Sept 5, 2018 ~ Israeli tax authorities have published final versions of two professional Circulars regarding transfer pricing issues of great importance for MNE's operating in Israel through a related local company.
Circular 11/2018 “Appropriate TP Methods for Distribution, Marketing and Sales Activities Multinational Groups in the Israeli Market”
The Circular considers certain typical international auxiliary group activities and identifies transfer pricing methods acceptable to determine the proper remuneration - for tax purposes - of the business activity attributed to the local Israeli group company. Instructions are given as to the selection of the most appropriate TP methods for distribution, marketing, and sales activities in Israel and introduces certain safe harbors for modest-value intra-group services, such as low risk distribution and marketing support.
The basis of the Circular is ITA's on-hands experience gained over the last couple of years paired with transfer pricing methodologies of the OECD guidelines. Where classifying marketing and distribution activities, and in particular making distinction between marketing support activity and distribution activity, the Israeli tax authority prefers approaches which require the analyzing of “functions”, “risk”, and “assets” that may be attributed to the Israeli operations – whether low-risk or high-risk full-fledged distribution.
The Circular does not discuss when a “permanent establishment” exists as a result of the activities in Israel; this remains a separate matter for discussion on a case per case basis. Circular 11/2018 has not been intended for web-related trading and activity (“digital economy”).
Circular 12/2018 “Transfer Pricing – Profitability Rates and Ranges for Certain Transactions”.
This Circular, in particular, provides a long-awaited, certain, TP safe harbor and alleviates TP reporting requirements with respect to income from certain activities and services for a foreign related company by an Israeli tax payer.
ITA adopts – regarding low value-adding intra-group services - Section 7.61 of the OECD transfer pricing guidelines of OECD/G20’s Base Erosion and Profit Shifting (BEPS) guidance, as initiated in BEPS Action 10. Israel follows OECD guidelines which require (a) a simplified process to test the benefit of the service, (b) a two-step process for determining cost pool, (c) building consistent allocation keys and (d) a standardized profit mark-up of 5% of the relevant costs. The intended "mark-up” would be effective on “direct and indirect expenses, including expenses relevant in accordance with generally accepted accounting principles, including those of employee options”.
As to “marketing support services”, discussed in detail in Circular 11/2018 above, ITA applies the safe harbor of this Circular 12 on low value-adding intra-group services when operating margin resulting from the marketing support services ranges from 10%–12% of the total expenses incurred in provision of the service (markup on total costs). The safe harbor would apply to a low risk distributor and operational profitability should be deducted from total sales turnover in the markets, where the Israeli entity runs the distribution activity, multiplied by 3%–4%. These profitability rates as now published for low value-adding services may be re-examined from time to time and may occasionally be updated.
Companies that report results from such activities using the safe harbor stipulated in this Circular will not be released from conducting a detailed analysis of “functions”, “assets” and “risk” analysis or from the documentation requirements as in the Israeli Transfer Pricing Regulations. The relief granted is an exemption from having to present a full economic analysis of the relevant intercompany transaction.
The above Circulars are of importance in particular for foreign groups maintaining a related company providing auxiliary support in Israel.
For more information, please contact Henriette Fuchs