Israeli Tax Alerts | Practical Interpretations | 2008-2020

169 insufficient in order to establish whether a specific transaction between related parties should substantially be subject to TP rules. Reporting and documentation requirements - the Regulations require to apply reporting and documentation requirement with respect to any cross-border "transaction" between related parties and on a very short time (60 days upon request of the ITA). A taxpayer is required also to indicate "all international transactions" in a special form. The term "transaction subject to report" is not defined and actually, an absurd scenario may be, where transactions performed on a daily basis between related entities should all be reported, while imposing an extensive and un-proportional administrative burden on the taxpayer (in addition to the heavy and unreasonable burden on the ITA). An Advance Approval may be granted by the ITA upon request, but this process may also create a heavy administrative burden to the ITA. (August 2008) Cross Border Loans and Israeli Transfer Pricing Exposure As we indicated on our Tax News Alert of August 25, 2008 the Israeli transfer pricing (" TP ") rules, which became effective on November 29, 2006 apply to cross border transactions in which one party is an Israeli tax resident. Loans between related parties are generally subject to Section 3(j) of the ITO. Section 3(j) imposes an income tax "deemed interest" income from loans which were provided with an insufficient interest rate (index linked amount plus 4% annual interest rate): deemed interest income is allocated to the lender in an amount equal to the difference between the "sufficient" interest rate that should have applied and the interest rate which was actually adopted by the parties. In many cases financing between related parties is performed through the use of a capital note - an unsecured loan with capital (rather than debt) characteristics and usually bearing no interest. In principle, both ITO provisions (85A and 3(j)) may apply to a capital note financing arrangement. However, according to a recent (February 18, 2009) announcement of the ITA, that follows a previous detailed announcement (March 12, 2008) - cross border financing transactions between related parties, while using capital notes, should only be subject to the Israeli TP rules under Section 85A (and the TP Regulations) and Section 3(j) would not apply. As long as an adequate legislation is not in force or until December 31, 2009 (the earliest), such capital notes should meet the following requirements: