On that last point, Israel has struggled more than most since the advent of the law 45 years ago. The definition of zero-rate services has been unabatedly subject to gratuitous torture from the VAT authorities, the Knesset and the courts, all of whom – instead of working to bring the law in line with our international competitors – have just added to the pain and lack of logic.
Earlier this month, the Lod District Court provided a little hope for those providing services from Israel abroad in cases where – shock, horror – Israeli residents share some of the benefit with foreign residents. According to the letter of the law (confirmed in a case late last year – see Tax Break, December 3, 2019), even if an Israeli resident is a relatively minor beneficiary of a service given to a foreign resident, VAT applies to the entire amount charged. As the foreign resident is not generally registered for VAT, the 17% tax either ups the price of the service, or – if absorbed by the service provider – lowers the Israeli profit.
In the case in question, the Israeli subsidiary of an American parent charged the parent for marketing services in Israel, while the American parent provided internet related services to Israeli customers. The law actually includes a Get Out Of Jail Free card for such services, where the import from abroad (in this case, the US) is of tangible goods, the VAT on which is paid by the importer according to the import or similar documentation. Were VAT to be charged on such a transaction, it would amount to a double charge to tax, which would not be fair. The problem is that the law specifically refers to tangible goods – services are not included. In the central argument of the case, the judge had to decide whether the omission of services in the law was intentional, or essentially an oversight.
The judge miraculously concluded that, as the intention of the law was to avoid double taxation, the exemption (zero rate) could be extended to services. However, aping his Creator who ‘giveth and taketh away’, His Lordship promptly announced that the appellant could not make use of this ruling because the company had failed miserably to prove that the Israeli service importers had paid VAT on the import. Whereas goods brought through a port/border cannot leave the port/border without VAT being paid (subsequently to be reclaimed by registered dealers) or subject to a special arrangement with the authorities, services have no such point of entry. Furthermore, the way a registered VAT dealer records such ‘payment’ of VAT is by issuing a self-invoice and registering the VAT on each side of his VAT return (ie paying and reclaiming the VAT on the same day – no cash changing hands). Suffice it to say, that many companies do not bother to make these book entries (or make the book entries in the VAT return without physically issuing an invoice). The company was snookered.
Other arguments proved even more futile, and the appellant company went home vanquished (pending a possible appeal to the High Court).
The important lesson here is not the case itself. Other than an element of liberalism by the judge that could, in the future, prove helpful in laboratory conditions, there were no surprises here. Tax advisors have for decades been finding solutions to this VAT problem, usually involving structuring transactions differently. Indeed, a salient question here is: ‘How did the problem arise?’