Global Tax Alert | 20 March 2014

Israeli High Court of Justice rejects petition to deny "foreign resident" VAT status from multinational internet companies

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Executive summary

On 11 March 2014, the Israeli High Court of Justice (HCJ) rejected a petition by an advocate, who asked the HCJ to order the Minister of Finance and the Israeli Tax Authority (ITA) to impose value-added tax (VAT) on cross-border digital delivery of services and products, made by foreign multinationals in the Israeli market. In its ruling, Guy Ofir vs. The Minister of Finance and others (HCJ 6845/13), the HCJ rejected the petition on the ground that it was submitted too early, while the ITA is still working on a tax circular which will be published soon, concerning the taxation of digital economic activities in Israel.

Detailed discussion

The petitioner’s position

The petitioner asked the HCJ to order the ITA to treat multinational internet companies which operate in the Israeli market in the same way the ITA treats Israeli interment companies.

The Petitioner argued that the digital activities carried out by the foreign multinational internet companies in Israel give rise to VAT liability which is not collected or enforced by the ITA. In particular, the petitioner argued, that the services and goods sold by the foreign multinationals are customized for the local language and currency in Israel; the foreign internet companies conduct marketing activities which are addressed to Israeli customers; and that the companies registered dozens of trademarks to protect their business in Israel. Based on the petition, the ITA does not impose VAT on those transactions because the ITA considers the location of the internet server as a key factor in determining the place of taxation (for VAT purposes). The Petitioner raised arguments to support his approach that this factor lost its relevance and therefore leads to wrong results in the current digital economy environment.

Based on the petition, failure to collect VAT from those multinationals entitle those foreign companies to favorable conditions in comparison to their Israeli competitors (because certain customers have no right to deduct/refund the VAT charged on the transactions that they conclude with the Israeli internet companies).

The ITA’s response

The respondents argued that the place of taxation may be a complex matter in the context of foreign internet companies that are doing business in Israel. The conclusion regarding the place of taxation should be examined from a wider perspective and not just based on the language of the Israeli VAT law. The respondents highlighted the fact that the OECD publication regarding base erosion and profit shifting (BEPS) covers this area and that the ITA will publish soon a professional circular which will provide guidance on this matter.

The HCJ Decision

As noted, the HCJ rejected the petition as it was submitted prior to the publication of the tax circular on this matter. The HCJ did not rule on the substantial tax matters and did not provide guidance regarding the appropriate interpretation of the VAT law in the context of digital economy activities in Israel.

Implications

The petition’s overview of the VAT environment in the area of digital economy activities does not reflect some recent developments regarding this matter (although the aforementioned tax circular has not yet published by the ITA). In recent instances, the ITA took an aggressive approach as to the place of taxation of digital activities carried out by foreign internet companies. In some cases the foreign internet companies ceased to be treated as “foreign residents” for Israeli VAT purposes. As a result, those foreign companies were required to register for VAT in Israel and to charge VAT to customers.

Accordingly, internet companies doing business in Israel should assess the potential impact of the recent VAT developments on their business and verify their VAT compliance in Israel.

For additional information with respect to this Alert, please contact the following:

Kost Forer Gabbay & Kasierer, Tel Aviv
  • Regev Itzhaki
    +972 3 563 9801
    regev.itzhaki@il.ey.com
Ernst & Young LLP, Israeli Tax Desk, New York
  • Ram Gargir
    +1 212 773 1984
    ram.gargir@ey.com

EYG no. CM4277