Client Update | Deduction of Input Tax by Holding Company
19 August 2018
Recently, a District Court judgement relating to the issue of the deduction of input tax by a holding company was issued (the “Judgement“). The Judgement was given on June 28, 2018, in the case of Elbit Medical Imaging Ltd. v. the Regional VAT Director (the “Elbit case“).
In this regard, under the Israeli VAT Law, input tax will be deductible provided that the inputs were used in a taxable transaction. The VAT Regulations further provide that with respect to inputs used partly in taxable transactions and partly in non-taxable transactions (“mixed inputs”), the basic principle shall be that the deduction of the relative part of the input tax, which can be directly attributed to a particular taxable transaction, should be allowed. If it is not possible to attribute the input tax directly, and the main use of the inputs is for the needs of the business, two-thirds of the input tax shall be allowed as a deduction. If the main use of the inputs is not for the needs of the business, then only one-quarter of the input tax will be allowed as deduction. However, the VAT Regulations do not clarify how to determine whether the “main use” of the inputs is for the needs of the business.
The subject of deduction of input tax in a holding company, the activity of which is mainly for investment purposes (such as capital gains and dividends) and where the inputs are, in essence, mixed inputs, is a matter which has given rise to a considerable amount of controversy between the Israeli Tax Authority and VAT Dealers. To that end, the Israeli Tax Authority has published its position, according to which, a holding company should be allowed to deduct only one-quarter of the input tax for general inputs, and only two-thirds of the input tax for inputs used directly in taxable transactions (“Position 1/2016”).
Under the Judgement, the Court opined that, in general, if the holding company carries out taxable transactions, the inputs of which are directly identifiable and can be quantified separately from the other inputs of the company, a full input tax deduction should be allowed. This is in opposition to Position 1/2016 of the Israeli Tax Authority, according to which a holding company is not allowed to deduct the full input tax, but rather two-thirds. The Court also noted that in its opinion, the basis for the Israeli Tax Authority’s Position is “unclear”.
The main implication of the above is that under certain circumstances, and if there is concrete and compelling evidence regarding the use and purpose of the inputs in taxable transactions, holding companies should be allowed to deduct the full input tax used in taxable transactions. For this purpose, where a holding company claims a full deduction of the input tax, then it must demonstrate the specific use of the inputs and attribute the inputs to taxable transactions.
The Court further added that in order to determine whether the main use of the mixed inputs is for the needs of the business, it is necessary to prove the particular use of the assets or the services. In this regard, it is only in the absence of a clear indication for a particular use, that a general examination of the company’s activity will be made. For this purpose, the income ratio (the income derived from a taxable activity compared to the income derived from non-taxable activity), should only be one indication as to the main use of the mixed inputs. However, this is by no means an exclusive test.
It should be noted that the Judgement was rendered by the District Court only. Accordingly, it is not precedential in its application. Moreover, it has not been decided whether an appeal will be filed to the Israeli Supreme Court.
In light of the above, the examination of the transactions, the activities of a holding company and the possibility to attribute inputs to taxable transactions is a matter of considerable importance. As such, we recommend that an estimate be made as to the rate of the company’s deductible input tax from the various inputs carried out by the holding company.
Click here for more on the Elbit case.