The Israeli tax authority tightening its standpoint regarding development centers


Recently, the Israeli tax authority announced its intention to tighten its standpoint with tax audits in relation to transfer pricing ("TP") policies with regard to research and development ("R&D") centers in Israel[1].

Generally, when an Israeli R&D center considers itself as a services provider (for a foreign related party), it chooses a cost base mechanism plus certain markup for determining the remuneration for its services.

According to the Israeli tax authority (stated in unofficial public discussion), it should be examined carefully, within FAR[2] analysis, if the Israeli R&D center indeed functions as a service provider or as a partially/fully owner of an intangible asset being developed.

To the extent it can be concluded that the R&D center economically owns an intangible asset, the costs base mechanism will not apply, due to the fact that it does not accurately reflect the contribution of such R&D center. In these cases a different pricing mechanism should be applied (i.e. profit split) between the R&D center and its foreign related party. This approach is based upon the OECD guidelines regarding the BEPS project.

According to the Israeli tax authority's perspective, the following are examples of characteristics which support the conclusion that the R&D center might have an economic ownership of an intangible asset:

  1. The origin of the intangible asset was in Israel and its development started in Israel.
  2. The Israeli entity engages in other activities besides the R&D activities.
  3. The group's headquarter is located in Israel.
  4. The Israeli R&D center is undertaking significant risks relating to the R&D activities.
  5. The activity of the Israeli R&D center is valuable and provides a unique contribution the multi-national group.

In contrast, the following are examples given by the Israeli tax authority for characteristics which represents the lack of economic ownership of an intangible asset:

  1. The Israeli R&D center was established at the initiative of a foreign multi-national group.
  2. The decisions regarding the intangible assets are made by the headquarters' personnel which are based outside Israel.
  3. The Israeli R&D center is not taking part in major business risks.
  4. The Israeli R&D center does not have the financial capabilities to support its activities.
  5. The Israeli R&D center does not have accumulated losses for tax purposes with respect to the development of intangible assets.
  6. The Israeli R&D center does not provide a valuable and unique contribution, within the multi-national group.

The more significant the R&D activity is (concerning the development activity of an intangible asset), the more vulnerable a cost base pricing method will be.

It is important to note that the representative of the Israeli tax authority indicated that in his opinion the majority of the R&D centers in Israel are probably "caught somewhere in the middle". As such, it cannot be definitively assumed that the R&D centers own or do not own an intangible asset. This position increases the tax uncertainty for the Israeli R&D centers (and this can get complicated in particular when it may lead to a potential double taxation).

Furthermore, recently the Israeli tax authority upgrade the TP documentation requirements (for example in a circular[3] issued in January 2020(, which outlines the standards for documentation, upgrades the 1385 TP form required with annual tax returns, and also published a bill[4] to update the documentation requirements, including reference to Master File and Local Files.

We strongly recommend that International Groups with relevant R&D centers in Israel, re-examine their TP policies in light of these developments. For further details and assistance please contact:

Amit Shalit, Partner, Head of Transfer Pricing
972 52 6008056


[1]  Which provide R&D services to their foreign related parties.

[2]  Functions, Assets, Risks.


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