I. Case Overview
A Securities Ltd. is a branch of a British company established in Israel. In this case, it provided financial intermediary services to a local Israeli bank and a foreign bank outside of Israel, charging service fees to both banks. Under Article 30(a)(5) of the Israeli Value Added Tax (VAT) Law, service fees charged to a foreign bank outside of Israel can be subject to a zero VAT rate. Based on this provision, A Securities Ltd. requested that the Israeli tax authorities treat the service fees received from the two banks as separate transactions, applying different tax treatments. The company argued that the service fees charged to the foreign bank should qualify for the zero VAT rate under Article 30(a)(5) of the Israeli VAT Law. However, the Israeli tax authorities disagreed and did not approve the request, prompting A Securities Ltd. to file a lawsuit with the Israeli District Court.
In August 2021, the Israeli District Court ruled in favor of A Securities Ltd., stating that the services provided to the foreign bank outside of Israel should be considered separate, allowing the service fees to benefit from the zero VAT rate under Article 30(a)(5) of the Israeli VAT Law. The Israeli tax authorities, disagreeing with the District Court’s ruling, appealed to the Israeli Supreme Court. The Supreme Court overturned the lower court’s decision, ruling that the financial intermediary services provided by A Securities Ltd. should not be treated as separate transactions for tax purposes. As a result, both sets of service fees charged to the two banks were subject to the full VAT rate, and the service fees charged to the foreign bank did not qualify for the zero VAT rate.
II. Key Point of Dispute
The central issue in this case was whether the financial intermediary services provided by A Securities Ltd. should be treated as two separate transactions with different VAT rates, depending on the recipients of the services. A Securities Ltd. and the Israeli tax authorities had different interpretations of this matter.
A Securities Ltd.’s Argument: The company argued that since it charged separate service fees to the two banks, these should be treated as two distinct transactions. Therefore, the service fees charged to the foreign bank should be eligible for the zero VAT rate under Article 30(a)(5) of the Israeli VAT Law.
Israeli Tax Authorities’ Argument: The tax authorities contended that according to Amendment 22 of Article 30(a)(5) of the Israeli VAT Law, “…If the actual recipients of the service include both foreign residents and Israeli residents, the service cannot be considered as provided to foreign residents alone…” Since the service recipients in this case included Israeli residents, A Securities Ltd. could not benefit from the zero VAT rate reserved for foreign residents.
III.Final Ruling
In February 2024, the Israeli Supreme Court issued its final ruling, deciding that the financial intermediary services provided by A Securities Ltd. to both Israeli and foreign residents should not be treated as separate transactions for tax purposes. The specific rulings are as follows:
Services to both foreign and Israeli residents do not qualify for a zero VAT rate: The Supreme Court emphasized that to avoid disputes over which party benefits more from the service and to prevent potential abuse where foreign residents might be used as intermediaries to gain tax exemptions, Amendment 22 of Article 30(a)(5) of the Israeli VAT Law includes a restrictive clause. This clause states that if services are provided to both foreign and Israeli residents, regardless of the extent of services provided to Israeli residents, the zero VAT rate does not apply.
Intermediary services are considered a single transaction: The Supreme Court ruled that the intermediary services provided by A Securities Ltd. should not be regarded as two separate transactions—one for Israeli residents and another for foreign residents. Splitting the same service into two would not accurately represent the economic substance of intermediary services, which are inherently designed to facilitate a single transaction between two parties. Even if different services are provided to different parties or different fees are charged, it does not change the fact that the intermediary service is a single transaction offered to multiple recipients.
IV. Insights for International Businesses
Understand the Host Country’s Tax Laws: When engaging in overseas business, companies should thoroughly research the host country’s tax laws to ensure their activities comply with local tax regulations. Different countries have different tax systems and rules governing cross-border services. Understanding these rules is essential to avoid unnecessary penalties or losses.
Enhance Tax Risk Management: Tax risks can arise from various factors, such as the characterization of services and eligibility for tax incentives. The tax issues faced by A Securities Ltd. were due to a failure to properly determine the nature of its intermediary services. This lack of understanding and research into the criteria for tax incentives and amendments to regulations was the core issue. Therefore, companies doing business abroad should establish robust tax risk management systems to identify and address potential tax risks proactively.
Improve Tax Compliance Awareness and Capabilities: Ensuring tax compliance is not only a legal requirement but also vital for stable business operations and avoiding financial losses. Companies should enhance training and education for their tax personnel, improving their professional skills and awareness of compliance, particularly regarding changes in tax regulations for cross-border transactions. Staying updated on relevant tax policies is crucial.
