Dear colleagues and clients,

Section 30(a)(5) of the Value Added Tax Law, 1975 (hereinafter: the “VAT Law”) stipulates that the provision of a service to foreign resident is subject to a zero-rate VAT, if the consideration for such service is part of the value of imported goods and certain additional conditions as stipulated in the VAT Law and the Value Added Tax Regulations, 1976 (hereinafter: the “VAT Regulations”) are satisfied. The Section, however, is silent with respect to the matter of providing services to a foreign resident where the consideration for such services is part of the value of imported services.

This raises the question of whether the legislature’s silence is accidental and unintentional, which would allow the courts to step into the legislature’s shoes and fill in the gap, or whether the legislature’s silence is intentional, and is meant to exclude zero-rate VAT under such circumstances. This issue was recently discussed at length in tax appeal 15803-02-18 Applause Quality Applications Ltd. V. the Tax Authority, (issued on 7.9.2020).

Applause Quality Application Ltd. (hereinafter: the “appellant“) is a private company that is registered as an “Authorized Dealer” and is wholly owned by Applause App Quality Inc., which is a foreign company (hereinafter: the “foreign resident“) and the owner of a digital platform for testing software for applications and websites (hereinafter: the “Platform“).

Following a VAT audit of the appellant by the Israel Tax Authority (hereinafter: the “ITA”), a transaction assessment was issued to the appellant, on the basis that at the audit period, the appellant provided marketing and sales services and support services related to the Platform, to the foreign resident in connection with its Israeli customers. According to the ITA, the appellant therefore is not entitled to apply zero-rate VAT on its transactions, as reported by the appellant, pursuant to the provisions of section 30(a)(5) of the VAT Law (hereinafter: “the assessment”). The appellant’s objection of the assessment was denied and hence the court appeal.

In the appeal (although the appellant refused to concede this point) the Honorable Vice President of the Central District Court, Dr. Ahikam Stoller, ruled that under the circumstances there is no dispute between the parties, that the services provided by the appellant to the foreign resident were actually also provided to Israeli residents in Israel.

Therefore, and in accordance with the parties’ arguments, the main issue discussed by the court is whether the appellant is allowed to apply zero-rate VAT to its transactions in accordance with the exception to the limitation set forth in section 30(a)(5) of the VAT Law, on the basis that the consideration for the services provided by the appellant to the foreign resident is part of the value of the services imported into Israel. In this context, the appellant argued that the same rule should apply to a service that the consideration for which is an integral part of imported Goods as the rule that applies to a service that the consideration for which is an integral part of imported services.

On this issue, the court was required to interpret whether the provision in Section 30(a)(5) of the VAT Law is a deficient in the legislative arrangement, and zero-rate VAT should accordingly apply, or whether it is the intention of the legislature to deny zero-rate VAT. The court examined the purpose of the law and the intention of the legislature, and ruled that the legislature clearly knows how to distinguish between goods, intangible assets and services and that a legislative arrangement, which determine that an Israeli dealer that provides services to a foreign resident is required to report and pay full-rate VAT, if such services constitute a part of imported services, while another Israeli dealer that provides services to a foreign resident may claim a zero-rate VAT on such services, if the consideration for such services constitutes a part of imported (tangible or intangible) goods, contradict both the specific purpose of the law and the general legislative purpose of equity between taxpayers and the collection of true tax.

Therefore, the court concluded that the provisions of Section 30(a)(5) represent a lacuna that should be filled by the court.

Accordingly, the Honorable Justice Stoller, ruled that the provision of a service to a foreign resident that the consideration for which is part of the value of the imported services is subject to zero-rate VAT, just as a service that was provided to a foreign resident that the consideration for which is part of the value of the imported goods is subject to zero-rate VAT.

We emphasize that the court however dismissed the appeal under the circumstances, after having found that although the appellant met the burden of proving that the consideration for the services provided to the foreign resident were included in the value of the services imported by the Israeli customers, the appellant could not prove that the Israeli customers reported and paid the applicable VAT with respect to the importation of such services.

Our tax department is available and will be happy to advise on the above matters and to assist with application to or discussions with the ITA. This client alert should not be constructed as providing tax advice, which depends on the facts and circumstances of each case.

We wish you and your loved ones a happy new year, a year of health, happiness and success.

Regards,

Value Added Tax Department

Herzog Fox Neeman