Transfer Pricing in Israel

The legal framework

Israel's transfer pricing regime rests on one charging provision and one set of regulations. Section 85A of the Income Tax Ordinance [New Version], 5721-1961 — inserted by Amendment 132 and operative from 29 November 2006, when the implementing rules were gazetted — requires that an international transaction between parties in a special relationship be reported and taxed on market terms, and lets the assessing officer call for the evidence.

Two boundaries matter. First, section 85A reaches only international transactions: those with a foreign-resident counterparty, or whose income is taxable abroad. Purely Israeli related-party dealings sit outside the regime, though the assessing officer can still attack them as artificial under section 86. Second, "special relations" is drawn broadly in section 85A(b) — a person and a relative, or where one party controls the other, or one person controls both, directly or indirectly, alone or together with another. Control means holding 50% or more of any single means of control, and section 88 treats the means of control as five distinct rights: profits, appointment of directors, voting, residual assets on liquidation, and directing how another holder exercises those rights. Each can arise from shares, contract, a voting agreement or a trust, so the 50% test is met far more often than a shareholder register suggests.

The mechanics live in the Income Tax Regulations (Determination of Market Conditions), 5767-2006, substantially rewritten by the amending regulations gazetted on 22 September 2022. The OECD Guidelines are not enacted and do not bind the courts. They are a persuasive interpretive source only — but a heavily used one, because Israel has no domestic rules at all on intangibles, hard-to-value intangibles, services, commodities or cost contribution arrangements and defers to the Guidelines on each.

Methods, comparables and benchmarking

Regulation 2(a) lists all five OECD methods plus a residual "other method", but selection is not left at large. Israel operates a genuine hierarchy. The comparable uncontrolled price method must be used where a sufficiently similar uncontrolled transaction exists; only when it cannot does the taxpayer descend to the second tier — a profitability-margin comparison or a profit split, whichever fits — and the residual method is reached only when neither tier works. Circular 1/2020 states the practical consequence plainly: a study that does not explain why the higher-ranked methods were rejected is not a compliant study.

The definition of the profitability margin is unusually prescriptive. Where a sector conventionally prices at a fixed mark-up on direct costs, the observed rate is the margin; where it prices at a fixed gross margin on the buyer's sales, that gross margin governs; failing both, the analyst picks the profit-level indicator best suited to the activity and defends the choice.

The range rule is where Israel departs hardest from international practice. Regulation 2(b) fixes the arm's length range as the interquartile range — the 25th to 75th percentile of the study's distribution — with the full range reserved for an unadjusted CUP. A result outside the range is not moved to the nearest edge. It is restated to the median. Planning to the 26th percentile is therefore a bad idea in Israel: the penalty for landing marginally outside is a jump to the middle of the set.

Comparability adjustments are mandatory rather than optional, and internal comparables rank ahead of external ones: an uncontrolled transaction of the tested party itself must be used where one exists with all or most criteria identical. Israel expresses no preference for local comparables and the ITA does not use secret comparables. In practice the Israeli filing universe is too thin to support most searches, so service and R&D studies are usually built on US or North American data and distribution studies on pan-European sets — but the geography must be argued, not assumed.

Documentation: what the Israel Tax Authority expects

There is no monetary de minimis for the local file. Every international related-party transaction must be supported by a market conditions study meeting the content requirements of the regulations, and a group below the master-file threshold still files Form 1385 and still holds a study. Amendment 261 added section 85B (documentation, including the master file) and section 85C (country-by-country reporting), both from the 2022 tax year, and the amended regulations aligned local file contents with BEPS Action 13.

The thresholds are straightforward. A master file is required where group revenue in the preceding year reached NIS 150 million. A CbC report is required where consolidated turnover reached NIS 3.4 billion and the ultimate parent is Israeli resident — filed within 12 months of year end, in OECD XML schema, through the ITA's automatic exchange portal, with Circular 01/2025 setting out the mechanics. Where the group files abroad, notification must reach the ITA by the end of the fiscal year, and if the partner jurisdiction has not received the report within 15 months of year end, the Israeli parent files locally.

The operational point that catches groups out is the production deadline. The 2022 amendment cut it from 60 days to 30. Some reference material still quotes 60, and it is possible the older figure survives in section 85A(c) while 30 sits in the amended regulation — but plan to 30, which means the study has to exist before the request arrives. Israel achieves contemporaneity without using the word: the revised Form 1385, in force since 23 December 2022, requires the taxpayer to declare whether it holds a study for each disclosed transaction at the moment the return is filed. Answering no invites audit; answering yes without a study is a false declaration.

Circular 1/2020 sets the quality bar. The ITA expects the entire comparables search documented, a complete accept/reject matrix with financial data, the method defended against the alternatives, and every comparability adjustment quantified and explained. Memoranda and slide decks are expressly rejected. Studies may be in Hebrew or English.

Audits, penalties and the enforcement climate

Israel has no bespoke transfer pricing penalty. An adjustment runs through the general deficiency fine in section 191, which is keyed to the tax deficiency rather than to income and which reverses the burden of proof: 15% applies where the deficiency exceeds 50% of the tax the person is liable for, unless the taxpayer proves he was not negligent. The rate doubles to 30% on either of two distinct routes — where the deficiency was caused by an intent to evade tax, or where it exceeds both ILS 500,000 in the tax year and 50% of the tax due and arises from one of five listed defaults, among them an undisclosed reportable position or reportable tax opinion, an artificial transaction under section 86, and acting contrary to a tax ruling. The fine is waivable at the assessing officer's discretion in settlement. The sharper cost is time: assessed tax carries CPI linkage plus 4% annual interest from the end of the tax year, so an adjustment for an older year lands well above the headline rate.

The real protection mechanism is procedural. A fully compliant study shifts the burden of proof to the assessing officer under section 85A(c). Circular 1/2020 narrows this considerably: the ITA tests the study for completeness first, and where it is incomplete, or the dispute turns on the underlying facts or the choice of method, the burden stays with the taxpayer and the officer may assess on best judgement without commissioning a competing economic analysis. That asymmetry is why documentation quality in Israel is a litigation strategy rather than a compliance chore.

Secondary adjustments are applied. An upward adjustment favouring a foreign parent is typically recast as a deemed dividend with treaty withholding; the reverse becomes a notional loan carrying imputed interest, which is far less painful because repayment generates neither income nor deduction. In practice the ITA will often trade the secondary adjustment as part of a settlement.

The case law has moved fast. Kontera and Finisar (Supreme Court, Case No. 943/16, 22 April 2018) settled that stock-based compensation belongs in the cost-plus base. Gteko (49444-01-13, Central District, June 2017) and Broadcom (26342-01-16, Lod (Central) District Court, 9 December 2019) mark the poles of post-acquisition restructuring — the first a transfer recharacterised as a sale of the whole Israeli business and priced off the acquisition consideration, the second a taxpayer win on migration to a cost-plus service model — and Circular 15/2018 codifies the ITA's position. eBay Marketplace Israel (5 April 2024) is the most consequential recent decision for inbound structures: the court accepted that cultivating Israeli customers went beyond marketing support and displaced cost plus with a distributor TNMM on operating margin. Hexadite (Tel Aviv-Jaffa District Court, 59306-01-23, 28 October 2025) then refined IP valuation, holding that the transfer value need not be grossed up for the future tax on the transfer, but that holdback payments to founders must be brought into the value of the company and its IP. Enforcement now concentrates on three themes: DEMPE-driven challenges to cost plus, recharacterisation of licensing as IP transfer, and conversion of marketing arrangements into distributor returns.

Dispute resolution and advance certainty

The domestic route is short and unforgiving on timing. An objection must be filed with the assessing officer within 30 days of the assessment; the ITA then has a year to decide, failing which the objection is deemed accepted. A rejection is appealable to the District Court within 30 days, where a single judge hears fact and law, and onward to the Supreme Court on law only.

Advance certainty is available under section 85A(d) in unilateral, bilateral and multilateral form. Israel was for years effectively a unilateral-ruling jurisdiction, so the ITA's announcement on 18 March 2024 that it had concluded its first bilateral APA is a genuine shift, and Circular 8/2025 now expressly encourages taxpayers towards bilateral and multilateral agreements. The timetable is statutory, but narrow. Section 85A(d)(4) fixes the period in which the Director must notify a decision on a complete application — reported as 120 days, extended to 180 in some cases — and section 85A(d)(5) deems the price to be at arm's length where he does not respond in time. That deemed approval is a unilateral remedy only: because bilateral and multilateral APAs run through the treaty mutual agreement procedure, the ITA states expressly that applications for them fall outside sections 85A(d)(4) and 85A(d)(5), and there is no published standard term. Claims of no user fee and of rollback for bilateral APAs remain unverified — confirm both with the transfer pricing department before building a timetable around them.

On the treaty side, Israel has more than 50 double tax treaties and the ITA acts as competent authority. The MAP circular of 17 August 2023 replaced a 2001 predecessor and aligns with BEPS Action 14: the competent authority function is separated from the assessing officer, timing and closed-year treatment are addressed, and the taxpayer has 30 days to accept or reject an agreed outcome. Two limits deserve attention. The circular preserves the position that where MAP fails, the competent authority need not relieve double taxation if it regards the Israeli charge as correct domestically. And Israel, having ratified the MLI with effect from 1 January 2019 and published its positions in Circular 01/2022, adopted the corresponding-adjustment provision but reserved on Part VI — so there is no mandatory binding arbitration behind a failed MAP.

Pillar Two and what changes in 2026

The Knesset passed the Minimum Corporate Tax on Multinational Groups Law on 29 December 2025, effective for fiscal years beginning on or after 1 January 2026. Israel has enacted a qualified domestic minimum top-up tax only, applying a 15% minimum effective rate to Israeli constituent entities of groups above EUR 750 million of consolidated revenue in at least two of the four preceding years. It has deliberately declined the income inclusion rule and the undertaxed profits rule for now.

For transfer pricing the consequence is arithmetical rather than conceptual. The margin left in an Israeli entity now feeds directly into an effective tax rate computation, and Israel's incentive regimes — including the 6% preferred intangible asset rate that Circular 8/2025 relies on — become the very thing a top-up tax is designed to claw back. Groups that spent a decade optimising the Israeli return downward should model whether that return now simply converts into domestic top-up tax. Amount B, meanwhile, has no Israeli footprint: no ITA adoption could be identified, and inbound distributors continue on the 3-4% band in Circular 12/2018.

How practitioners should respond

Four practical conclusions follow. First, build the study before the request. Thirty days is enough to hand over a finished file and nowhere near enough to construct one, and Form 1385 forces an annual declaration about whether the file exists. Second, treat the DEMPE analysis as the contested ground, not as boilerplate. The ITA's argument in almost every significant matter is that the Israeli entity is not the routine party, and Circular 1/2020 already requires the study to explain why profit split was rejected where both sides hold valuable intangibles.

Third, choose a lane early and disclose it. The Circular 12/2018 safe harbours and the Circular 8/2025 R&D route each buy real certainty, but each is conditional on characterisation and on attaching the right analysis to the return. A structure that quietly sits outside both, with a cost-plus margin defended on generic comparables, is the profile the ITA is actively auditing. Fourth, model the median. In Israel the downside of a result marginally outside the interquartile range is restatement to the 50th percentile, and secondary adjustments then convert the shortfall into a deemed dividend with withholding. Price both into any settlement position.

Finally, verify the primary texts. The ITA publishes everything on gov.il, which blocks automated access, so much of the readily available commentary is second-hand and some of it is stale. Section numbering, the production deadline, the CbC form number and the safe harbour wording should all be read from the Hebrew source before advice is given.