Following article 85A, the Income Tax Regulations (Determination of Market Conditions), 5767-2006 (the "Regulations") were issued, in order to describe the methodologies for determining the arm’s length prices.

The most preferred method in the Regulations is the Comparable Uncontrolled Price method (CUP). If the CUP method proves unreliable, then the Profitability Ratio method or the Profit Split method (PSM) shall be used. If none of these methods prove to be reliable, the price shall be determined using any other method that is most appropriate under the circumstances.

It should be emphasized that the Profitability Ratio method consists of three sub-methods: The Cost Plus Method (CPM), the Resale Price Method (RPM) and the Transactional Net Margin Method (TNMM). However, the RPM and the CPLM are preferable to the TNMM.

The CUP method aims to find comparable transactions to estimate an arm’s length price. In such transactions at least one of the parties needs to be uncontrolled. The CUP method is not appropriate when there is a difference in the quality or the type of the products being compared.

The CPM refers to the gross profit markup (the gross profit divided by cost of goods sold or services provided) realized in a comparable uncontrolled transaction. Under the CPM, when selling goods is on stake, comparability depends primarily upon the similarity of the functions performed and the risk assumed by the manufacturers, and is less dependent on the similarity of the goods. When provision of services is on stake, there needs to be a comparability of the costs on which the markup is to be applied.

The RPM refers to the gross profit margin (the gross profit divided by sales) realized in a comparable uncontrolled transaction. The RPM is ordinarily appropriate in cases of distribution of tangible goods in which the party does not add substantial value to the goods, that is, he does not physically alter them or uses marketing intangibles. Under the RPM, comparability depends primarily upon the similarity of the functions performed and the risk assumed by the distributors, and is less dependent on the similarity of the tangible goods distributed.

The TNMM compares the ratio of operating profits (cost, sales, or assets) earned by one of the parties engaged in controlled transactions to the same ratio earned by uncontrolled parties engaged in similar business activities. The TNMM measures the total return on business activities of the taxpayer, and therefore, comparability depends primarily upon the similarity of capital invested, costs incurred, and risks assumed by the controlled and uncontrolled parties. Under the TNMM, comparable need to be only broadly similar, and significant product diversity and some functional diversity between the controlled and uncontrolled parties are acceptable.

The PSM method refers to the relative value of each party’s contribution to the combined profit or loss. This method is suitable for examining profitability in transactions in which the contribution of one party is combined with the contribution of the other party, so the related parties act as one economic unit. Generally, the method will be applied in cases where each party owns a valuable intangible asset, which contributes significantly to the common operating profit or loss.