by Jacky Houlie & Shlomo Hubscher, JH & Co. Law Office, Tel Aviv-Yafo, Israel
The Israeli tax authority today published important transfer pricing circulars addressing the characterization and selection of the most appropriate method for distribution, marketing, and sales activities and introducing safe harbors for low value-adding intra-group services, low risk distribution, and marketing support activities.
Circular 11/2018
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,” describes how to analyze multinational group activity and identify the most appropriate transfer pricing method for determining arm’s length remuneration attributed to a local [Israeli] company out of the group’s total business activity.
According to the circular, the Israeli tax authority based its specifications on experience acquired over the years while implementing transfer pricing 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 Israeli tax authority specifies approaches that emphasize the analysis of functions, risks, and assets with regard to local operations – whether low-risk distributors or high-risk, full-fledged distributors.
The Israeli tax authority emphasizes that the circular does not intend to discuss the existence, or lack thereof, of a permanent establishment.
In addition, this circular is not intended to apply to economic activity arising from web-related trading and activity (i.e. digital economy).
Circular 12/2018
In parallel to the above, the Israeli tax authority published Circular No. 12/2018: Transfer Pricing – Profitability Rates and Ranges for Certain Transactions.
This circular offers transfer pricing 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 Israeli tax authority adopts Section 7.61 of the OECD transfer pricing guidelines initiated in the OECD/G20 Base Erosion and Profit Shifting (BEPS) guidance, Action 10.
To this end, the OECD guidelines specify: (i) a simplified process to test the 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 Israeli tax authority states that the low value-adding intra-group services safe harbor applies in the event that the operating margin 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 circular states that the safe harbor applies to a low risk distribution 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 using the safe harbor stipulated in this circular will not be exempted from conducting a detailed functions, assets, risk 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-determined).
The circular 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.
–Jacky Houlie, LL.M, is Founder and Managing Partner at JH & Co. Law Office. He can be reached at [email protected] or phone: +972-52-851-2569.
–Shlomo Hubscher is a partner at JH & Co. Law Office. He can be reached at [email protected] or phone: +972-52-600-6804.
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