International taxation - An Israeli Transfer Pricing Circular
Transfer pricing (“TP“) tax implications should be regarded as a key factor, in relation to any cross border transaction. A re-llocation of income by any tax authority may cause significant tax liabilities and double taxation, in addition to a possible tax inspection by the Israeli ITA.
It should be noted that the Israeli TP rules are under constant changes and developments. Section 85A of the ITO was enacted while introducing the arm’s length principle into the Israeli law. Detailed regulations were introduced on November 29, 2007 (the “Regulations“), These Regulations allow a taxpayer to use alternative TP methods (or another most appropriate method) for Israeli TP purposes, in order to determine the arm’s length price. Additionally, the Regulations impose detailed reporting requirements.
Considering the complexity of this issue and the high level of uncertainty, the ITA have recently published (July 14, 2008) a very detailed TP Circular (the “Circular“).
Due to wide scope of the TP area, we chose to highlight only few selected issues that were discussed in the Circular.
Special relations – the definition of the term “special relations” in Section 85A should be interpreted not only as family relations or control within a group of companies, but also as intending to address “other” relations that may influence pricing policies between the parties.
According to the Circular, this means that special relations may exist also were there are mutual economic interests between the parties, or where the parties are guided by the same interest and therefore choose not to set “market price” (a transaction between a senior employee and his employing entity us provided as an example). We hold the view that the Circular has widened the scope of the legal provisions and that it further contributes to the lack of clarity under the Israeli TP rules.
A one-time transaction between related parties – according to the Regulations, a one-time transaction, if authorized as such by the ITA, should not trigger TP reporting requirements as well as the determination of an arm’s length price between related parties. However, neither the Regulations nor the ITO define the term “one-time transaction” or assist the taxpayer in this respect, and the Circular only provides a general guidance: the very low frequency of transactions and its limited economic scope
(the Circular indicated that where the transaction does not exceed 10% of the annual income amount of the taxpayer in the specific business area and the actual amount is up to 4 million Israeli Shekels, the transaction should be regarded as a “one-time-transaction”. We hold the view that these two parameters are 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.
