This is an important update for any online foreign company that provides services or sells items to Israeli customers.

Yesterday, the Israel Tax Authority ("ITA") published a memorandum of proposed draft legislation addressing the issue of VAT in transactions offered by foreign entities providing digital, radio and TV services to Israeli customers as well as foreign entities selling products electronically to Israeli consumers ("Foreign Service Provider") (the "Proposed Draft Legislation") and shifting the payment obligation from the customer to the Foreign Service Provider in B2C type transactions. This Proposed Draft Legislation comes on the back of heavy criticism aimed at a draft circular issued by the ITA which interpreted the current law as requiring internet based foreign entities to register and pay VAT in Israel. The justification behind the Proposed Draft Legislation is: (i) the problematic nature of collecting the VAT from individual customers; and (ii) to avoid discrimination between Israeli based businesses that pay VAT and Foreign Service Providers that do not currently pay VAT in Israel.

The Proposed Draft Legislation is a preliminary stage in the legislative process. The final law can differ from the Proposed Draft Legislation.

VAT Payment Obligation

Under the Proposed Draft Legislation, the obligation for payment of VAT when a foreign entity provides digital B2C services (including sales of items online) to an Israeli customer is on the Foreign Service Provider. The obligation for payment of VAT in the case of B2B services in the ordinary course of the Israeli client's business has not changed such that the Israeli business is still required to pay the VAT on a reverse charge mechanism. However, when the service is not provided in the ordinary course of the Israeli B2B client's business, the VAT liability is imposed on the Foreign Service Provider.

A foreign entity is defined as an entity that is incorporated outside of Israel and which does not have any activity in Israel which requires it to register for VAT. The definition of an Israeli resident is not based on the definition used elsewhere in the Israeli tax legislation, but rather it refers to a taxpayer that has been identified as Israeli according to some general parameters (such as payment method, the equipment used to purchase the service or item, and where such customer sits (presumably his address)).

The definition of electronic services is very broad and would include most (if not all) of the services our digital clients provide.

The payment obligation arises on a cash basis when payment is received by the Foreign Service Provider, and is based on the amount received.

Registration and Reporting Obligations

The Proposed Draft Legislation requires the foreign entity to register for VAT in Israel unless the Foreign Service Provider does not meet the de-minimums threshold (currently USD 20 thousand). The registration is in a separate registry for Foreign Service Providers.

Timing and period for the VAT reporting is not specified (e.g., what currency will be used for the reporting, how frequent will one need to report, etc.). However, the report will need to provide information about the price of the transactions with Israeli customers as well as the applicable VAT amount.

The Foreign Service Provider will need to save information on the transactions in question for a period of 10 years. The ITA will have a period of ten years to conduct an audit.

We will keep you updated as to any developments in this area.