Israel to Tax Internet Giants With Local Offices: Tax Chief

By Matthew Kalman

Israel’s efforts to levy taxes on multinational internet giants will be limited to those with physical operations within its borders, the head of Israel’s Tax Authority told Bloomberg Tax in an exclusive interview.

“We are checking, carrying out a review and assessment of those companies that operate in Israel via the internet,” Tax Authority Director General Moshe Asher said by phone on Jan. 16.

Internet companies would be assessed on earnings from sales to Israelis, primarily of advertising, Asher said. The tax authority will determine whether a company has a “permanent establishment” in the country for tax purposes, then “allocate the revenues that relate to Israel.”

“If we come to the conclusion that there is a permanent establishment in Israel, then at the second stage you have to say—with regard to this permanent establishment of this multinational company—how much of its profit relates to Israel? Only on that profit which relates to Israel, you can apply corporation tax and issue an assessment accordingly,” he said.

Israel is among the countries grappling with the tax treatment of internet giants.

Asher’s comments appear to retreat from the tax authority’s apparent assertion in its 4/2016 Circular that a company without offices in Israel but a substantial “digital presence” should also be assessed.

“There must be some, even a little, physical presence in Israel, and the authority detailed the relevant criteria in a 2016 circular. If it’s only an internet presence in Israel, we cannot right now, according to international law and tax treaties, assess these enterprises or define this presence as a permanent establishment,” he said.

Facebook Inc. already pays tax on its Israeli advertising sales, while Alphabet Inc.'s Google pays 20 percent corporation tax, most of it in the U.S., company representatives told a Knesset committee on Jan. 8. Amazon.com Inc. does not have an Israeli office or subsidiary but is reported to be opening a distribution center.

“In December we announced that advertising revenue supported by our local teams will no longer be recorded by our international headquarters in Dublin, but will instead be recorded by our local company in that country. This also applies for Israel,” Facebook Inc.'s Europe communications director Tina Kulow told Bloomberg Tax in an email Jan. 17.

Get to Court?

The tax authority knows its assessment of internet companies’ profits is controversial. “It’s possible it may reach the courts,” Asher told a Knesset committee on Jan. 8. It already has.

“We know there are large assessments on the table and they are obviously going to be subject to a lengthy discussion,” said Henriette Fuchs, international tax partner at Pearl Cohen Zedek Latzer Baratz law firm in Tel Aviv.Internet companies would be assessed on earnings from sales to Israelis, primarily of advertising, Asher said.

However, in at least one case now in court, the tax authority’s assessment is based on what percentage of a multinational’s worldwide profits can be attributed to Israel, said Daniel Paserman, head of tax at Gornitzky and Co. law firm in Tel Aviv, who is representing a digital company in an appeal against the authority. A company may have only a handful of employees in Israel, charging the parent for their services, rent and other costs, plus a five or 10 percent margin on a “cost-plus basis,” he said.

Transfer Pricing

“The Israel Tax Authority is saying this does not really reflect the contribution of the parties to the production of the profits and you should look at the profit of the overall group and try to allocate the profit differently, allocating a higher percentage to Israel,” Paserman said Jan. 17. “The difference is huge. It’s a transfer pricing issue.”“They don’t go after the foreign company. They go after the Israeli subsidiary. They think it’s easier. I think they are trying to circumvent the challenges with arguing that the foreign entity has a permanent establishment. The issue is new. They are learning along the way,” he said.If the tax authority wins, it could influence the operation of multinationals in Israel. “They will take it into consideration. I don’t know if they will shut down. Things will be done differently,” Paserman said, adding that one client planning to open an office in Israel was “astonished” to learn of the new approach.

U.S. Tax Reform an ‘Earthquake’

Meanwhile, tax reform in the U.S. could make Israel a less inviting territory for foreign companies, derailing the pursuit of internet companies.

Prime Minister Benjamin Netanyahu has tasked the head of the country’s National Economic Council with coordinating Israel’s response to the U.S. reforms. According to an internal presentation prepared by the Israel Innovation Authority of the Finance Ministry, obtained by Bloomberg Tax, this could lead to a shift in intellectual property to the U.S. and a wholesale change in the structuring of multinational corporations. “A distributed structure for a multinational corporation has become less attractive from a financial point of view,” the presentation states. It also notes that the 12.5 percent U.S. tax on intellectual property registered abroad might lead to companies preferring to register IP in the US, and predicting a “tax war” as European states respond to the U.S. reforms.The U.S. legislation is “an extremely significant reform, even an earthquake, in the world of taxation,” Asher said. “As a result of this reform we are liable to see in the future businesses located outside the U.S. returning to the U.S., bringing their revenues from outside the U.S. to the U.S., and effectively re-examining their entire plan and business structure: where to locate marketing, where to locate production, where to locate development. We expect change around the world.” Israeli officials are “following these processes very closely in order to gauge the implications of the reform on Israeli companies,” he said.“In light of the developments in the U.S. and the significance of whether companies will decide to operate in one way or another, we will recommend to the government and the finance minister to make amendments as these developments demand,” he said. “We are meeting businesses to understand the issue. Even in the U.S., the advisers don’t have yet all the answers to the questions how to implement the reform in all its details.”“The moment everything is clear, then it will be possible to know where this is going and what from Israel’s perspective needs to change,” he said.

Trying to Understand

Israeli practitioners are meeting with government officials to try and understand the effect of the reforms.

“There might be substantial implications” for multinationals, Paserman said. “Israel like other countries will have to react.”

The response does not have to be unilateral, Fuchs said Jan. 17. “I believe the solutions are usually found either in the adjustment of a treaty, or an understanding, or in dialogue under the mutual agreements procedure of tax treaties,” she said.

To contact the reporter on this story: Matthew Kalman in Jerusalem at correspondents@bloomberglaw.comTo contact the editor responsible for this story: Penny Sukhraj at psukhraj@bloombergtax.com

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