Israel’s Ministry of Finance, the Israel Tax Authority (ITA) and the Israel Innovation Authority (IIA) on 2 November 2025 unveiled an income tax circular that provides a comprehensive tax reform for the high-tech industry.
A draft version of Income Tax Circular 8/2025: Attribution of Income to Research and Development Centers, was originally published in February 2025. (For prior coverage, see Israel - Tax Authority Issues Draft Circular on Taxation of Technology Development Centres - BDO).
Circular Highlights
The circular addresses cases involving multinational enterprises (MNEs) that receive research and development (R&D) services from an Israeli related party (subject to Section 85A of the Income Tax Ordinance, Israel’s transfer pricing legislation) where the services are reported as routine and low-risk. The foreign affiliate bears the R&D costs and funding risks and has the capacity to control and manage those risks. The development services are priced using a net cost-plus mechanism.
The circular introduces an internal audit mechanism limiting the tax inspector’s ability to apply alternative methods (such as the profit split) if certain conditions are met, including:
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The ultimate parent company (defined in Section 85C(a) of the ordinance) is a foreign resident incorporated outside Israel and resident in a country that has entered into an income tax treaty with Israel to prevent double taxation.
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Israeli residents do not hold (directly or indirectly) 10% or more of the controlling rights in the ultimate parent company.
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The Israeli company attaches to its annual tax return a copy of the R&D service agreement and a transfer pricing analysis that includes certain elements such as a DEMPE (development, enhancement, maintenance, protection, and exploitation) functional analysis, a benchmarking matrix of accepted/rejected comparables, and other documentation, provided the report under Section 131 of the ordinance is submitted after the publication of this circular.
This procedure applies to tax years open for assessment and with respect to all tax returns to be submitted by the end of the 2029 tax year.
If a tax inspector seeks to apply a net cost-plus markup mechanism exceeding 14%, and the company meets the above conditions, the tax inspector will be subject to certain restrictions.
Israeli companies providing R&D services to non-Israeli related parties — whether they meet the conditions in Chapter 2 of the circular or not — may apply for an advance tax ruling confirming that the transaction price reflects arm’s length terms under Section 85A.
Taxpayers transacting with related parties in treaty partner countries may request a bilateral or multilateral advance pricing agreement (APA), binding both the Israeli Tax Authority and the foreign tax authorities, subject to the applicable double taxation treaty.
The circular also allows Israeli companies developing a “preferred intangible asset” (as defined in Section 51Kd of the Encouragement of Capital Investments Law, 1959) that were acquired by a foreign ultimate parent and sold the intangibles asset to that parent while transitioning to an operating model of providing R&D services with limited risk, to apply for a tax ruling confirming that:
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The consideration for the intangible assets sold reflects an arm’s length value under Section 85A.
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The ongoing R&D services related to the continued development of the intangibles sold will be priced on a cost-plus basis for seven years following the closing of the acquisition of the Israeli company shares.
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This ruling is subject to several conditions, including that the minimum attributed value of the intangibles sold equals at least 85% of the total consideration (net of cash and cash equivalents), plus certain liabilities of the acquired company. From the closing date, the attribution of profits to the target company will be in accordance with the R&D service provision model as a provider of services with limited risk regarding the continued development of the intangible assets sold.
For more information on the new rules, please consult your regular BDO contact or the author of this article.
Amit Shalit
BDO in Israel