, for classifying it as a capital or ordinary income transaction.

Tax Circulars 11/2018 and 12/2018

On September 5 2018, the ITA published two circulars, Tax Circulars 11/2018 and 12/2018, setting out its approach towards classification and TP methods appropriate for use in connection with certain inter-company transactions between an Israeli entity and related overseas parties that are part of a multinational group.

“Several changes are expected, including regarding adopting the CbCR and master file concepts, as well as requirements for further information to be included in the study (local file).”

The Circulars focus on inter-company transactions involving marketing services or sales and, in particular, on the approach to be used to classify a given entity as either a marketing services entity or a sales (distributor) entity. In addition, the ITA opined on how to choose the most appropriate TP method, as well as which ranges of profitability (safe harbours) it sees as appropriate for these types of Israeli entities.

Taxpayers submitting reports in accordance with the approach outlined in Circular 11/2018, and whose results fall within the safe harbours provided under Circular 12/2018, would be exempt from the requirement to provide benchmarking support for the assertion that the transfer prices used are in accordance with market pricing. Nonetheless, the Circular does not otherwise provide an exemption from the existing requirement to prepare TP documentation.

Recent litigation

TP cases are rarely adjudicated in court in Israel. Since the adoption of the regulations, very few TP cases have been submitted to the courts, with most cases being settled with the ITA out of court.

Barzani case

In the recent Barazani case, the Jerusalem District Court dealt with the distinction (and the different tax treatment) between a ‘capital note’ and an inter-company loan, which was provided by an Israeli parent company to its foreign subsidiaries.

The District Court ruled in favour of the ITA, accepting its approach that in the case at hand, the inter-company financing arrangement did not qualify as a capital note, resulting in deemed interest income for the Israeli parent company and, in addition, a deficit fine.

To qualify as a ‘capital note’, the court determined that the terms and conditions of the note must be decided on and documented in advance to show that the note meets the said requirements (e.g. duration not less than five years, does not bear interest and is subordinated to other debts). Furthermore, the mere use of the title ‘capital note’ is not sufficient if the document does not meet the essential conditions described above.

Important takeaways from those court rulings are the facts that the court was somewhat reluctant to take a retroactive TP study into consideration long after the date on which it was supposed to be in place and thus may not have correctly reflected the regulations. The court was also reluctant to accept results that were not segmented properly. Additionally, the court rejected the inter-company agreement between the parties since this did not abide by the requirements of the regulations and the OECD Guidelines.

Gteko case

A court ruling in the Gteko case (June 2017) concerned the tax implications of changing a business model and the transfer of activity and assets from Israel abroad between related parties. The main dispute in the Gteko case concerned the scope of the transfer transaction that legally referred to the transfer of IP only and to the market value of the assets sold under the transfer while not referring to the value of the Israeli operations as reflected in an earlier Share purchase.

In light of the specific circumstances of the case, and in accordance with TP regulations incorporated in Section 85A, the court ruled in favor of the ITA and determined that the IP transaction is greater in its scope and equals the sale of the entire activity of Gteko to Microsoft (US) (subject to certain adjustments). Therefore, the transaction should be taxed accordingly, with the starting point for determining the market value for the IP Transaction being the consideration paid in the Share Transaction.

Broadcom case

Another case of business restructuring ruled by the district court was the Broadcom case, which dealt with the classification of a business restructuring concerning a post-acquisition set of agreements that included the license of intellectual property (IP) in return for royalty and the provision of R&D, marketing and technical support services on a cost-plus basis, provided by the acquired Israeli company to its US parent and other group entities.

The court ruled in favour of the taxpayer and decided that the change of business model does not necessarily lead to the conclusion that the company essentially sold its assets. The general claim of the ITA according to which any business restructuring and change in the composition of FAR results in a capital gain requires a careful analysis and comparison of pre- and post-FAR, and is not automatic.

The implications of this ruling can be very significant for multinationals acquiring Israeli technology companies and performing a business restructuring thereafter. In the Broadcom case, the court also referred to the burden of proof issue, which later led to Tax Circular 1/2020 described above.

The court ruled that in cases where there is a disagreement concerning the factual background of the intercompany transaction under assessment, the burden of proof remains with the taxpayer and not the tax assessment officer, as the taxpayer has the full knowledge to justify the facts relating to the assessed transaction. This is relevant in cases where the tax assessment officer reclassifies the form of the transaction or otherwise questions the nature of the transaction or the method applied.

Additional TP issues

Tax challenges arising from digitalisation

Currently there is no update on whether Israel will adopt the OECD’s pillar one and pillar two blueprints and apply a minimum standard. Nevertheless, Israel monitors any updates concerning this issue.

TP implications of COVID-19

Israel has not issued any guidelines concerning the implication of the COVID-19 pandemic on TP. In general, Israel follows the OECD Guidelines and may also adopt recommendations promulgated under the OECD Guidance on the TP implications of the COVID-19 pandemic.

Double taxation

Double taxation would seem to be unavoidable in cases where another jurisdiction has taxed the company on account of TP issues. For example, in the event a related party in a foreign jurisdiction is characterized as a permanent establishment, or accused of having inadequate TP documentation or failing to implement it, the foreign jurisdiction will tax it accordingly and the ITA will not take this into consideration, which will result in double taxation. Nevertheless, a MAP process is available where applicable.


Eyal Bar-Zvi, the author, recently participated in discussions, on behalf of the Israeli Bar, with the Finance Committee of the Knesset (the Israeli Parliament) with respect to the amendment of the Ordinance, as well as to the regulations, specifically regarding the implementation of the master file and CbCR concepts and reporting obligations in Israel, as well as with regard to additional amendments to the current requirements.

Key takeaways from the aforementioned discussions include shortening the period of time required to submit TP documentation to the ITA, upon request, to 30 days, as well as establishing some required sections in the classic TP documentation, either similar to or adapted from the requirements in the OECD.

Further, the Finance Committee is looking to incorporate master file and CbCR requirements, effective of FY 2022 onwards. The master file thresholds will be NIS 150 million while the CbCR threshold will be NIS 3.4 billion.

Herzog Fox & Neeman Law Offices will be available to expand upon the Knesset discussions and assist with any queries that may arise.

The author wishes to thank Ari Siff and Yossi Shebson for their contributions to this article.

Click here to read all the chapters from ITR's TP Special Focus

Eyal Bar-Zvi



Herzog Fox & Neeman Law Offices

T: +972 3 692 2020


Eyal Bar-Zvi is head of the TP department at Herzog Fox & Neeman. He has over 15 years of experience in drafting, negotiating and defending TP documentation, TP studies and intercompany agreements, and he often participates in TP due diligence processes as part of mergers and acquisitions involving Israeli companies.

Eyal represents both foreign and Israeli companies in their audits in Israel and abroad, and often lectures at the Institute of Certified Public Accountants in Israel on matters related to TP.

Eyal is currently participating in the think tanks of the TP department of the Israel Tax Authority on issuing further circulars on matters relating to, inter alia, DEMPE analysis and the digital economy, and participates in the legislation process. He has published numerous articles on those subjects, both online and offline, and is also an adjunct professor at the University of Haifa Faculty of Law, where he leads workshops on TP.

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