TA 15803-02-18 Applause App Quality Ltd. v. Israel Tax Authority, VAT Director Petah Tikva
The Central District Court (Lod) held on September 7, 2020 that there is a lacuna at the end of Section 30(a)(5) of the VAT Law: the exception allowing zero-rate VAT on a service included in the value of imported goods can, in principle, also apply to a service included in an imported service. Applause failed to prove that the Israeli customers paid VAT on the services they imported, and therefore the appeal was dismissed and the company was ordered to pay costs of NIS 50,000. Adv. Shlomi Vaknin represented the company.
Court: Central District Court (Lod), Deputy President Judge Achikam Stoller.
Proceeding: TA 15803-02-18, judgment dated September 7, 2020.
Counsel for the Appellant: Adv. Shlomi Vaknin.
Outcome: The appeal was dismissed, and the appellant was ordered to pay costs and attorney's fees of NIS 50,000.
Full judgment: On the Israel Tax Authority website at gov.il.
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What Were the Facts?
Applause, an Israeli company, provided services to its foreign parent company, Applause App Quality Inc., and reported the receipts as subject to zero-rate VAT. The parent company also sold software testing services to customers in Israel, meaning that Israeli residents also benefited in practice from Applause's services. The VAT Director in Petah Tikva assessed the receipts at the full tax rate.
Applause argued that its service was included in the value of the services that the Israeli customers imported from the parent company, and that those customers were liable for tax on the imported service. Therefore, following the rationale of the exception applicable to imported goods, such a service should also qualify for zero-rate VAT; otherwise, double taxation would result.
What Did the Court Hold?
Starting Point: The Restriction Applies
There was no dispute that Israeli residents benefited from the service in practice. Therefore, Applause was not entitled to zero-rate VAT unless it fell within the exception at the end of the section.
A Lacuna in the Law, Not a Negative Arrangement
The court held that the legislature did not intend for an importer of goods to enjoy zero-rate VAT while an importer of services would bear double taxation. Accordingly, the concluding clause of the section, which refers only to the value of goods under the Customs Ordinance, constitutes a lacuna that must be filled, rather than a negative arrangement.
But Payment of Tax Must Be Proven
The exception was not applied because Applause failed to meet the burden of proving that the Israeli customers paid VAT on the services they imported. The court also rejected the alternative arguments: recognizing the invoices issued to the parent company as an "other document" for input tax deduction by the customers, and allowing Applause to retroactively issue invoices directly to the Israeli customers.
What Does This Mean for Subsidiaries of Foreign Corporations?
An Israeli company providing services to a foreign parent company, where the end customers are in Israel, must examine whether the service is in practice also rendered to Israeli residents. If so, zero-rate VAT is not guaranteed.
Anyone relying on the exception needs evidence that the Israeli customers paid VAT on the imported service. Without such evidence, a principled argument alone is insufficient.
The contractual structure also matters. Applause switched in December 2016 to a model of invoicing the Israeli customers directly, but the court did not allow the new model to be applied retroactively to the assessment period.
Two judgments address this exception from different angles: Applause deals with a service included in imported services, and the Hagshama judgment deals with a service included in the value of goods. In Hagshama, the court held that there is no need to prove that the tax was actually paid. The rule and exceptions under Section 30(a)(5) are explained on the page Zero-Rate VAT on Services to Non-Residents.
A district court judgment is not binding on other courts, but it illustrates how the court examines the argument. For advance review, see VAT Opinions and Tax Rulings. After an assessment, see Objection to a VAT Assessment. For representation in VAT cases generally, see VAT Attorney.
