Non-Profit to Dealer Reclassification Is Prospective Only: The Shomrei Emunim Ruling

The Jerusalem District Court held on 22.11.2023 that reclassification of an entity from a Non-Profit Institution (Malkar) to an Authorized Dealer takes effect from the date of the VAT Director's decision and not retroactively. The Court upheld the reclassification of Shomrei Emunim as an Authorized Dealer and rejected its claim that it was a Non-Profit Institution, but ruled that the change takes effect from the date of the decision (11.7.2018) and not from 1.1.2013. The company was ordered to pay costs of NIS 20,000. Adv. Shlomi Vaknin represented Shomrei Emunim.

• Jerusalem District Court, Hon. Judge Avigdor Durot.

• The decision under appeal: The decision of the VAT Director of Jerusalem dated 11.7.2018 to reclassify the company from a Non-Profit Institution to an Authorized Dealer, effective from 1.1.2013.

• Outcome: The reclassification as an Authorized Dealer was upheld, but it takes effect from the date of the decision and not from 1.1.2013. The company was ordered to pay costs of NIS 20,000.

A Non-Profit Institution (Malkar) does not charge VAT on its transactions and may not deduct input tax. Instead, it pays payroll tax. An Authorized Dealer charges VAT on its transactions and deducts input tax. Section 58 of the Value Added Tax Law authorizes the Director to reclassify a taxpayer, or a specific activity thereof, under a different classification. When such a change is applied retroactively, a VAT liability arises on past transactions for which no tax was collected from customers.

On 11.7.2018, the VAT Director of Jerusalem decided to reclassify Shomrei Emunim from a Non-Profit Institution to an Authorized Dealer, effective from 1.1.2013. This meant imposing output tax on approximately five and a half years of activity preceding the decision. The company appealed the decision to the Jerusalem District Court.

The Court accepted the Director's position that the company is an Authorized Dealer and not a Non-Profit Institution. However, it held that the reclassification takes effect from the date of the Director's decision and not from 1.1.2013, and therefore the company may not be charged output tax as a dealer on transactions conducted before the decision. For the period preceding the decision, the classification that was in force at the time applies.

Regarding the deduction of input tax, the Court held that under Section 116(a) of the Law, the Director may extend the deduction period to up to five years before the decision — i.e., from 11.7.2013 — and no further. In light of the outcome, in which the Director's substantive position was accepted, the company was ordered to pay costs of NIS 20,000.

An entity registered as a Non-Profit Institution that also conducts commercial activity is exposed to reclassification. This ruling limits retroactive exposure, as it holds that the change takes effect from the date of the decision. However, it was rendered under the specific circumstances of this case. It is advisable to examine in advance whether a particular activity may be deemed that of a dealer, and to consider registering it separately or obtaining a professional opinion and early ruling from the authority.

For information on the classification and taxation of such entities: Taxation of Financial Institutions and Non-Profit Organizations.

1. Check whether the entity engages in activity that competes with dealers, such as selling at market prices.

2. Have you received a reclassification decision? Check from when it takes effect. If it applies retroactively, you may rely on this ruling. See Representation in Tax Assessment and Objection Proceedings.

3. Compile the input tax invoices for the years preceding the reclassification. In the Shomrei Emunim case, the Court held that the Director may extend the deduction period to up to five years before the decision.