On June 2nd, 2020, the Israeli Tax Authority ("ITA") released a tax circular (Tax circular-1/2020) detailing the conditions required to comply with the provision of Section 85A of the Income Tax Ordinance and the regulations promulgated thereunder - which require to prepare a Transfer Pricing ("TP") analysis for an international transactions performed between related parties in accordance with section 85A (c) (1) and TP Regulation.
The fulfillment of the conditions means transferring the burden of proof to the ITA inspector (within the framework of a tax audit), as opposed to the rule placing the burden of proof and the burden of persuasion on the taxpayer.
The following is a non-exclusive list of the main conditions detailed in the Tax circular:
1. Detailed and Substantiated TP analysis
The documents submitted as part of the TP analysis should support the claims of the taxpayer and lead to the conclusion of the TP analysis in a way that will connect the facts, the evidence, and the claims. Also, the TP analysis should be thorough and exhaustive in a way that is appropriate to the circumstances of the matter.
2. Method selection
The TP analysis should also include a reasonable explanation for the choice of the selected TP method. For example, in case where both parties to the transaction hold valuable intangible asset that have a significant impact on the shared profit and loss, and the taxpayer determined the arm's length price by a measure of markup on the total direct and indirect costs, without a reasonable explanation as to why he did not choose the profit split method - Then it will be determined that the taxpayer did not meet the requirement of section 85A.
3. Documentation of Benchmark's steps
Documentation of the steps in the search for comparable companies; a list of companies that have been manually disqualified to serve as comparable companies; the list of companies accepted as comparable companies and the financial data of the comparable companies accepted on which the arm's length price calculation was done on.
4. Additional supporting documents
The TP analysis should include all the documents described in regulation 5 of the Income Tax Regulations, as well as important documents that can be used to support the TP analysis, in the matter of both factual claim and method of analysis, as well as financial reports of the tested party, financial reports of the international group, etc.
5. The arm's length TP analysis refers to transactions with similar characteristics.
6. Implementation
Documents that implement the arm's length price. The requirement applies to both the report on the Israeli side and the reports of the other side of the
transaction (it should be emphasized that the new transfer pricing form (1385) also refers to the financial statement).
In the case where the taxpayer did not submit a TP analysis, or in case where the TP analysis was submitted but does not comply with the requirements of the law and regulation for determination of arm's length conditions, the tax inspector will not be obliged to perform a complete TP analysis (in the same scale initially required), instead the inspector will set the assessment according to the best of his judgment (i.e. estimates, evaluations, personal experience, etc.).
Nevertheless, the inspector holds the right to activate full sanctions by law including a deficit penalty and more.
As long as the taxpayer fulfills the duty to provide evidence as detailed in section 85A(C)(2) of the Income Tax Ordinance, this duty will be transferred to the inspector.
There is no doubt that working according to the above will save many arguments and discomfort and will create a clear advantage for the taxpayers.
BDO IL's transfer pricing team is at your service for consultation throughout the process including conducting arm's length TP analysis according to the terms mentioned above.
Amit Shalit, Partner, Head of Transfer Pricing
AmitS@bdo.co.il
972 52 6008056