Israel: Final guidance regarding local R&D centers and IP valuations

The Israel Tax Authority (ITA) on November 2, 2025, released their finalized Tax Circular laying out various criteria and requirements for certain local research and development (R&D) centers, as well as for post-acquisition sales of intellectual property (IP), for which the ITA may provide certainty.

Background

Many foreign multinational enterprise (MNE) groups currently maintain some form of captive R&D services in Israel, with the majority applying transfer pricing treatment based on a “cost-plus” recharge of expenses in line with accepted transfer pricing practice (i.e., Transactional Net Margin Method in the parlance of the OECD Transfer Pricing Guidelines and Comparable Profit Method under U.S. Treas. Reg. § 1.482-5). A recurring area of controversy with the ITA has been whether a cost-plus is acceptable (as opposed to ITA claims of possible profit sharing or even IP ownership) and at what level.

Another area of perennial local ITA controversy concerns a common scenario where a local entity has been acquired by a foreign MNE group, and the local IP is sold (or otherwise transferred) elsewhere within the group. The ITA has taken various valuation positions that reach amounts far in excess of that reported by the local taxpayer, and often in excess of the original acquisition price.

The ITA in February 2025 released a draft of the Circular for public comment (read TaxNewsFlash), which has now been updated and released in final form.

The Circular

The Circular covers two primary areas:

• Local R&D centers compensated with a cost-plus: When a taxpayer has met the relevant conditions, an ITA exam team will only be permitted to raise a claim of an alternative transfer pricing method if they have prior and ongoing involvement and approval of the ITA's dedicated technical teams that handle the relevant transfer pricing topics. These criteria include (not an exclusive list):
  • A foreign ultimate parent company that has full direct/indirect control of the local entity.
  • Israeli tax residents (or former tax residents) do not exercise more than 10% control of the parent entity.
  • The local entity engages solely in contract R&D activity, which meets the criteria in the local Encouragement Law covering provision of R&D service to a foreign resident.
  • The local entity is compensated for all its costs as well as a markup/margin.
  • The entity attaches to its annual corporate tax return the relevant intercompany agreement, a full transfer pricing study including a DEMPE analysis and benchmarking with the associated accept/reject matrix, as well as making a written declaration that it intends to apply these provisions.

Additionally, the Circular states that where all the criteria are met, an ITA exam team must obtain similar approvals to seek an assessment raising the cost-plus margin above 14%.

Companies engaged in provision of R&D services to a foreign resident, regardless of meeting the mentioned criteria, can apply for a ruling from the ITA approving their transfer pricing approach, in line with local 85A(d)(1). Per the Circular, if the company and ITA do not reach an agreement on the transfer pricing approach, the company may withdraw its ruling application.

• Sale of IP post-acquisition and subsequent conversion to contract R&D: The ITA will provide a formal ruling affirming the IP value and the go-forward cost-plus treatment for a period of seven years, if the taxpayer has met various criteria, including:
  • Prior to acquisition, the entity met the criteria of a “Preferred Technology Company,” with its IP meeting the definitions of a “Beneficial Asset,” under the local Encouragement Law.
  • The acquiring entity did not have material shareholding in the local entity prior to acquisition.
  • The local IP is sold within 180 days of the acquisition closing (changed from 30 days in the prior draft), and effective as of the closing date.
  • The IP is sold at a value that is not less than 85% than adjusted enterprise value, inclusive of off-balance sheet "liabilities" such as employee bonuses and expected grant repayments to IIA; crucially, the final Circular does not include a “gross-up” calculation for the expected tax as had been in the prior draft.
  • The company will continue to provide R&D services for the complete duration of the seven-year ruling period.
  • The Circular does not include a stipulation that local workforce will continue to remain consistent with the workforce levels prior to acquisition, as had been in the prior draft.

Importantly, as added in the final Circular, the IP ruling will include approval of the reduced 6% capital gains rate applicable for a “Beneficial Asset,” under the local Encouragement Law.

In addition, the final Circular includes an appendix detailing documents that will be required for an application for the above IP valuation ruling. Some of these (such as acquiror target model and internal approval documentation) may represent internal material of non-Israel taxpayers.

Finally, the Circular references the process for seeking a bilateral/multilateral advance pricing agreement (APA) with other jurisdictions, and states that ITA encourages the use of multilateral APAs in this area, allowing for greater taxpayer certainty.

The Circular is a part of a broader effort by the Ministry of Finance and ITA to provide tax clarity and certainty to the technology community. The Circular has included important changes from the prior draft, although the criteria potentially include elements that may continue to be a source of controversy in the local context.

Read an unofficial translation of the Tax Circular.
 

For more information, contact a tax professional with KPMG’s Global Transfer Pricing Services practice in Israel:

David Samson | dsamson@kpmg.com

Itay Falb |  itayfalb@kpmg.com