Today, September 5, 2018, the Israeli Tax Authorities (“ITA”) published two new circulars regarding Transfer Pricing (“TP”).
Circular 11/2018
The first circular is entitled “Circular 11/2018: Determination of the Appropriate TP Method for Activities Related to Distribution, Marketing and Sales of a Multinational Group within the Local [Israeli] Market”.
The purpose of this circular is to specify the manner of identifying and analyzing the activity and the most appropriate TP method for determining the arm’s length remuneration attributed to the local [Israeli] company out of the Group’s total business activity. According to the circular the ITA bases such specifications on the experience it has acquired over the years, while implementing TP methodologies addressed in the OECD Guidelines.
This circular consists primarily of general concepts. However, in an attempt to accurately classify marketing and distribution activities, in particular to make a distinction between marketing support activity and distribution activity, the ITA specifies herein approaches that emphasize the analysis of functions, risks and assets (“FAR”) with regard to local operations – whether low-risk distributors (“LRD”) or high risk Full Fledged Distributor. It is indicated that it is not intended to discuss the existence of a permanent establishment. In addition, this circular is not intended to apply on economic activity on web-related trading and activity (i.e. digital economy).
Circular 12/2018
In parallel to the above, the ITA published another circular, entitled “Circular No. 12/2018: Transfer Pricing – Profitability Rates and Ranges for Certain Transactions.”
This circular offers “safe harbors” and alleviates the reporting requirements with respect to certain activities and services granted by an Israeli party to a foreign related party.
With regards to ‘Low Value-Adding Intra-group Services’, the Israel Tax Authority adopts Section 7.61 of the OECD Guidelines (and initiated in the Base Erosion and Profit Shifting [“BEPS”] guidance, Action 10). To this end, the OECD Guidelines and BEPS specifies: (i) a simplified process to test benefit of the service, (ii) a two-step process for determining the cost pool, (iii) the construction of consistent allocation keys and (iv) a standardized profit mark-up of 5% of the relevant costs. As per the language of this circular, the stated profit mark-up would be effective on “direct and indirect expenses, including expenses that should have been required in accordance with generally accepted accounting principles, including employee options”.
With regards to the marketing support services discussed in detail in Circular 11/2018, the ITA states that the ‘safe harbor’ applies in the event that the operating margin (“OM”) resulting from the marketing support services ranges from 10% – 12% of the total expenses incurred in providing the service (i.e. markup on total costs).
With regards to distribution activity, the ITA states that the ‘safe harbor’ applies to a low risk distribution (LRD) model and operational profitability equals the total sales turnover in the markets, in which the Israeli entity undertakes distribution activity, multiplied by 3% – 4%.
It should be emphasized that companies that report on the results of the said activities in Israel according to the ‘safe harbor’ stipulated in this circular will not be exempted from conducting a detailed FAR analysis and / or from the documentation requirements stipulated in the Transfer Pricing Regulations of Section 85A of the Israeli Tax Ordinance. The only formal relief granted in this case is an exemption from presenting a full economic analysis to support the arm’s length nature of the intercompany transaction (since such has been pre-determine).
The ITA notes that the stipulated profitability rates for each type of Low Value-Adding service will be examined from time to time and may be updated in the future.