Tax Authority to impose VAT on foreign Internet cos

A new circular says multinational corporations like Google and Facebook will pay taxes on online business with Israelis.

Foreign Internet companies and another other foreign corporation with significant business in Israel must register with the VAT authorities as authorized dealers, and their transactions are liable to VAT. Under certain conditions, some of the companies whose business constitutes a “permanent establishment” are also subject to income tax.

The Israel Tax Authority expressed this position in draft rules published today for taxation of foreign companies’ business in Israel conducted through the Internet. This means that major foreign companies like Google and Facebook will have to register in Israel as dealers and pay tax on income from the services they provide here, such as advertising and website promotion.

In view of the enormous expansion in recent years in online economic activity in Israel and worldwide, and given the need to adapt to the changing economy, the Tax Authority has published for public comment a draft circular explaining in which situations the income of a foreign corporation (one that is not resident in Israel) from providing Internet-based services to Israeli residents is taxable in Israel.

Under current law, income of a foreign corporation from the provision of services to Israeli residents is subject to income tax if the income was produced in Israel. If the corporation is resident in a country with which Israel has an agreement to prevent double taxation (a tax treaty), the foreign corporation will be taxed in Israel only if its activity constitutes a “permanent establishment,” defined in tax treaties as a permanent place of business at the disposal of the enterprise, or when the enterprise’s business in Israel is conducted through an agent with the power to sign contracts in the name of the enterprise.

In view of the changes that have taken place in the “conventional” economy and the transition to a digital economy, the Tax Authority circular makes clear that a permanent establishment can also exist in Israel when the foreign corporation’s business in Israel is conducted primarily through the Internet and other conditions are fulfilled, such as if the foreign company connects the Israeli customer with an Israeli supplier, adapts itself for use by Israel customers, if representatives of the foreign corporation are involved in finding Israeli customers or collecting information, if the foreign corporation confers on its Israeli agent the authority to contract binding deals for it, etc.

VAT

The circular states that a foreign corporation with significant business in Israel is obligated to register with the VAT authorities as a authorized dealer, and must pay VAT on its transactions. For example, a foreign corporation operating a website providing advertising or intermediary services to Israeli customers aimed at Israeli consumers must register with the VAT authorities, and its income from Israeli customers is subject to VAT.

The question of taxing foreign Internet companies has been discussed by the Tax Authority for a long time, and is the basis of a petition to the High Court of Justice against the Minister of Finance, Israel Tax Authority head Moshe Asher, Google, and Facebook asserting that the VAT “exemption” for these giant companies should be eliminated. The High Court of Justice dismissed the petition in March 2014, in view of the fact that the Minister of Finance and the Tax Authority had stated that they were formulating new taxation rules that would apply to these companies.

Justice Uzi Fogelman, with Justices Yoram Danziger and Yitzhak Amit concurring, dismissed the petition out of hand “as premature.” The ruling stated, “Indeed, the way the VAT law is implemented for multinational corporations, insofar as transactions or business through the Internet is involved, is liable to arouse complex questions that are likely to have far-reaching consequences.”

The ruling continues, however, “We learned from the state’s response that the parties responsible for enforcing the law are working on the formulation of a professional circular on this subject… and there is therefore no need to respond at this time to the allegations raised in the petition.”

The petition, filed last October by Adv. Guy Ophir, alleged, “For the Tax Authority, all taxpayers are equally subject to the tax burden, but some are more equal than others, and therefore are not required to pay VAT, and are not subject to criminal prosecution for illegitimate tax planning, failure to report, and misleading the Israeli consumer into believing that VAT collected from him is being paid back to the public treasury.”

In response to the circular, Adv. Ophir said, “Although the actual implementation imposing VAT remains to be assessed, this is a real revolution. If the circular is implemented as written, Google, Facebook, YouTube, Amazon.com, Microsoft, and other corporations will have to pay VAT to the public treasury. This will add enormous sums to the public purse, and can reduce the deficit.

“As far as making these corporation pay income tax is concerned, I think that on this issue, the Tax Authority could have expressed itself better. Their demand that a foreign corporation have an ‘agent’ in Israel as a substitute for a permanent place of business is superfluous. Google has an entire team of Israelis in Ireland calling Israeli businesses and customers, negotiating with them, and closing deals for substantial amounts, and they usually do not hold meetings in Israel. In the era of Skype, e-mail, and other technologies, a physical ‘agent’ in Israel is not needed in order to conduct business in Israel. I therefore think that putting the word ‘agent’ into the circular and giving the term a definition that could be interpreted as a physical agent is superfluous.

“At the same time, the dramatic change moving us forward in the direction of fair and equal taxation of those who earn the most – multinational corporation – is welcome. Keep in mind that not only do the multinational corporations pay no taxes; they also take income away from Israeli corporations that do pay taxes and do their spending in the Israeli economy. The damage from not collecting taxes is therefore manifold.”