New Israeli transfer pricing guidance addresses business restructuring

By Jacky Houlie, JH & Co. Law Office & Shlomo Hubscher, JH Consulting Ltd.

Israel is often referred to as the “Startup Nation”, with many technology companies being acquired by foreign multinationals. As such, the transfer pricing aspects of such exits and other restructurings, including implementation thereof, has become very much on the radar of the Israeli tax authorities.

To address this matter, the Israeli tax authorities on November 1 published new guidance, Circular 15/2018,“Business Restructuring within a Multinational Group,” clarifying the government’s stance on the tax and transfer pricing aspects of such changes in business models.

In Circular 15/2018, the Israeli tax authorities outline techniques for identification and characterization of a restructuring (including required disclosures), acceptable methodologies for assessing the functions, assets, and risks that have been transferred or ceased, and the tax implications of the restructuring.

The circular clarifies that it does not profess to constitute a systematic guide to transfer pricing or valuations, but rather establishes the Israeli tax authorities’ position and approach, as aligned with the OECD’s transfer pricing guidelines on business restructurings.

The Circular is also heavily based on the first Israeli court case that addressed this matter, Ruling 49333-01-13, Gteko Ltd. vs. Kfar Saba Assessing Officer (June 2017).

In Gteko, the court emphasized that the focal question in transfer pricing should be what the essence of the transaction is, and not the ‘dressing’ around it (what is widely referred to as ‘substance over form’).

The circular dictates three main stages of identifying a potential business restructuring, starting with a thorough functional analysis (pre- and post-restructuring), review of intercompany agreements in place, and consideration of realistically available alternatives at the time of the suggested restructuring.

As aligned with the OECD guidelines, Circular 15/2018 addresses and incorporates the following issues: 

• Legal vs. economic ownership of intangibles;
• Sale vs. license of intangibles;
• Execution and control of the primary functions and risks, especially those related to the development, enhancement, maintenance, protection, and exploitation (DEMPE) of intangibles;
• Critical elements of restructuring, including group synergies, going concern value, workforce in place, and market-specific advantages;
• The Israeli tax authorities’ preferred methodologies for evaluating business activity that was transferred or ceased;
• Other tax ramifications that may result from a restructuring, such as how it would affect Israeli tax incentives and potential secondary adjustments; and
• Disclosures and documentation request forms in Hebrew and English.

Circular 15/2018 represents the fourth circular that the Israeli tax authorities have published in the last two months, following circulars regarding distribution transactions and safe harbors, as well as addressing low-interest loans.

These circulars, along with a recent Israeli Supreme Court ruling regarding the inclusion of stock-based compensation, have demonstrated the state of Israel’s proactive position in transfer pricing in the post-BEPS era.

–Jacky Houlie, LL.M, is founder and Managing Partner at JH & Co. Law Office and can be reached at [email protected] or phone: +972-52-851-2569.

–Shlomo Hubscher is a partner at JH Consulting Ltd. and can be reached at [email protected] or phone: +972-52-600-6804.