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Transfer Pricing Reporting and Documentation Obligations in Israel – A Complete Guide

Adam Zur — Thu, 04 Dec 2025 14:20:23 +0000

Documentation and reporting are fundamental pillars of transfer pricing compliance. Without proper documentation, a company may struggle to demonstrate adherence to the arm’s length principle. Clear reporting and documentation obligations exist in Israel and numerous countries worldwide. A thorough understanding of these obligations is essential for compliance. This article provides a comprehensive overview of transfer pricing reporting and documentation obligations in Israel.

The Three-Tiered Approach to Documentation

In most countries, transfer pricing documentation follows the three-tiered approach introduced by the OECD. This framework was established under the BEPS (Base Erosion and Profit Shifting) project. It prescribes documentation obligations that scale with the multinational group’s consolidated revenues.

The three tiers are:

Local File, also referred to as a transfer pricing study or market conditions analysis.
Master File.
Country-by-Country Report (CbCR).

What is a Local File (Transfer Pricing Study)?

The first tier of documentation is the Local File. It is the most relevant to most companies. In Israel, this is commonly known as a transfer pricing study or market conditions analysis. This document focuses on cross-border transactions between the Israeli entity and its related foreign parties.

Its purpose is to provide detailed information on these transactions. The focus is on their pricing methodology. While the document includes certain information about the broader group structure, its primary emphasis remains on the specific transactions of the local entity.

In Israel, the required content of a transfer pricing study is based on OECD guidelines. It is detailed in the Israeli Income Tax Regulations for Determining Arm’s Length Conditions.

Globally, various threshold values exist for the obligation to prepare a Local File. Not every company conducting international transactions is required to prepare one. However, in Israel, the obligation to prepare a transfer pricing study applies to every international transaction between related parties. This applies even if the transaction value is relatively low.

In most countries, there is no obligation to submit the study automatically with the annual tax return. Submission is required only following a specific request from the tax authority. In such cases, the document must be provided within a predefined timeframe. This typically ranges between 30 and 90 days. In Israel, the study must be submitted to the Israeli Tax Authority within 30 days of receiving a request.

Master File

The Master File focuses on the activities of the multinational group as a whole. Its purpose is to provide a comprehensive overview of the group’s business operations. This includes a description of the group’s transfer pricing policies, principal profit drivers and intangible assets portfolio. It also includes additional relevant information.

The obligation to prepare a Master File generally applies to relatively large corporate groups. Small and medium-sized enterprises are typically exempt. In Israel, the Master File obligation was introduced under Amendment 261 to the Israeli Income Tax Ordinance. Effective from the 2022 tax year, an Israeli company that is part of a multinational group is required to prepare this documentation. This applies if the group’s revenues reached 150 million NIS or more in the preceding year.

Similar to the Local File, most countries do not require automatic submission of the Master File. Submission is required only upon request from the tax authority. This is also the case in Israel.

Country-by-Country Report (CbCR)

CbCR represents the highest level of documentation. It is relevant to very large multinational groups. Its purpose is to provide tax authorities with comprehensive information on the distribution of revenues, profits, taxes paid and economic activities. This information covers all group entities across all countries. Unlike the Local File and Master File, the CbCR must be filed annually.

Most OECD member countries adopted the CbCR filing obligation in 2016. In Israel, the obligation was introduced under Amendment 261 to the Israeli Income Tax Ordinance. It applies effectively from the 2022 tax year.

Groups with consolidated revenues of 750 million EUR or more (or an equivalent amount in the local currency) are generally required to file the report. Filing occurs in the countries of the group’s ultimate parent entity. In Israel, if the ultimate parent entity is an Israeli tax resident and group revenues exceed 3.4 billion NIS, a filing obligation in Israel applies.

Documentation Obligations – Summary Table

Type of Documentation	Revenue Threshold for Preparation	Submission Deadline	Notes
Transfer Pricing Study (Local File)	Every international transaction between related parties	Within 30 days of the Assessing Officer request	Focuses on specific transactions of the local entity
Master File	Group revenues exceeding NIS 150 million	Within 30 days of the Assessing Officer request	Comprehensive overview of the group and its policies
CbCR	Group revenues exceeding NIS 3.4 billion	Within 12 months from the end of the tax year	Details distribution of revenues, taxes, and activities by jurisdiction

Additional Documentation Obligations

Beyond the three-tiered documentation framework, companies are required to maintain supplementary supporting documentation. This is necessary to substantiate compliance with the arm’s length principle. Such documentation includes intercompany agreements, invoices, and any other documents relevant to transaction pricing. Maintaining these documents is crucial to substantiate compliance before the Israeli Tax Authority when required.

Reporting in Annual Tax Returns

In addition to documentation obligations, companies are typically required to provide information about intercompany transactions. This information is included in their annual tax returns submitted to tax authorities.

In Israel, the following forms must be attached to the annual tax return, as applicable:

Form 1385 – Declaration of International Transactions. Companies and individuals with transactions involving related foreign parties must file this form. The form includes information about the transaction and its pricing.
Form 1485 – Declaration Regarding Loans in International Transactions. Companies that elected to issue capital notes to related companies pursuant to Section 85A(6) must file this form.
Form 1585 – Declaration of Affiliation with a Multinational Group. Companies that are part of a multinational group (as defined in Section 85A) are required to declare this status. They must also provide details about the group.
Form 1686 – Country-by-Country Report (CbCR) pursuant to Section 85C(3) of the Israeli Income Tax Ordinance. This form is filed by Israeli ultimate parent entities of multinational groups. It applies to groups with revenues of 3.4 billion NIS or more.

Practical Example – ABC Group

ABC Group is a multinational group operating in 20 countries worldwide. Its consolidated revenues amount to 5 billion NIS. Israeli company abc heads the group and serves as the ultimate parent entity. British company XYZ and American company INC provide distribution services to it.

What documents and forms will ABC Group need to prepare and file in Israel?

First, abc Company must prepare a transfer pricing study. This study addresses the distribution services provided to it by XYZ and INC.

Additionally, because its revenues exceed 150 million NIS, it must also prepare a Master File.

Finally, since the group’s revenues exceed 3.4 billion NIS and the ultimate parent entity is an Israeli tax resident, the company must prepare and file a Country-by-Country Report.

Regarding the forms abc Company must attach to its annual tax return:

Form 1385 – for transactions with XYZ and INC.
Form 1585 – To report its classification as a multinational group.
Form 1686 – to file the Country-by-Country Report.

Companies engaged in cross-border-related-party transactions must ensure full compliance with the arm’s length principle. They must price transactions at market conditions. Proper documentation and reporting as required by law are essential. Non-compliance with these obligations may result in administrative penalties. It may also create a heightened burden of proof before the tax authorities and substantial tax exposure.

Nimrod Yaron & Co. – Israeli and International Taxation specializes in transfer pricing. The firm provides comprehensive professional support for all transfer pricing matters. To contact a representative from our firm, click here.

FAQ

Is it necessary to submit a transfer pricing study with the annual tax return in Israel?

What expenses should be included in the cost base for Transfer Pricing Purposes

Adam Zur — Wed, 12 Nov 2025 21:38:37 +0000

Insights from the Kontera Technologies Ltd. Ruling

Transfer Pricing and proper intercompany Pricing are a complex challenge for international companies. One of the key questions that concern them is how the cost base should be determined. Which costs should be included, and which should not? The answer to this question has a significant impact on intercompany payments and on the companies’ profits. The Kontera ruling provides an answer, at least partially, to this question.

Kontera Technologies Ltd. Ruling

The Kontera ruling is the first Israeli ruling about transfer pricing and one of the most significant in the field. The ruling is essentially a consolidation of two appeals. “Kontera Technologies Ltd.” V. Assessing Officer Tel-Aviv 3 and “Finisar Israel Ltd.” V. Assessing Officer Tel-Aviv Rehovot. The issues discussed in both appeals were very similar; therefore, the Supreme Court decided to consolidate them into one ruling.

We will focus primarily on matters relating to Kontera.

Kontera is a company whose main activity is providing R&D services to its American parent company. The payment for these services was outlined in an intercompany agreement signed in 2005. According to which, the payment would be based on Konterra’s costs for providing the services, minus social benefits expenses, and plus a markup of 7%.

In other words, pricing is calculated under the cost-plus method, which divides the payment into two components: the relevant costs (“cost”) and a fixed profit markup (“plus”). The Transfer Pricing study prepared by the company established an interquartile range of 4.5% to 15.3%. Meaning, the study supported the company’s pricing.

In 2009 and 2010, the parent company granted stock options to Kontera’s employees. Following this, an amendment was made to the intercompany agreement, which stipulated that these expenses should not be included in the cost base. Kontera chose to report the options under the Capital gains track with a trustee pursuant to Section 102 of the Israel Income Tax Ordinance (the ITO). Thus, it was able to record the costs as an accounting expense, but not as a tax-deductible expense, which prevented it from deducting the costs as salary expenses.

The Assessing Officer relied on Section 85A of the ITO, which allows him to intervene when the pricing between two related companies is not done in accordance with market prices and to modify it. His main arguments were:

The cost base was calculated incorrectly – in his view, there is no justification for omitting the social benefits expenses and stock option allocation costs from the cost base. Neutralizing these expenses significantly reduces the profit margin. Rather than remaining at 7%, the rate declined to 1.73% in 2009 and further to 0.97% in 2010, indicating a deviation from the accepted interquartile range.
The profit margin selected is inappropriate – in his view, the company should have used the median rate, 9.1%, and not 7%.

The Assessing Officer increased the profit that Kontera should have received in two ways. On the one hand, by increasing the amount to which the markup is applied, and on the other, by increasing the profit margin itself.

Kontera did not agree with these arguments and filed an appeal with the District Court. The District Court dismissed Kontera’s appeal. Therefore, Kontera appealed to the Supreme Court.

The Supreme Court Ruling

The Supreme Court divided its discussion into two levels, examining the economic substance of the expense and how unrelated parties would’ve acted in such a situation.

From an economic substance perspective, stock option allocation costs are an expense incurred in the production of income for Kontera. The options are part of the employees’ compensation package intended to incentivize them. Thus, all components of the compensation package, whether cash, options, or other equity instruments, are expenses incurred in the production of income. Therefore, there is no substantive justification for not including them in the cost base.

However, this does not necessarily mean that the Assessing Officer can intervene in the intercompany agreement between the parties. This is only possible if the company fails to prove that its pricing was done in accordance with market conditions. In our case, Kontera failed to shift the burden of proof to the Assessing Officer, and therefore he is entitled to intervene in the pricing. The transfer pricing studies submitted by the company show that the comparable companies took into account the value of the options. In other words, the company did not act in accordance with market conditions.

Additionally, regarding the profit margin, the Supreme Court refers to Regulation 2(C) of the Regulations for Determining Market Conditions. This regulation stipulates that if a transaction falls outside the range, its price shall be reported according to the median value. Since Kontera was not within the range, the transaction shall be reported and taxed according to the median value, 9.1%, meaning the Assessing Officer’s argument is accepted.

The Supreme Court did not allow the deduction of stock option allocation costs against its taxable income. This is because such a deduction is inconsistent with Section 102 of the ITO. Kontera’s argument that the section refers to a deduction upon exercise of shares and not upon allocation of options was not accepted. This is because in this case, the specific provision (namely Section 102) prevails over the general provisions of Section 17 of the ITO.

Allowing the deduction would grant Kontera a double benefit, on the one hand, a lower tax rate for the employees, and on the other, the deduction of the expenses. This is because reporting under the capital gains track, in which employees are taxed at a rate of 25%, does not allow for the deduction. Had the company chosen the employment income track, under which employees are taxed at their marginal tax rate, it would have been able to deduct the costs.

Summary of Arguments

Issue	Kontera’s Position	Assessing Officer’s Position	Court’s Decision
Inclusion of stock option allocation costs in the cost base	Exclude	Include	Include
Profit margin rate	7%	9.1%	9.1%
Burden of proof	Burden shifted to the Assessing Officer	Burden remained with Kontera	Burden stayed with Kontera

The Cost-Plus Method in Transfer Pricing

Using pricing based on the costs associated with providing services is a common practice across many industries and in numerous intercompany agreements. This pricing method determines that the payment for the services will be calculated as follows: the service provision costs plus a profit markup. For example, if a company’s expenses amount to 100 and the agreed profit margin is 5%, the payment it will receive would be 5+100=105.

When the parties are unrelated, the profit margin is determined according to industry standards and the outcome of negotiations between the parties. However, when the parties are related, the margin must be determined based on a transfer pricing study that examines how unrelated parties would have acted in the same transaction.

In examining intercompany pricing for transfer pricing purposes, several methods may be applied, one of which is the cost-plus method. Despite its name, this method is not typically used in cases such as the one described above, as it compares net profit margins. A metric that is very difficult to compare across companies. Instead, the TNMM (Transactional Net Margin Method) is generally applied, which compares profit margins between companies.

For further reading on the cost-plus method, click here.

Insights from the Kontera Technologies Ltd. Ruling

This ruling was delivered in 2018 and was considered highly significant, leading to the publication of Circular 1/2020. Although several years have passed since its issuance, it continues to influence corporate transfer pricing policies, the positions of the Israeli Tax Authority, and broader tax practices.

At a time when Transfer Pricing assessments and litigation are on the rise in Israel and worldwide, it is increasingly important to be familiar with court rulings in this field. Doing so provides a clearer understanding of the approach taken by the courts and the tax authorities.

The main conclusion from the Kontera ruling is that stock option allocation costs should be included in the cost base for determining intercompany payments for transfer pricing purposes.

When deciding which costs should be included, the key question is whether the costs constitute an expense directly related to the provision of the services. In other words, the analysis should focus on the economic substance of the services and the expenses, examining whether these costs are connected to the provision of the services or not.

In addition, the mere existence of a transfer pricing study is not sufficient to shift the burden of proof to the Assessing Officer. If the study does not support the company’s actual activity, the burden of proof remains with the company. Therefore, it is essential to carefully examine both the study and its implementation to ensure consistency between them.

Nimrod Yaron & Co., Israeli and International Taxation – specializes in transfer pricing and provides clients with comprehensive assistance on the matter – from the planning stage of the intercompany arrangement to supporting accountants in its practical implementation.
To contact a representative from our firm, click here.

FAQ

Should the parent company's stock option allocation costs for the subsidiary's employees be included in the cost base for transfer pricing purposes?

Cost-Plus Method for Transfer Pricing

Nimrod — Sun, 28 Sep 2025 07:27:08 +0000

The cost plus method

When conducting a transfer pricing study, it’s essential to select the most appropriate comparison method to demonstrate that the prices set in a controlled transaction (i.e., a transaction between related parties) are at arm’s length. The Organization for Economic Cooperation and Development (OECD) outlines various methods for this purpose in its transfer pricing guidelines, categorizing them into two distinct groups: traditional transaction methods and transaction profit methods. The Cost Plus method falls within the category of traditional transaction methods.

This method compares the gross profit mark up in a controlled transaction to that of a similar uncontrolled transaction.

The cost-plus method is commonly used in industries in which is common to set the price by a adding a mark-up to the cost of goods sold. At times when transactions involve tangible property, manufacturing or assembling activities and relatively simple service are provided, the cost plus method will be usually used.

This method is particularly valuable in cases where semi-finished goods are sold between related parties, where the related parties have joint facility agreements, or where there are long-term buy-and-supply arrangements or the provision of services.

How does the Cost Plus Method work?

First, it’s crucial to identify comparable transactions. Ideally, transactions between the supplier and other unrelated parties (i.e., internal comparables) will be used for this purpose. External transactions involving other unrelated parties can also serve as a guide. Note that a comprehensive analysis should be performed to ensure that the circumstances of the transactions are indeed comparable.

Next, the markup of the comparable transactions should be measured.

Afterward, the Cost of Goods Sold (COGS) for the supplier must be calculated. This figure is then multiplied by the markup to determine the transfer pricing, or the arm’s-length price.

According to the OECD guidelines, when applying the Cost Plus method, a controlled transaction and an uncontrolled transaction are deemed comparable if one of the following conditions is met:

Differences between the compared transactions or companies do not affect the determination of the cost-plus markup in an open market.

Reasonable adjustments can be made to eliminate the benefits that might arise due to the differences mentioned above.

Example of the application of the cost plus method

Let’s look at a simple example to illustrate the application of the Cost Plus method.

Suppose we have a multinational enterprise (MNE) called Company A, which operates in Country X. Additionally, there is a related party, Company B, operating in Country Y, and an unrelated party, Company C, also conducting business in Country Y.

Company A specializes in manufacturing bags for Company B. Company C also manufacture bags and operates under conditions similar to those of Company A, , earning a markup of 15-20% on its costs.

After conducting a comprehensive comparability analysis, it is determined that these transactions are suitably comparable. The comparable markups identified align with the cost basis employed by Company C, serving as a foundation for implementing the Cost Plus method. Based on this, we can now proceed to calculate the selling price that Company A should set for its sales to Company B.

Let’s assume that the COGS for producing a single bag by Company A amounts to 100$. The calculation unfolds as follows:

Cost of COGS for comapny A = 100$
+ Gross profit mark up (15-20%) = 15$-20$
Arm’s length price = 115$-120$

In essence, the determined arm’s length price for Company A’s sales to Company B ranges between 115$ and 120$.

Advantages

Like all transfer pricing methods, the Cost Plus method has its strengths and weaknesses that require careful consideration before application. No single method is perfect for every scenario; therefore, your choice should be based on a case-by-case analysis.

Some of the advantages of the cost plus method are:

Relatively Accessible Data – the Cost Plus method utilizes internal costs– i.e., costs that are directly related to the manufacturing or purchasing of an item or activity. This information is generally readily accessible to the enterprise.
Comparability of Functions Preformed – when applying the Cost Plus method, the comparability of the functions preformed is more crucial than the comparability of the products. This is because the functions preformed have a larger impact on the margins.

Disadvantages

Some of the disadvantages or weaknesses of the Cost Plus method include:

Cost Determination – First, there are challenges in accurately determining the costs. While enterprises need to cover their costs to sustain their operations, these expenses may not necessarily dictate the appropriate profit for a specific year. Although companies often set prices based on cost, there are times when price and cost are not directly correlated.
Cost Allocation Issues – The costs considered in the Cost Plus method are those incurred by the supplier of goods or services. This can create complications in allocating some expenses between the supplier and the purchaser. For example, some costs may be borne by the purchaser, not the supplier, thus lowering the basis for determining costs.
One-Sided Analysis – The Cost Plus method involves a one-sided analysis, focusing solely on the manufacturer or the service provider. This may not provide a complete picture of the transaction dynamics between the related parties.

Considerations when applying the Cost Plus Method

Some points should be kept in mind when applying the cost plus method, including,

Comparable Cost Basis – It’s essential to ensure that a similar markup is applied to a comparable cost basis when using this method.
Accounting Consistency – One critical aspect of comparability is accounting consistency. If there are differences in accounting practices between the controlled and uncontrolled transactions, adjustments should be made to the data. This ensures that the same types of costs are considered in both sets of transactions.
Different Expense Types – It’s important to take into account differences in types and levels of expenses. Operating and non-operating expenses may include financial costs tied to the functions performed and the risks assumed by the parties or transactions. Recognizing these differences may necessitate adjustments or additional steps. For example, if costs are associated with functions different from those being tested, separate compensation should be provided for them.
Applying Historical Costs – Historical costs should be applied to individual units of production. In some instances, costs may fluctuate over time, such as labor or material costs. In these cases, it may be more appropriate to apply an average cost rather than an annual cost. Averaging costs might also be relevant in situations involving fixed assets and production or processing of multiple products in varying quantities. Additionally, for a more accurate profit estimation, consider including replacement and marginal costs when they can be calculated.

Our firm specializes in international taxation and provides our clients with a comprehensive assistance for their transfer pricing needs. To schedule a consolation call with our team, click here.

Additional articles on transfer prices:

Transfer Pricing Reporting and Documentation Obligations in Israel – A Complete Guide

What expenses should be included in the cost base for Transfer Pricing Purposes

Cost-Plus Method for Transfer Pricing

Update on the Reporting Obligation for Multinational Groups in Israel

Redefining Transaction Terms: A Landmark Tax Authority Ruling on Coca-Cola’s Royalty Payments

Israeli Income Tax Circular 01/2025 – Country-by-Country Report (CBCr)

Update on the Reporting Obligation for Multinational Groups in Israel

Adam Zur — Tue, 27 May 2025 07:05:46 +0000

Amendment 261 to the Israeli Tax Ordinance (The Ordinance), which was published to the Knesset Records in July 2022, updates the reporting obligations of an Israeli entity that is part of a multinational group starting from the 2022 fiscal year.

In addition, following Amendment 261, the Income Tax Regulations (determining market conditions) (2006) (the Regulations), were also amended.

Under Amendment 261, sections 85B and 85C were added to the Ordinance, creating the requirement to fill out forms 1585 and 1685.

Definitions Added following Amendment 261 to the Ordinance

What is an entity under section 85A?

An entity is “a body of persons including a business unit of a body of persons for which separate financial statements are prepared.”

What is a multinational group?

A multinational group consists of two or more entities, where at least one of them is a foreign resident and one owns, directly or indirectly, the means of control of the other entities.
Therefore, all structures with a parent company and a subsidiary where one is a foreign resident, are considered to be a multinational group. On the other hand, a structure in which an individual holds an entity doesn’t fall under the scope of a multinational group.

What is an ultimate parent entity?

An ultimate parent entity is an entity that holds the majority of the means of control of the other entities within the group and meets the following criteria:

According to Israeli accounting laws, or if it were publicly traded, a submission of a consolidated report would be required.
No other entity holds it.

Expansion of Reporting Liability

Local file – Transfer pricing study

As a result of the amendment, transfer pricing studies must also include information on the taxpayer’s organizational structure, its main competitors, and amounts received due to transactions with foreign relations.

Master file

Due to the amendment, a taxpayer who is part of a multinational group with a turnover above 150 million NIS (in the tax year before the reporting year) must prepare a master file according to section 5(A)(10) of the regulations.

The information in the master file must include, among others, an overview of the group’s business, information on intangible assets, details about the group’s funding, and other relevant data.

Form 1685- Ultimate parent entity report (‘Country by Country Reporting’)

The ultimate parent entity report was initially introduced by the OECD Organization as part of the BEPS program. The OECD organization published the required information in the report, including general information on the financial and business data of the group. For example, the residence of the group’s entities, their main field of activity, their income, etc. In Israel, the reporting requirement was introduced as part of Amendment 261 and went into effect in the 2022 fiscal year.

A taxpayer who is part of a multinational group with a consolidated turnover surpassing 3.4 billion NIS, where the ultimate parent entity is Israeli, must submit form 1685. This form needs to be submitted to the Israeli Tax Authority within twelve months of the end of the tax year via a unique portal, the Automatic Exchange of Information (AEOI) Portal.

In the situation that the consolidated turnover surpasses 3.4 billion NIS but the ultimate parent entity is not Israeli, the taxpayer must update the Israeli Tax Authority in which country the form is submitted. In addition, the Israeli Tax Authority allows a taxpayer whose ultimate parent entity is not Israeli to submit the form in Israel.

If the ultimate parent entity is Israeli and the taxpayer is interested in submitting the form outside of Israel, they must request approval from the Israeli Tax Authority.

The information reported by the taxpayer in the form will be transferred, as part of the AEOI, to other countries where the multinational group’s entities operate and are part of an automatic information exchange agreement.

Form 1585-Declaration of being part of a multinational group

Taxpayers part of a multinational group must state this on form 1585. Reporting is required even if the taxpayer didn’t perform international intercompany transactions during the fiscal year.

The form includes information on; the Israeli entities, the multinational group, and the group’s turnover.

Additional Updates in Amendment 261

A smaller time frame for a taxpayer to submit transfer pricing documentation (both local and master files), from the moment of the assessor’s request, reduced from 60 before the Amendment to 30 days after the Amendment.
Repeal of Regulation four of the regulations regarding one-time transactions and the addition of Section 85A(E1) in its place. Section 85A(E1) allows the manager of the Tax Authorities to determine the requirements of Section 85A(E) won’t apply to one-time transactions or transactions of a small scope, as well as for transactions where there is a concern that setting a price not according to market conditions, doesn’t justify the application of the section.

Our firm specializes in international taxation and offers comprehensive assistance for transfer pricing needs. Our transfer pricing department guides our clients in implementing the proper legal provisions and assists them in correctly filling out all required forms.

To contact a representative at our firm, click here.

Additional articles on transfer prices:

Transfer Pricing Reporting and Documentation Obligations in Israel – A Complete Guide

What expenses should be included in the cost base for Transfer Pricing Purposes

Cost-Plus Method for Transfer Pricing

Update on the Reporting Obligation for Multinational Groups in Israel

Redefining Transaction Terms: A Landmark Tax Authority Ruling on Coca-Cola’s Royalty Payments

Israeli Income Tax Circular 01/2025 – Country-by-Country Report (CBCr)

Redefining Transaction Terms: A Landmark Tax Authority Ruling on Coca-Cola’s Royalty Payments

Adam Zur — Thu, 20 Mar 2025 17:19:08 +0000

Overview of Coca-Cola Ruling: Central Company vs. Gush Dan Tax Officer

The Tel Aviv District Court recently mandated that the central company for soft drink production Ltd. (“Coca-Cola Israel”), the official distributor and seller of Coca-Cola in Israel, is liable for an additional tax in the hundreds of millions of shekels. This ruling has significant implications for the field of transfer pricing.

Background to the Decision

Coca-Cola Israel operates in the marketing and sales of Coca-Cola products within the country. The business model involves Coca-Cola Israel purchasing concentrates from the global Coca-Cola company, producing the beverages, and subsequently selling them within Israel. The agreement between Coca-Cola Israel and the global Coca-Cola company relates to the payment for concentrates and does not explicitly cover payment for the use of intangible assets.

This decision follows the Tax Authority’s policy shift after nearly two decades. This shift pertains to the royalties for using Coca-Cola’s intellectual property. Previously, the Tax Authority did not view Coca-Cola Israel’s payments to the global company as inclusive of a royalties component, seeing them instead as merely for the beverage concentrate.

However, the Tax Authority now contends that these payments also encompass a royalties component, arguing that the concentrates themselves incorporate the value of Coca-Cola’s intangible assets beyond just the cost of the material (since these concentrates are not available from competitors, and it is evident that the cost of the physical material alone is not substantial). This shift has substantial tax implications for Coca-Cola, potentially increasing its tax burden by hundreds of millions of shekels, and affects other companies in the industry as well.

Court’s Determination

The court ruled that while the payment agreement between Coca-Cola Israel and the global Coca-Cola company does not explicitly include royalties, there exists an exception in Section 85A of the Income Tax Ordinance. According to this, if there are special relationships between the companies, the tax officer is empowered to intervene in the agreement and adjust the pricing. Therefore, if special relationships exist between Coca-Cola Israel and the global Coca-Cola company, the tax officer can modify the transaction in such a way that it incurs additional tax payment.

Understanding ‘Special Relationships’ in Tax Law

The framework of the term ‘special relationships’ as outlined in Section 85A of the Income Tax Ordinance is an “open weave” requiring an examination of the entirety of circumstances and relationships between the parties to determine if ‘special relationships’ indeed exist between them. This definition of special relationships includes relationships between relatives, control of one party over another in the transaction, or control by one person over the parties involved, directly or indirectly, alone or together with others, and is not a closed definition. An analysis of the relationships between the parties can lead to a determination that they indeed share special relationships.

Indeed, the court analyzed the nature of the relationships between the parties and determined that special relationships exist, noting the transactional arrangement that has been woven between the appellant and Coca-Cola, which creates ‘special relationships’ of connection and mutual involvement between the two companies in the production and marketing of Coca-Cola beverages in Israel, akin to a ‘joint venture.’

Consequently, the judge established that since there are special relationships between the companies, Coca-Cola Israel is obliged to pay additional tax for the royalties to the global Coca-Cola company. This determination leads to additional tax payments amounting to hundreds of millions of shekels.

Conclusions from the Legal Decision – Defining Special Relationships in Section 85A

Key Insights from the Ruling

The main conclusions include attention to an exception in the law that allows the tax officer to intervene in the nature of the transaction and reclassify it. Generally, the tax officer must respect the agreement forged between two parties. However, as stated in the judgment, there are exceptions in the law. The relevant exception for our matter specifies that the tax officer is authorized to disregard the provisions of the existing agreement between the involved parties and establish new provisions in their place. For the tax officer to employ this exception, the international transaction must occur between parties that maintain “special relationships,” and the terms of the transaction must be less profitable compared to a deal that would occur between parties without such relationships.

Application of the Exception

To activate this exception, special relationships must exist between the parties tied to the agreement. The classic interpretation of ‘special relationships’ is aimed at relationships between companies related in a corporate structure, such as subsidiary and parent companies or sister companies.

Despite the fact that there is no corporate structure relationship between Coca-Cola Israel and the global Coca-Cola company, the judge determined that special relationships exist between them. The judge based his ruling on the terms of the agreement negotiated between the parties and the mutual involvement forged between them, which, among other things, relied on the method of accounting.

Implications of the Broad Definition of Special Relationships

This determination highlights that the definition of ‘special relationships’ in Section 85A of the Ordinance is not a closed one, but a broad definition that can also include transactions between parties not linked in the simple sense. It is important to consider such issues when conducting international transactions with parties that might be claimed by the Tax Authority as related, potentially altering the transaction.

Global Judicial Decisions on Similar Tax Issues

It’s important to note that the Israeli Tax Authority is not the only tax body worldwide that has deliberated on this matter. Similar issues have been discussed in both Australia and Spain. Moreover, the debate is not exclusive to Coca-Cola; the Australian court also addressed a similar claim by the Tax Authority against Coca-Cola’s main competitor, PepsiCo.

The Israeli Tax Authority even utilized the Australian court decision to strengthen its case. According to the Israeli authority, the Australian judgment concerned a company performing similar operations to Coca-Cola Israel, and it was determined in the decision that the payments made by this company for beverage concentrates included a component of royalties. The judge noted that while this foreign ruling could be used, he saw no necessity to rely on it for his determination, which was analogous to the Australian court’s decision.

However, after the proceedings in Israel, the Australian judgment reached the Federal Court, where the ruling was reversed. The Federal Court in Australia ruled that the payments received by the company did not include a royalties component. This reversal could significantly assist the central company in altering the decision of the district court.

A similar case also occurred in Spain, where the court made a decision similar to the one in Israel. Thus, it appears that other legal systems around the world have not yet settled the issue, which could potentially cost international companies hundreds of millions in tax payments.

These cases illustrate the significant power that tax officers have in intervening and reclassifying the nature of a transaction when dealing with related parties, even if they are not connected in the straightforward sense of the definition. Therefore, it is necessary to consult with relevant experts in the field to regulate the relationships between parties as precisely as possible. Our firm specializes in Israeli and international taxation and offers our clients a professional package in the field of transfer pricing. For an initial consultation with a representative from our firm, click here.

Additional articles on transfer prices:

Transfer Pricing Reporting and Documentation Obligations in Israel – A Complete Guide

What expenses should be included in the cost base for Transfer Pricing Purposes

Cost-Plus Method for Transfer Pricing

Update on the Reporting Obligation for Multinational Groups in Israel

Redefining Transaction Terms: A Landmark Tax Authority Ruling on Coca-Cola’s Royalty Payments

Israeli Income Tax Circular 01/2025 – Country-by-Country Report (CBCr)

Adam Zur — Thu, 13 Feb 2025 13:51:51 +0000

In February 2025, the Israeli Tax Authority published Circular 01/2025 on transfer pricing – Amendment 261 to the Income Tax Ordinance – Country-by-Country Report (hereinafter: CBCr). The purpose of this circular is to detail the obligations and requirements associated with the CBCr.

This article reviews the features of the CBCr and the obligations of Israeli companies in this context.

What is a CBCr report?

The Country-by-Country Report (or CBCr) was introduced as part of Action 13 of the OECD’s BEPS Project. In May 2016, an agreement was signed for the automatic exchange of information pertaining to the implementation of reporting by multinational groups through the submission of CBCr.

The report includes information on the distribution of income, taxes, and activities among the companies within a multinational group. The reporting obligation in most OECD countries began in the 2016 tax year. The threshold for reporting in most countries is similar – the group’s consolidated turnover exceeds €750 million (or its equivalent in local currency) and the Ultimate Parent Entity is a resident of that same country.

Israeli Regulations and CBCr Reporting Obligations

Under Israeli regulations, the obligation to submit a CBCr was introduced as part of Amendment 261 to the Income Tax Ordinance. In light of this amendment, certain entities are required to submit the CBCr in Israel.

Reporting Obligation – Who is Required to Submit the Report?

The obligation to submit the CBCr is detailed in Section 85C of the Ordinance and includes two cumulative conditions: the entity is part of a multinational group whose consolidated turnover in the year preceding the tax year was ₪3.4 billion (the NIS equivalent of €750 million) or more and the Ultimate Parent Entity is an Israeli resident.

The report can be submitted directly to the Israeli Tax Authority or through automatic information exchanges. The report must be submitted within 12 months of the end of the tax year of the Ultimate Parent Entity.

It is important to note that the threshold for submitting the report is stated in NIS. If the Ultimate Parent Entity reports in a currency other than NIS, the value of the turnover in NIS must be examined. The conversion to the NIS value can be done either by using the average exchange rate for the tax year or the average rate for the quarter. This means that the turnover might exceed €750 million but be less than ₪3.4 billion, and the company would not be obligated to submit the CBCr in Israel.

CBCr Submission in Israel

A multinational group that meets the conditions outlined above needs to submit the CBCr in Israel. However, the group can submit the report to another country if the Israeli Tax Authority approves that it meets three cumulative conditions:

As of the date of submitting the application, there is a valid Competent Authority Agreement between Israel and the country where the report will be submitted.
The group has notified the Israeli Tax Authority by the end of the tax year, via the Automatic Exchange of Information portal, about the reporting in another country.
Proof must be provided within a year from the end of the tax year that the report has been submitted in the other country. This will be done via the Automatic Exchange of Information portal.

The report submitted in another country must reach the tax authority within 15 months from the end of the tax year. If the report has not arrived by this date, the final parent entity must submit the CBCr report in Israel.

Likewise, a group whose Ultimate Parent Entity is not a resident of Israel can submit the report in Israel. Of course, it is necessary to check the guidelines in the country of residence of the Ultimate Parent Entity to ensure compliance with the reporting requirements in that country.

There are several scenarios in which, even if the multinational group is not obligated to submit the report in Israel, the tax authority can require it to be submitted in Israel:

In the country of residence of the final parent entity of the group, there is no obligation to submit a CBCr.
As of the date of submitting the report, there is no Competent Authority Agreement between Israel and the country where the report was submitted, but there is an international agreement (as defined in the regulations).
There is an agreement, but Israel knows there is a systematic issue with the country of residence of the Ultimate Parent Entity.

If one of the above conditions is met but the group has submitted the report in another country within the group, it will be exempt from submitting the report in Israel.

Our firm provides comprehensive support to our clients regarding transfer pricing. To contact a representative from our office, click here.

FAQs

What is a final parent entity?

According to Section 85C(a), an entity that directly or indirectly holds the majority of control instruments of the group entities and no other entity holds such control.

How is a CBCr report submitted in Israel?

The report is submitted online via the Automatic Exchange of Information portal.

If the final parent entity of the group is Israeli and the transaction turnover is reported in dollars amounting to $800,000, is a CBCr report required to be submitted in Israel?

Not necessarily. The obligation to submit depends on the shekel value of the group’s transaction turnover. If the transaction turnover exceeds ₪3.4 billion – a CBCr report needs to be submitted in Israel. If the transaction turnover is below ₪3.4 billion – there is no obligation to submit a CBCr report in Israel.

Additional articles on transfer prices:

Transfer Pricing Reporting and Documentation Obligations in Israel – A Complete Guide

What expenses should be included in the cost base for Transfer Pricing Purposes

Cost-Plus Method for Transfer Pricing

Update on the Reporting Obligation for Multinational Groups in Israel

Redefining Transaction Terms: A Landmark Tax Authority Ruling on Coca-Cola’s Royalty Payments

Israeli Income Tax Circular 01/2025 – Country-by-Country Report (CBCr)

Form 1385 – Declaration on International Transaction

Adam Zur — Mon, 20 May 2024 17:01:31 +0000

The transfer pricing branch belongs to the field of international taxation and deals with situations where there are international transactions between related parties. In the context of these transactions, the question arises as to which portion of the profit should be attributed to each of the countries involved in the transaction.

Section 85A of the Income Tax Ordinance stipulates that the terms of an international transaction between related parties should be similar to those of an identical transaction between unrelated parties. Under this section, in November 2006, the Income Tax Regulations (Market Terms) 2007 – 2006 were enacted. The regulations specify how to examine whether a transaction was made in accordance with market terms, the rules for documentation and reporting on transfer pricing research, and they also address one-time transactions.

In the context of the annual tax report that companies submit, Form 1214, they are required to indicate whether the company had international transactions with related parties abroad as defined in Section 85A of the Income Tax Ordinance. If such transactions occurred, the company must attach Form 1385 as an annex to the annual report. Form 1385 includes information about the intercompany international transaction, such as the nature of the transaction, its amount, and more.

In 2022, the Tax Authority updated Form 1385 and added a requirement to report on the existence of a transfer pricing study. The person filling out the form must indicate whether “there is a market terms investigation report in accordance with Regulation 5 of the regulations, as of the date the report is submitted.” The significance of the update is that, in effect, the Tax Authority is tightening the enforcement of conducting transfer pricing studies.

If the taxpayer has not conducted a transfer pricing study and declared as such on the form, the case will definitely lead to an audit by the Tax Authority. If the taxpayer did not conduct a transfer pricing study but falsely declared that such a study exists, this constitutes a false entry with all its implications. According to Section 215 of the Income Tax Ordinance, a person who unreasonably provides an incorrect report or submits incorrect information is liable to a penalty of two years’ imprisonment or a monetary fine as stated in Section 61(a)(3) of the Penal Law, or both. In addition to the mentioned fine, there is also the possibility that the taxpayer may receive an additional deficit penalty.

Important points for filling out Form 1385

Details of the Parties to the Transaction: It is necessary to provide details of both the Israeli and foreign entities involved in the transaction.
Details About the International Intercompany Transaction:

Description of the Transaction: Provide a clear explanation of the nature of the transaction.
Method Adopted: Specify the transfer pricing method used. If a method that compares the profitability ratio between the international transaction and a similar transaction was selected, the chosen profitability ratio should also be mentioned.
Transaction Amount: Indicate the monetary value of the transaction.

Declaration and Signature: There must be a statement and signature confirming that the international transaction was conducted under market conditions.

What is a market conditions investigation according to Regulation 5 of the Income Tax Regulations (Market Terms)?

Regulation 5 outlines the guidelines for a full market conditions investigation and the information it must include:

Details of the taxpayer
Description of the taxpayer’s organizational structure
Information about the parties to the transaction including their residencies and the nature of their special relationships with the taxpayer.
The contractual terms of the international transaction
The taxpayer’s field of activity
The economic environment in which the taxpayer operates and the risks they are exposed to
The main competitors of the taxpayer (if any)
Use of intangible assets
Detailing all the transactions the taxpayer conducted with the transaction party (including the amounts of the payments)
Detailing similar transactions, the comparison method, and the comparison characteristics used for preparing a range of values
The manner of reporting in the country of the transaction party

Benchmarking work, unlike a complete transfer pricing study, includes only information about the analysis conducted in the database and its results, and does not include the other detailed information mentioned above, does not meet the regulations, and is not considered a full market conditions investigation. Therefore, if only benchmarking work was performed, it would not be possible to declare that there is a market conditions investigation on the form. If the taxpayer nevertheless declared that a market conditions investigation exists, this declaration would be considered a false report.

What is an up-to-date market conditions investigation?

An up-to-date market conditions investigation, according to the Income Tax Regulations (Market Terms), requires that transfer pricing work be updated annually. This differs from the OECD guidelines, which state that a transfer pricing study is valid for three years. Due to the high costs associated with conducting a new transfer pricing study every year, our office proposes to clients a transfer pricing work that will be valid for the next two years, with a new study only performed after the third year. The validation is done by examining the circumstances and terms of the transaction to see if they remain unchanged.

Our office specializes in Israeli and international taxation and offers a professional and comprehensive package in the field of transfer pricing. Our transfer pricing department supports many companies from the correct filing of the form to the planning of reporting and tax payments in the most optimal way. To schedule an initial consultation with a representative from our office, click here.

Additional articles on transfer prices:

Transfer Pricing Reporting and Documentation Obligations in Israel – A Complete Guide

What expenses should be included in the cost base for Transfer Pricing Purposes

Cost-Plus Method for Transfer Pricing

Update on the Reporting Obligation for Multinational Groups in Israel

Redefining Transaction Terms: A Landmark Tax Authority Ruling on Coca-Cola’s Royalty Payments

Israeli Income Tax Circular 01/2025 – Country-by-Country Report (CBCr)

The Sixth Method of Transfer Pricing

Adam Zur — Mon, 12 Feb 2024 13:48:47 +0000

When carrying out a transfer pricing study, it’s essential to choose the most suitable method for demonstrating that the prices in a controlled transaction (that is, a transaction between affiliated entities) align with arm’s length standards. The OECD provides guidelines on transfer pricing, detailing various methods that are broadly divided into two main categories: traditional transaction methods and transaction profit methods.

However, there’s also an additional method, not included in the OECD guidelines, called the “Sixth Method” which is used mainly in some Latin countries as Argentina, Bolivia, Brazil and more, for setting prices in controlled transactions involving commodities such as minerals, and oil and gas. This method stands apart from the standard methods recommended by the OECD, as it sometimes strays from the arm’s length principle, which is a key principle in the OECD guidelines.

To select the most appropriate transfer pricing method, it’s crucial to perform a detailed analysis of the transaction’s functions, find comparable transactions not controlled, and apply the chosen method consistently. The OECD Transfer Pricing Guidelines offer important advice on this, particularly stressing the importance of keeping detailed records and documentation.

The Sixth Method

At times, it can be hard for tax authorities to establish whether a controlled transaction is at arm’s length, this issue is can be more prevalent in developing countries, as they might not have enough information to make comparability analyses and they also might not have enough knowledge and resources to do a transfer pricing analysis.

To overcome this hardship some countries, especially in Latin America, have adopted the sixth method, also known as the commodity ruleThis method uses the quoted price in the commodity market to establish the price that should be set in a controlled transaction, mainly in transactions involving import and export of commodities such as agricultural products (grains, coffee, meat, sugar, wool, cotton), metals (gold, silver, copper, platinum), and energy sources (oil, gas, electricity) or other goods with known prices in transparent markets. Depending on the way this method is applied it can be considered as a safe harbour.

It is important to note that this method is not officially recognized by the OECD Transfer Pricing Guidelines, which can cause some difficulties in compliance with the transfer pricing regulations if the other country that is a side to the transaction does not allow for the use of this method or the use of other methods that aren’t specifically mentioned in the domestic regulations (some countries, while not specifically allowing the use of this method, do allow the use of other methods that aren’t included in the OECD TP guidelines if the taxpayer convinced the tax authority that all of the other method aren’t suitable and this method is the most appropriate one).

How Sixth Method works

The sixth method in transfer pricing, while similar to the Comparable Uncontrolled Price (CUP) method in using external market prices for benchmarking, has its unique focus and application. This method specifically bases the transfer price on the market value of goods at the time of shipment, independent of contract terms or the roles of the related parties in the transaction. It’s primarily used for commodities or other goods with easily identifiable prices in transparent markets.

The rationale behind this method is to counteract potential price manipulation by multinational companies. These companies might otherwise exploit the fluctuations and complexities inherent in commodity markets to their advantage. By anchoring the transfer price to the real-time market value, the sixth method ensures a fair and market-reflective pricing, reducing the opportunities for artificial inflation or deflation of prices for tax benefits.

This method, however, comes with its challenges. The volatility of commodity market prices can make determining the exact price at the time of shipment complex. Also, it might not be suitable for all types of transactions or industries where market prices are not transparent or easily determined. Despite these challenges, the sixth method is a crucial tool in ensuring that transfer pricing in multinational corporations reflects fair market values, especially in commodity transactions.

An example of the implementation of the 6^th method is, transaction between Company A, a wheat producer in Argentina, that sells wheat to its subsidiary Company B, a flour miller in Brazil, on January 3^rd, 2023. The price set in the market price of wheat on that date is $220 per ton, considering that the type, quality and quantity of wheat traded in the stock exchange is similar to that the tested transaction and that the prices sent include all of the related fees of the transfer of the wheat between the countries, the price that should be set in the transaction, in order to reflect the arm’s length principle is the quoted price, i.e., 220$ per ton.

Comparability Adjustments

A comparability adjustment aligns transactions between related and unrelated parties by eliminating significant differences. In the context of mineral sales, the OECD Transfer Pricing Guidelines mandate consideration of various factors such as physical features, quality, volumes, delivery terms, transportation, insurance, foreign exchange, and payment terms to ensure economic comparability. The degree of comparability adjustments permitted by tax authorities influences how closely the Sixth Method adheres to the arm’s-length principle.

Due to restricted access to taxpayer information and comparable data, some countries limit allowable adjustments to those easily observed and verified. For instance, Zambia only allows adjustments to the quoted price based on proof of low mineral quality or grade. This approach simplifies implementation but may not fully align with the arm’s-length price, particularly when adjusting for factors like varying metal percentages in different mineral products.

Advantages of the Sixth Method

Some advantages of the sixth method for transfer pricing are:

It is simple and certain, as it uses the market price of the traded goods on the date of shipment, regardless of the contractual terms or the functions performed by the related parties.
It is flexible enough to allow stakeholders to leverage upon it based on unusual facts and circumstances, such as the Covid-19 pandemic.
It allows the stakeholders to not only compare it with an actual transaction but also with quotations, which can provide a clear and relatively objective point of reference.

Disadvantages of the Sixth Method

The sixth method has some drawbacks and challenges, including:

It may not reflect the actual economic reality of the transactions, as it ignores the functional analysis, comparability factors and economic circumstances that are essential for the application of the arm’s length principle.
It may be difficult to determine the relevant market price, as there may be different sources, methods, and adjustments for obtaining the quoted prices of the commodities or the goods.
As mentioned above, the fact that this method is not widely recognised as a method that is allowed to be used in the domestic regulations, can cause compliance difficulties.
This method can result in a price that allocates a part of the profits to side of the transaction that is higher than it should be, which can result in double taxation.

In conclusion, it is advisable that the decision to utilize the sixth method is made with thorough consideration and careful judgment. This entails a comprehensive evaluation of the unique facts and circumstances surrounding the transactions, as well as a detailed analysis of the availability and reliability of relevant data. Additionally, it is very important to understand and plan for the potential tax implications.

Our firm specializes in international taxation and provides our clients with a comprehensive assistance for their transfer pricing needs. To schedule a consolation call with a member of our team, click here.