Change of Assessment Basis in Objection Decision Voids VAT Assessment: The M.G.D.S. Ruling

On January 16, 2014, the Tel Aviv District Court annulled VAT assessments, a notice of book disqualification, and a demand for double tax, finding that the VAT Director had changed the basis of the assessment in his objection decision without giving the companies an opportunity to address the new basis. The Court regarded this as a "surprise" that violated the right to be heard.

• Tel Aviv-Jaffa District Court, the Honorable Judge Eitan Orenstein. Judgment delivered on January 16, 2014.

• Outcome: The appeal was granted. The assessments, book disqualification, and double-tax demand were annulled.

One of the appellants sold three plots of land to three companies. The transaction was not completed. The seller claimed the purchasers had breached the agreement, canceled it, and issued credit notes in order to recover the VAT that had been paid. The purchasers argued that the cancellation was unlawful and that they were entitled to enforce the agreement.

The VAT Director determined in the assessment that the transaction had never been canceled. At the objection stage, he changed the basis, ruled the transactions were artificial, and imposed double tax on the appellants.

The Court allowed the appeal on two grounds.

The first ground was procedural. A taxpayer filing an objection addresses the grounds stated in the assessment. When the basis of the assessment is changed in the decision rejecting the objection, the taxpayer loses the opportunity to challenge the new basis, and a fundamental right is impaired. The Court therefore held that the objection decision constituted a surprise.

The second ground was substantive. If the Director believed the transactions were artificial, the proper tool at his disposal was Section 138 of the Value Added Tax Law, which allows disregarding an artificial or fictitious transaction. The Director did not invoke that section and instead chose to issue assessments under Section 50 of the Law, which deals with the unlawful issuance of a tax invoice and imposes double tax. The Court held that Section 50 was irrelevant to the matter, and therefore the assessment should be annulled on this ground as well.

An objection is the stage at which a taxpayer presents arguments against the assessment. According to this ruling, the VAT Director may not use the objection decision to replace the original grounds of the assessment with new grounds that the taxpayer was not given an opportunity to respond to. In addition, a claim that a transaction is artificial must be raised using the statutory tool designated for that purpose, rather than through a section intended for a different situation. A similar principle was applied in 2024 in the Ram Pal ruling: the VAT Director may not issue a new input-tax assessment within an objection decision on a transaction-tax assessment.

In canceled real-estate transactions, the question of whether the cancellation is valid directly affects the VAT refund. For assistance with such transactions: Taxation of Complex Real-Estate Transactions.

1. Compare the grounds of the objection decision with the grounds of the original assessment. A change in the basis of the charge is a ground for appeal.

2. Check under which section the assessment was issued and whether that section matches the Director's claim — for example, Section 138 for an artificial transaction.

3. When canceling a transaction, retain the cancellation documents and credit notes, as they form the basis for a VAT refund.

4. Assistance with assessments, objections, and appeals: Representation in VAT Assessment and Objection Proceedings.