A reported Israeli plan for a digital services tax could provide a sounder basis for taxing multinational groups than previous attempts that relied on permanent establishment arguments or claims the groups are subject to VAT.
On April 28 both the Haaretz and Globes newspapers published reports that the Israel Tax Authority (ITA) and the Ministry of Finance have been working on plans for a DST. Both articles mentioned the 3 percent tax on the turnover of digital companies that is being considered by the French parliament. Frustration over the relatively low amount of tax paid by foreign-based online groups prompted the French government to propose the DST, which would be payable by companies with global digital turnover of at least €750 million and French revenue of at least €25 million. The proposed French tax would apply to sales from online advertising and the sale of consumer data, and to revenues derived from serving as an intermediary between sellers and buyers.
Yuval Navot, a tax lawyer with Herzog Fox & Neeman, said the planning for an Israeli DST is an initiative of the MOF and the ITA to fund the budget for the new government following the April 9 elections that saw a right-wing coalition under Prime Minister Benjamin Netanyahu secure a majority of seats in the Knesset.
Henriette Fuchs, a tax lawyer with Pearl Cohen Zedek Latzer Baratz, said the discussions about a DST are nonpolitical. Like many other countries, "Israel . . . is trying to assert ways in which to fairly — and hopefully modestly — tax foreign companies selling goods and services in Israel," she said.
Navot said that while the planning for the DST is still in the early stages, he can't rule out the possibility that it will be enacted into law.
Although Haaretz reported that the ITA had discussions with internet companies over the payment of tax based on a circular published in April 2017, Navot said the tax agency's position was actually based on ITA Circular No. 4/2016, which was issued a year earlier. He said that the MOF and the ITA might have shifted their focus to a DST after recognizing that the tax agency's earlier position, as outlined in the 2016 circular, that foreign-based internet groups have a PE in Israel was problematic and was based on a very aggressive interpretation of the PE concept under the country's network of tax treaties.
"The legal difficulties stem from the fact that the April 2016 circular is based on the interpretation of the existing law with no legislative change," Navot said. "It applies for tax periods that predate the entry into force of the [OECD's] multilateral instrument, which poses even more difficulties for companies resident in countries that are counterparties to the MLI. The current proposal reflects a different position, which is to abandon the battle with the internet companies over whether or not such companies have an Israeli PE and to look for a legislative solution."
The multilateral instrument addresses treaty shopping and provides jurisdictions with the tools to implement binding arbitration and fight tax avoidance by multinational enterprises. It was adopted by the OECD in 2016 to provide signatories with a quick way to put into place recommendations of the base erosion and profit-shifting project by updating the existing network of bilateral tax treaties.
The Haaretz article reported that, "for the large companies, such as Google, tax assessments were begun." Fuchs said that while the ITA might have issued significant tax adjustments, they were probably not based on Circular No. 4/2016. "It is likely that these assessments would be based on a narrower interpretation of tax law and treaty commitments and not on the circular," she said.
In April 2018, eBay Marketplace Israel Ltd. said in a court filing that it had received tax assessments totaling ILS 156 million (around $43 million). "EBay's local subsidiary has been served with significant assessments in Israel," Fuchs said. She added that, in most cases, it is likely that a multinational group would have a local Israeli affiliate that was not merely doing research and development or providing intragroup services, but instead was actually representing the foreign related party as a seller or a provider of services to ultimate customers in the local marketplace.
Previous VAT and PE Positions
Fuchs said the 2016 circular has no standing in law. "[While] the Israel tax authorities like to attribute binding power to their circulars, a circular is not a government-backed legislative position," she said. "It is merely the interpretation of the taxing authorities appointed to implement and enforce the law, and not to write law."
In January 2017, amendment 238 to the Income Tax Ordinance was proposed to carry out, among other things, a conceptual repositioning of the understanding of a foreign group selling in Israel for transfer pricing purposes and the legal presumption of a PE in Israel, Fuchs said. "The concept of permanent establishment is currently, as such, not embedded in the income tax ordinance of Israel," she said. "Right now, there is no definite view [about that] because the head of the tax authorities is waiting for the new finance minister to be appointed before an actual legislative proposal will [or] can be sponsored and advanced."
Navot said a previous proposal by the ITA that internet companies be required to pay VAT when they engage in business-to-consumer transactions was blocked by the MOF. "It remains to be seen if this initiative will also be promoted alongside the DST, or whether the focus will be just on DST [under the assumption] that VAT will increase the cost of living of Israeli consumers because Israeli consumers end up bearing the cost of the VAT, even though the formal taxpayer is the non-Israeli Internet company," he said.
Fuchs said concern about VAT explains part of the ITA's reasoning for promoting a DST. "One of the reasons why inclusion of foreign-based providers of services [over] the internet seems to be called for is because local providers of such services are fully taxed and must also charge VAT, [which] puts them at a competitive disadvantage compared to foreign . . . suppliers who supposedly — which is still not proven — pay less tax," she said in an email.
She said that in 2014, the High Court of Justice dismissed a petition demanding that the tax authorities force foreign digital service suppliers to charge and pay VAT. "The High Court of Justice dismissed the petition [by] explaining it found the petition premature and [said] that in the digital world, internet transactions can trigger complex issues, which have broad tax implications that need to be addressed by the legislature and the [ITA]," Fuchs said. "The Court also explained that because the [ITA] was in the process of formulating a professional circular on the taxation of internet companies and transactions, it did not find it appropriate to interfere (yet)."
After the release of Circular No. 4/2016, the state comptroller and the ombudsman of Israel released a report criticizing the ITA's approach on enforcing tax laws via circulars and not by amending legislation, Navot said. "The report is a somewhat positive development in that it confirms that domestic and treaty law changes in response to BEPS should come in the form of new legislation and amendments to treaties as opposed to through administrative fiat," he said. "The downside, however, is that it strongly suggests that the state comptroller approves of the substantive rules set forth in the circular and merely disapproves of the manner in which they have come into being, and the selective and inconsistent manner in which they are being enforced."
Navot said the ITA refuses to allow Israeli-based internet companies to take foreign tax credits for turnover-based taxes similar to a DST that they pay in non-Israeli countries. "I believe that passing DST legislation, which would essentially be a substitute for an income tax charge, will put pressure on recognizing such taxes as creditable taxes," he said.
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