Israel’s Tax Demand of Internet Giants Gets Instant Opposition

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By Matthew Kalman

Efforts by the Israel Tax Authority to assess the Israel-based earnings of digital multinationals are unlikely to proceed smoothly, local practitioners said, even as the authority’s head said he was determined to issue demands to Alphabet Inc.'s subsidiary Google, Facebook Inc. and other internet giants.

“Ultimately taxes can be charged based on their operations in Israel,” Moshe Asher, director general of the Israel Tax Authority, told the Haaretz daily Nov. 15. “Our goal is to obtain as much data as we can, even if many of these figures are held outside of Israel,” Asher said. “Within a year we’ll issue these companies tax bills.”

The authority’s policy is based on its circular 4/2016, issued in April 2016, which laid out new guidelines for taxing the online commerce of businesses not present in Israel, Asher said.

A spokesman for the Israel Tax Authority confirmed the accuracy of Asher’s comments but declined to answer further questions.

Issuing Demands

The authority has already begun issuing such demands, said Daniel Paserman, an attorney and CPA and head of tax at Gornitzky & Co. law firm in Tel Aviv. “We are dealing with a case of a multinational. They issued [a demand] already and we are in court. It’s not a theoretical matter,” he said.

He added that the authority is attempting to be a world pioneer in drafting domestic guidelines for implementing the OECD’s base erosion and profit shifting (BEPS) recommendations and in addressing the digital economy’s tax challenges.

“There is no doubt that a major change has been set in motion for the foreign entities operating via the internet and therefore these entities should make proper arrangements,” Paserman said. “You can imagine the frustration of tax authorities around the world. All these multinationals generate a lot of profits from Israeli clients,” and some even have Hebrew websites but “they pay no tax in Israel.”

But he questioned the tax authority’s methods. It should be done with legislation after considering all the issues, instead of in a non-binding circular, he said.

“There are a lot of questions whether you can do this or not. I think that’s not the way to do it,” he told Bloomberg Tax Nov. 20.

Permanent Establishment Test New?

Some of the companies—including Facebook and Google—have Israeli offices or subsidiaries, usually involved in research and development rather than sales.

“Even though these companies do not act physically, or do not carry out physical activity in Israel, the tax authority will claim that in substance they have a permanent establishment in Israel and therefore they should pay taxes in Israel,” Binyamin Tovi, partner in charge of international taxation at Tel Aviv-based Shekel and Co. law firm, told Bloomberg Tax Nov. 19.

He noted that the “test of economic substance” hasn’t been addressed in Israeli tax law or Israeli court rulings.

“It’s a new test which has been introduced into the Israeli tax law. If you want to introduce some kind of a new law, you have to do it through the Knesset, through a legitimate legislative process, and not through the issuance of a circular,” he said.

In Pursuit of IP Royalties

Israel’s tax-collecting efforts coincide with an aggressive pursuit of tax on intellectual property royalties belonging to Israeli subsidiaries, and parallel attempts to woo the same online companies to develop and even relocate their IP to Israel with the offer of rock-bottom corporation tax rates.

Attempting to collect taxes based on the location of the marketplace contradicts Israel’s policy of taxing IP according to residence, said Henriette Fuchs, international tax partner at Pearl Cohen Zedek Latzer Baratz in Tel Aviv.

“We are an IP-generating country. We would like to hold on to the added value of the IP being created in Israel, and we’re very insistent on doing that. We’ve also revised our law for encouraging investment to that extent to make Israel more of an interesting country to allocate or re-allocate IP to,” Fuchs said. “If you then as the tax collector adhere great value to where the marketplace is of an IP, then you are basically helping the foreign tax authorities to hollow out the value of the IP, because the greatest value of a digital service is in its IP and not in where your consumers are.”

“The policy of the legislator might be at odds with the policy of the tax collector, and we might be shooting ourselves in the foot,” she said.

Companies Fed Up ?

Internet companies are losing faith with the Israel Tax Authority, Paserman agreed.

“We have a lot of clients who say: ‘Listen, after we have been litigating all these tax issues with the tax authority for so many years, now they are trying to attack us? We don’t believe in them. They come up with this legislation but who knows how it will be applied when the time comes? We have bad experience with the Israel tax authorities,’” he said.

Facebook and Google declined to comment.

To contact the reporter on this story: Matthew Kalman in Jerusalem at correspondents@bloomberglaw.com

To contact the editor responsible for this story: Penny Sukhraj at psukhraj@bloombergtax.com

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