Client Update: Israel Tax Authority Issues Transfer Pricing Ruling Confirming Cost-Plus Method for Large-Scale Israeli R&D Center

We are pleased to share a recently published a summary of a tax ruling (the “Ruling“) issued by the Israel Tax Authority (“ITA“). The Ruling was issued at the request of our firm on behalf of a client. The Ruling addresses the arm’s length compensation for limited-risk research and development (“R&D“) services provided by an Israeli subsidiary to its foreign parent company, and confirms that the cost-plus method (under the transactional net margin method, or “TNMM/CPM“) is the appropriate transfer pricing methodology for determining the Israeli company’s remuneration, even where the Israeli R&D center plays a substantial role in developing the multinational group’s core products.

The Ruling is particularly significant for multinational enterprises (“MNEs“) operating Israeli R&D centers, as it provides much-needed certainty and reinforces that substantial Israeli development activities, including senior-level personnel and meaningful contributions to core IP, are consistent with a limited-risk, cost-plus characterization, provided that the requisite structural and governance conditions are met.

Background

Over the years, there has been some debate in Israel as to the question of how Israeli R&D centers should be compensated. The ITA has, in the past, raised the contention that the profit-split methodology should be implemented for the purpose of compensating Israeli R&D subsidiaries of multinational groups, due to the Israeli entity’s contributions to IP development. In November 2025, the ITA published a circular on this topic (the “Circular“), introducing internal audit mechanisms and oversight requirements governing any change from a cost-plus to a profit-split methodology during tax audits (see our previous client update here). The Circular also allows Israeli taxpayers to apply for tax rulings confirming the applicability of the cost-plus method and the relevant margin.

The Ruling discussed herein is the first concrete ruling issued after the Circular, and it offers valuable insight into the ITA’s approach and the factual parameters that the ITA considers acceptable for a cost-plus determination.

Key Facts of the Ruling

The Ruling involves an Israeli company (the “Israeli Company“) that is a wholly owned subsidiary (directly or indirectly) of a large, publicly traded foreign company (the “Foreign Parent“) resident in a treaty jurisdiction. The Foreign Parent heads a multinational group with revenues exceeding USD 10 billion. No Israeli residents (including former Israeli residents) hold 10% or more of the means of control of the Foreign Parent.

The Israeli Company provides limited-risk R&D services to the Foreign Parent under an intercompany R&D services agreement, in exchange for a cost-plus markup on its total operating costs. Notably, the following features of the arrangement were accepted by the ITA as consistent with a limited-risk characterization:

• Significant Israeli workforce, including senior-level employees: The Israeli Company employs R&D personnel at all levels – junior, mid-level, senior technical, and managerial – although not at the level of the group’s senior management.
• Meaningful contribution to core products: The Israeli Company participates in the development of the Foreign Parent’s core products and has developed certain components of those core products, subject to the approval of the Foreign Parent’s senior management.
• DEMPE functions retained by Foreign Parent: The Foreign Parent performs all functions relating to the development, enhancement, maintenance, protection, and exploitation (“DEMPE”) of the group’s intangible assets and retains full ownership of all IP. Strategic decisions regarding IP development are made by the Foreign Parent’s senior management. Israeli employees may present professional recommendations but decision-making authority rests with the Foreign Parent.
• Foreign Parent controls R&D risk: The Foreign Parent has the capability and authority to control all R&D-related risks, approves the Israeli Company’s budget, supervises its operations, and funds its activities.
• One of several R&D centers: The Israeli Company is one of multiple R&D centers fully owned by the Foreign Parent.

The Ruling

The ITA confirmed that the arm’s length compensation for the Israeli Company’s R&D services should be determined using the TNMM, with a mark-up on total costs (MTC) as the profit level indicator (PLI).

In determining the applicable interquartile range, the ITA took into account characteristics similar to those of the Israeli Company, including the sector of activity, the economic environment, the competitive landscape, and the size and complexity of the R&D services provided. The cost-plus markup was set at 13%.

Key Takeaways and Practical Implications

The Ruling carries several important implications for MNEs with Israeli R&D operations:

1. Significant Israeli teams are compatible with cost-plus: The Ruling makes clear that an Israeli R&D center can employ a large and skilled workforce, including personnel at senior technical and managerial levels, without jeopardizing a limited-risk, cost-plus transfer pricing model. This is a much-needed confirmation for MNEs that wish to maintain and grow substantial Israeli development teams.
2. Core IP development does not preclude cost-plus: The fact that the Israeli Company develops significant portions of the group’s core products, and may even be responsible for certain components on an exclusive basis, did not prevent the ITA from confirming the cost-plus methodology. What matters is the overall governance and risk allocation structure: so long as DEMPE functions and strategic decision-making remain with the foreign parent, and the Israeli entity operates as a limited-risk service provider, cost-plus remains appropriate.
3. Alignment with the ITA Circular: The Ruling is consistent with the framework established by the ITA’s November 2025 Circular and demonstrates the ITA’s willingness to grant advance certainty to qualifying MNEs through the tax ruling process. This should provide comfort to MNEs considering applying for similar rulings with respect to their own Israeli R&D centers.
4. Benchmark of a 13% markup: Although every ruling is fact-specific and the applicable margin will depend on the particular characteristics of the Israeli entity and its comparables, the 13% cost-plus markup adopted in this Ruling serves as a useful data point for MNEs benchmarking their own Israeli R&D arrangements and potential agreements with the ITA.
5. Structural considerations remain critical: The Ruling underscores the importance of maintaining proper governance structures, intercompany agreements, and documentation, including clear allocation of DEMPE functions, strategic decision-making authority, budgetary oversight, and risk control at the foreign parent level. MNEs should carefully review their existing arrangements in light of the standards reflected in this Ruling and the Circular.
6. Application to MAP: The ruling does not prevent later MAP proceedings over the transfer pricing or plus margin.

Our tax department has extensive experience advising multinational companies on transfer pricing matters involving Israeli R&D centers, including the preparation and negotiation of tax ruling applications, transfer pricing studies, and representation in ITA audits and litigation. As noted, our firm was the first to obtain this tax ruling. We encourage MNEs with Israeli operations to consider whether a tax ruling of this kind may be beneficial in providing certainty and mitigating transfer pricing risk.

Sincerely,

Tax Department Herzog, Fox & Neeman

This client update does not constitute legal advice, and should not be relied upon without obtaining proper legal counsel.