Google, Facebook to meet Israeli tax man

Under new rules proposed last week by the Tax Authority, Internet companies that do business in Israel will likely have to begin paying taxes, including Value Added Tax and income tax. The Authority has been working on the rules for months, in response to critics, and to a lawsuit that charged that while Israeli web sites are taxed for their activity, multinationals like Facebook, Google, Amazon, and eBay get off tax-free.

In a notification released Thursday, the Authority stated that “due to the changes in the ‘traditional’ economy, which has now morphed into the ‘digital’ economy, this Notification sets rules for what can be considered an Israeli entity when that entity’s business dealings are mainly on the Internet.”

Under the new rules, if a site sells to Israelis, gathers data on them so that a site can sell them goods and services, or connects them to an Israeli agent to sell them goods and services, the site can be required to pay Israel’s steep 18% VAT sales tax, and the income derived from the site’s Israeli activities can be subject to corporate income taxes (currently 26.5% before exemptions).

The notification has not been adopted officially, and is subject to change, the Authority said. It is expected that Israeli representatives of multinational Internet sites will raise objections, and the Authority said it would give companies an opportunity to comment on the proposal.

Key to the rule changes is the expansion of the definition of “Israeli entity.” Under the old rules an Israeli entity was one that earned money in Israel, either directly or through a bona fide local representative. A rule change was needed, the Authority said in its notification, because a situation developed where companies, customers, servers, and the goods themselves can be in distant geographic locations.

Under the new rules, the definition of Israeli entities will be greatly expanded, to include any site anywhere that has business dealings in Israel or with Israelis. In the case of companies located in countries with which Israel has tax treaties, the usual rules against double taxation will apply to ensure that the company does not have to pay taxes more than once on income earned abroad. In the case of companies based in countries with which Israel has no such treaties (such as China), the Authority will be free to set policies as it likes.

Another reason why the rule changes were necessary was because the Authority promised the High Court that it would try to develop fresh ideas on Internet taxation – the result of a lawsuit by Israeli attorney Guy Ophir. In 2013, Ophir filed a petition with the High Court demanding to know why the Tax Authority was not collecting taxes from Internet sites that were making money selling goods and services to Israelis, as well as brokering business deals inside the country, albeit from foreign locations.

“It seems,” Ophir wrote in his petition, “that although all taxpayers are equal when it comes to paying the high taxes the country demands, there are those who are ‘more equal’ than others and who do not face penalties, civil or criminal, for failing to report taxes or misleading consumers into thinking that the VAT collected on purchases is sent to the government.”

The court in March 2014 rejected the petition – but only because the Tax Authority promised to develop new rules to deal with the digital economy.

In a statement Thursday, Ophir said that he was pleased with last week’s Tax Authority notification. “The new rules need to be tested to ensure that they have the desired effect, but it appears that there will now be substantial changes. If the proposals are indeed adopted, sites like Google, Facebook, YouTube, Amazon, Microsoft, and other corporations will be required to pay VAT, bringing in huge sums to the state treasury, money that can reduce the country’s budget deficit.”

The rule change proposals were issued a day before Israel “broke” for Passover vacation, with most businesses – including the Israeli branches of the Internet giants – on limited work schedules.

In a statement, Google said that the company “complies with the tax laws in every country where we operate. The reality is that most governments use tax incentives to attract foreign investment that creates jobs and economic growth and, naturally, companies respond to those incentives. If politicians don’t like those laws, they have the power to change them. We believe international forums like the OECD are the right places to decide tax rules for multinational businesses because everyone would benefit from a simpler and more transparent system.”