Non-Profit Organizations and Financial Institutions Under VAT: Payroll Tax and Profit Tax

A non-profit organization (Malkar) does not charge VAT on its sales and does not deduct input tax. Instead, it pays a payroll tax at a rate of 7.5% of the wages it paid. A financial institution, such as a bank or insurance company, pays payroll tax and profit tax at a rate of 18% (Section 4 of the VAT Law and the Order issued thereunder). Disputes arise when the VAT authorities claim that part of an association's activity is commercial, or when they seek to expand the payroll tax base.

A decision to change a classification may be appealed to the District Court within 30 days. Send us the decision or the assessment, and we will review them.

Usually when the VAT authorities are re-examining the classification or the tax base. These are the most common situations:

• You received a notice that the Director is considering registering part of the association's activity as a dealer under Section 58 — for example, a shop, a cafeteria, or hall rentals. Before making such a decision, the Director must give you an opportunity to present your arguments (Section 62).

• The assessor seeks to apply the new classification retroactively to prior years and impose VAT on transactions that have already been carried out.

• The association operates in a market where businesses also operate, and the VAT authorities claim it competes with them.

• During a payroll tax audit, the assessor adds to the tax base payments that you did not report as wages, such as payments to an employee on sabbatical abroad.

• Your company engages in check discounting or non-bank financing, and you need to determine whether it is classified as a dealer or a financial institution and how Position Paper 09/2026 applies to it.

• A financial institution received a profit tax assessment — for example, regarding what is included in "profit" under Section 1 of the Law.

The Value Added Tax Law, 5736-1975, recognizes three types of taxpayers: a dealer, a non-profit organization (Malkar), and a financial institution (Section 1). Each is subject to a different taxation method:

• A dealer charges VAT at a rate of 18% on its transactions and deducts the input tax it paid to suppliers.

• A non-profit organization includes, among others, the State, a local authority, and a body of persons whose business is not conducted for profit. It pays payroll tax at a rate of 7.5% of the wages it paid (Section 4(a)) and does not deduct input tax.

• A financial institution includes, among others, a bank, an insurer, and categories designated by the Minister of Finance in the Value Added Tax Order (Designation of Financial Institution), 5737-1977. It pays payroll tax and profit tax at a rate of 18% (Section 4(b)) and files separate returns for payroll and profit (Section 67). A bank that is not a "bank with a small volume of activity" also pays, from April 1, 2026 through December 31, 2027, a special payment on profit under a temporary provision.

A non-profit organization with turnover exceeding NIS 20 million and a financial institution with turnover exceeding NIS 4 million must also file a special report on tax invoices received from dealers (Section 70(b)).

Reclassification Under Section 58

• The Director may, upon the taxpayer's request or on his own initiative, register the taxpayer as a different type — for all or only some of its activities — if their substance is closer to the other type (Section 58). Thus, an association may be classified as a non-profit for one activity and as a dealer for another.

• The Supreme Court held that the Director examines the substance of the activity itself, even when the entity's ultimate purpose is public. A commercial activity remains commercial even when its profits fund the public purpose.

• A classification under Section 58 takes effect 30 days after the end of the month in which the notice was delivered, or on another date set by the Director (Section 63).

• The decision may be appealed directly to the District Court within 30 days of service of the notice. Filing the appeal stays the execution of the decision, unless the court orders otherwise (Section 64).

A case of this kind is built primarily on data about the actual activity. Here is how the process works:

1. You send us the notice or assessment, the articles of association, the financial statements, and a breakdown of income by type of activity.

2. We examine each activity separately: who pays, at what price relative to market price, who performs the work (salaried employees or volunteers), and whether the activity can be separated from the public activity.

3. If the Director has not yet decided, we submit arguments at the stage where he is required to hear you (Section 62). If a decision has already been made, we check from what date the Director seeks to apply the classification and calculate the 30-day appeal deadline.

4. In a payroll tax case, we review every component the assessor added to the tax base, against the definitions in Section 4 and the Israel Tax Authority's position papers.

5. We file an objection to the assessment or an appeal against the classification. Before launching a new activity, you may request a tax ruling on its classification.

A judgment on the question of reclassification, and the Israel Tax Authority's new position paper on check discounting.

Shomrei Emunim: Reclassification Applies Prospectively Only, TA 23407-08-18 (Nov. 22, 2023)

The Jerusalem VAT Director reclassified the company from a non-profit to a dealer and imposed tax on transactions that preceded the decision. The District Court upheld the reclassification as a dealer but held that it applies from the date of the decision (July 11, 2018) and not from January 1, 2013. The company was ordered to pay costs of NIS 20,000. Regarding input tax deduction, the court held that the Director may extend the deduction period to up to five years before the decision (Section 116(a)). Adv. Shlomi Vaknin represented the company. The Shomrei Emunim judgment.

Check Discounting: Position Paper 09/2026 in Calcalist (Sep. 17, 2026)

On August 26, 2026, the Israel Tax Authority published a position paper stating that check discounting constitutes a sale transaction subject to VAT, and that the exemption under Section 31(5) of the Law — for a loan from a dealer to a financial institution — does not apply to it. The tax is calculated under Sections 19(b) and 9(b), on the difference between the purchase price of the checks and the amount collected. In the firm's article in Calcalist, it was argued that the position disregards the risk-transfer test established in case law. The article on check discounting and VAT.

The practice is led by Adv. and CPA Shlomi Vaknin together with his firm's team. He served for nearly a decade as a national supervisor in the Professional Division of VAT at the Israel Tax Authority headquarters. In cases of this kind, we also review the entity's financial statements and payroll reports.