Israel – Tax Authorities issue Draft Circular regarding activities of foreign companies through the Internet

The Israeli Tax Authorities (ITA) issued draft guidelines titled “Activities of Foreign Companies through the Internet” (hereafter the “Draft Circular”) for comments.

The purpose of the Draft Circular is twofold:

  1. To elaborate on when service income is generated by a foreign entity; in cases where the internet serves as a key tool for generating such service income, income would be regarded as generated by a permanent establishment (PE) of such an entity in Israel.
  2. To determine, if, and under what circumstances, a foreign entity, which provides services to Israeli customers through the internet, should register for Israeli VAT purposes.

It should be noted that the Draft Circular is effectively the opinion of the Israeli Tax Authority, but it does not change the Israeli tax legislation. However, it does provide insight into how the ITA might interpret the existing local tax legislation.

Permanent Establishment

With regards to the PE issue, the Draft Circular provides that, when a foreign entity’s core activity is conducted through the internet, and the following characteristics are met, then such activity of the foreign entity will not necessarily fall within a PE Exemption, but rather it should be viewed as an activity that is likely to give rise to a PE claim. The main characteristics listed in the Draft Circular are:

  • Other than the facility in Israel, such foreign entity operates a customized website for its Israeli customers (e.g., language, advertisements, currency, etc.);
  • The website connects between Israeli customers and Israeli suppliers;
  • High popularity among Israeli users;
  • The ability to generate profits out of the website increases as the use of it increases;
  • Representatives of the foreign entity in Israel are involved in tracing potential customers or collecting information with the help of the facility located in Israel;
  • Customers’ management control – there is a current and ongoing connection between the foreign entity and the Israeli customer, with the help of the Israeli facility, which includes, inter alia, arranging customers’ conventions, creating new opportunities to present new products, developing and enhancing customer service, giving feedback with respect to the foreign entity’s activity in Israel.
  • The scope of marketing and support services which are rendered in Israel by the foreign entity’s representatives are significant;
  • The foreign entity bears business risks in Israel.


With respect to the potential VAT registration obligation, the Draft Circular provides that when there is a strong direct nexus between Israel and a foreign company’s significant scale of online services provided to Israeli customers in such a manner that the circumstances relating to such services are linked to Israel, it may be contended that in essence business transactions exist in Israel.

The Draft Circular states that this nexus may be based, inter alia, on the following parameters:

  • The service is provided to Israeli customers interested in different services in connection with Israeli users in Israel (e.g., mediation services or advertising in connection to Israeli users).
  • The service provided to Israeli customers of the foreign corporation is directed to Israeli users.
  • The service is provided in practice in Israel since the service is performed by presenting content on users’ computers in Israel, and usually through Israeli websites as well.
  • In some cases, marketing and locating customers for the foreign corporation, as well as the support of those customers, is performed in Israel, through Israeli companies that are related to a foreign corporation.
  • The services provided by the foreign corporation are consumed in Israel.

The Draft Circular provides the following examples of cases that require registration as an Israeli “Authorized Dealer” for a foreign company online advertising, mediation services etc. in Israel:

  • A foreign company operating a search engine will have to register as a result of its income from advertising services provided to Israeli customers who are directed to Israeli consumers or users.
  • A foreign company operating a website service for reserving hotel rooms in Israel will be required to register in connection with its reservation income relating to stays and visits in Israeli hotels by Israeli consumers.

The Draft Circular also provides, that to the extent a PE is established for Israeli income tax purposes, then such foreign entity will be regarded as conducting a business operation in Israel for VAT registration purposes.

What does it mean for you?

It is interesting to see that the ITA’s thinking goes further than demanding a VAT registration “only” of B2C electronic service providers, what seems to be the current trend around the world (see also for example the EU, Switzerland, South Africa, or more recently Albania, Japan or South Korea, just to name a few.) By trying to imply a PE for foreign entities, as a result of on-line sale of electronic services to Israeli private customers, the ITA is clearly investigating the options how to tax such revenues also for direct tax purposes. It is therefore recommended to keep an eye out on the developments in this regard, so that you have the right strategy in place for any upcoming changes.

For further information please contact Liat Neuwirth of PwC Israel or me.