Israel Transfer Pricing Rule Updates and Changes 2026

Israel is becoming harder to treat as routine for transfer pricing purposes where local R&D teams perform meaningful DEMPE activity, support product decisions, or sit within acquisition-related IP transfer structures.

Israel transfer pricing is becoming harder to treat as routine for R&D centres

Israel has long been a key jurisdiction for technology groups with local R&D activity.

But the 2025-2026 transfer pricing message is becoming much clearer: an Israeli R&D entity cannot be treated as a routine cost-plus provider simply because the intercompany agreement says so.

The Israel Tax Authority’s Circular 8/2025, published on 2 November 2025, introduces a more substance-driven framework for Israeli R&D centres and post-acquisition IP transfers. In practice, businesses now need to show whether the Israeli entity is genuinely an execution-only R&D provider, or whether Israeli teams are performing higher-value DEMPE functions linked to the development, enhancement, maintenance, protection, or exploitation of intangibles.

For finance and tax teams, the message is simple: review the actual conduct, the cost base, the DEMPE profile, and any IP transfer history before the ITA does it for you.

1. Cost-plus is no longer just a documentation position

Circular 8/2025 is most relevant for multinational groups with Israeli R&D subsidiaries that are remunerated on a cost-plus basis.

The key point is that the ITA is looking beyond the contractual label. If the Israeli entity is genuinely an execution-only service provider, cost-plus may still be supportable. But if Israeli personnel control product direction, approve budgets, manage key R&D decisions, or otherwise perform DEMPE-active functions, the ITA may expect a higher return, a different transfer pricing method, or some attribution of IP value to Israel.

This makes the functional analysis more important than the intercompany agreement alone.

What to review: whether the Israeli entity is actually routine in practice, who controls the R&D roadmap, who approves the budget, who initiates projects, and whether the TP file includes a real DEMPE analysis.

2. The safe harbour depends on strict conditions

The circular provides a safe harbour framework for qualifying R&D service centres, but it is not automatic.

According to the brief, the Israeli entity must meet cumulative conditions, including sole R&D service activity, cost-plus compensation, no legal or economic ownership of IP, a foreign ultimate parent control structure, compliance with the Encouragement of Capital Investments Law, and required documentation attached to the annual tax return. The brief also highlights that the ITA specifically expects stock-based compensation to be included in the cost base.

That matters because many groups treat stock-based compensation as a finance or HR issue rather than a transfer pricing cost-base issue. In Israel, that distinction can become difficult to defend if the R&D remuneration excludes material employee-related costs that support the local development activity.

What to review: whether the Israeli R&D centre meets all safe harbour conditions, whether stock-based compensation is included in the cost base, and whether the annual documentation package includes the required DEMPE and benchmarking support.

3. Post-acquisition IP transfers need stronger valuation support

The circular is especially important for groups that acquired an Israeli company and then transferred IP out of Israel.

For those cases, the brief highlights a ruling track where the IP transfer price must generally be at least 85% of the adjusted enterprise value of the Israeli entity. The adjusted value should take account of relevant items such as cash, cash equivalents, off-balance-sheet liabilities, employee bonuses, and Israel Innovation Authority grant repayment obligations.

This is a clear signal that the ITA is focused on whether value is leaving Israel without appropriate compensation. It also means that a standalone valuation prepared without close transfer pricing and restructuring analysis may not be enough.

What to review: any post-acquisition IP migration, the valuation basis used, whether the 85% floor is relevant, whether Israel Innovation Authority grant obligations were reflected, and whether the group considered a Chapter 3 ruling or APA route.

4. The Hexadite decision reinforces the focus on IP valuation

The 2025 Hexadite decision adds another important signal for acquisition-related IP transfers.

The Tel Aviv District Court held that the value of transferred IP did not need to be grossed up for the expected Israeli tax liability, but that holdback payments linked to the acquisition had to be included in the company and IP valuation.

For taxpayers, this is a mixed but useful signal. The no-gross-up conclusion is taxpayer-favourable, but the inclusion of holdbacks shows that contingent or deferred deal economics cannot be ignored simply because they are structured differently from upfront consideration.

What to review: acquisition agreements, earn-outs, holdbacks, retention-linked payments, IP transfer valuations, and whether the valuation reconciles properly to the broader deal economics.

5. Pillar Two adds another layer for large groups

Israel has also enacted a Qualified Domestic Minimum Top-up Tax, or QDMTT, with effect for fiscal years beginning on or after 1 January 2026. The regime is relevant for MNE groups within the Pillar Two threshold, generally groups with consolidated revenue of at least EUR 750 million.

This should not be viewed as separate from transfer pricing.

If an ITA adjustment increases Israeli taxable income, that can also affect the local tax base and the group’s effective tax rate analysis. For large groups, transfer pricing, R&D remuneration, IP valuation, and Pillar Two readiness need to be coordinated rather than managed as separate workstreams.

What to review: whether Israeli entities are in Pillar Two scope, whether local TP positions could affect QDMTT calculations, and whether TP and Pillar Two teams are working from consistent data.

6. The wider message is substance over form

The main mistake in Israel is to treat an R&D centre as routine simply because the legal agreement says it is routine.

The direction of travel is different. The ITA is looking more closely at actual decision-making, DEMPE activity, cost-base completeness, valuation support, and whether IP has moved out of Israel on defensible terms.

For CFOs and tax managers, the practical question is simple: does the group’s Israeli TP model reflect what people in Israel actually do?

What to review: the gap between contractual characterisation and operational reality, especially where Israeli teams influence product, technology, architecture, budget, or roadmap decisions.

Final takeaway

Israel’s 2025-2026 transfer pricing story is not just about updating documentation.

It is about substance, DEMPE, cost-base integrity, IP valuation, and readiness for a more structured ITA approach to R&D centres and post-acquisition restructurings.

For groups with Israeli R&D entities, the right response is to test the functional profile, review the cost-plus model, confirm whether stock-based compensation and other costs are included properly, and revisit any historic or planned IP transfer before it becomes an audit issue.

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