February 16, 2021
Israeli Tax Authority publicly presents its view on profit split application for R&D centers
In recent years, the Israeli Tax Authority (ITA) has been considering the appropriate transfer pricing method for the taxation of research and development (R&D) centers of multinational enterprises (MNEs) in Israel.
Traditionally, R&D centers in Israel have been remunerated under the cost-plus method. However, the ITA’s position as expressed recently is that, in many cases, the appropriate profit allocation method should be based on the profit split model.
At a recent public conference in which the professional department of the ITA participated (the Conference), a senior official identified the criteria that would be used for such a determination.
The ITA is currently drafting a tax circular, which will be published in the coming weeks, that will address this issue. It is anticipated that these criteria will identify situations where an R&D center might share the economic ownership of the intangible assets that it is a partner in creating.
This classification has significantly broader implications than just profit allocation, as it may lead to ownership claims when an intangible asset is transferred, for example upon a change of a business model within the group. In some cases, it may also lead to tax implications for foreign residents upon their sale of shares in a foreign company that operates an R&D center in Israel.
The following are the criteria that the ITA has stated are indicative of economic ownership of intangible assets by the R&D center:
On the other hand, these criteria may indicate the R&D center lacks economic ownership of intangible assets:
The official concluded that even in cases where there is no economic ownership of an intangible asset by the R&D center, it is possible that the existing cost-plus remuneration is too low and not aligned with the contribution of the R&D center in Israel, and that the purpose of the ITA is to find the balance point for fair taxation of R&D centers in Israel.
Multinationals with R&D centers in Israel should follow the anticipated developments on this issue. While written guidance has not been published, taxpayers should be prepared to review the facts and transfer pricing policies of their R&D centers. Companies that are uncertain about the transfer pricing treatment of their R&D center, may want to consider an Advance Pricing Agreement (APA) to obtain certainty.
A detailed Tax Alert will be issued once the circular is officially published.
For additional information with respect to this Alert, please contact the following:
EY Israel, Tel Aviv
Ernst & Young LLP (United States), Israeli Tax Desk, New York