How a US Company Recovered NIS 312,000 of Israeli VAT It Should Never Have Paid

Result: NIS 312,000 of Israeli VAT credited back across 22 months of invoices and zero-rating established going forward · Timeline: 7 months · Challenge: Israeli suppliers charging VAT to a customer with no Israeli presence · Authority: Israel Tax Authority, VAT Department · Financial Impact: NIS 312,000 recovered plus roughly NIS 185,000 a year saved

Background

A software company incorporated in Delaware and run from Austin sells a subscription product to customers in North America and western Europe. It has no Israeli subsidiary, no branch and no Israeli employees. What it does have is two Israeli suppliers: an engineering and quality assurance firm in Herzliya that maintains part of the product, and a smaller marketing agency in Tel Aviv.

Both suppliers invoiced with Israeli VAT added. At 17%, then at 18% from 1 January 2025, this was not a rounding error. Over the period we eventually looked at, the company had paid NIS 358,000 in Israeli VAT on services consumed entirely outside Israel by a customer with no way to reclaim any of it.

That last point is what makes this expensive rather than merely irritating. An Israeli business deducts input tax against its output tax. A foreign company that is not registered as an Israeli dealer has nothing to deduct against. The VAT is simply an 18% surcharge on the price, paid to a state where the company does no business.

Their US controller had raised it twice with the Herzliya supplier and been told, politely, that this was how it worked.

The Challenge

It is not how it works, but the suppliers' caution was not irrational.

Section 30(a)(5) of the Value Added Tax Law 1976 applies a zero rate to the supply of a service to a foreign resident. The rate is zero rather than exempt, which matters to the supplier because it preserves the right to deduct its own input tax. So a properly zero-rated Israeli supplier is not out of pocket; it simply stops adding 18% to a foreign customer's bill.

Three conditions have to hold, and each one has generated Israeli assessments.

The first is who the customer is. For the purposes of Section 30(a)(5), the definition in Section 30(c) requires a corporation to be registered or incorporated only outside Israel and to have no business or activity in Israel. Incorporation abroad on its own is not enough. Our client had two facts that an assessing officer would have seized on: a co-working desk in Tel Aviv licensed in the company's name, used a few weeks a year by a visiting US employee, and two Israeli individuals engaged directly as contractors rather than through a supplier.

The second is the proviso inside Section 30(a)(5) itself, and it is where most of these arguments are lost. Where the subject of the agreement is that the service is in fact also rendered to an Israeli resident in Israel, the service is not treated as given to a foreign resident at all, and the zero rate falls away. The Tax Authority reads this broadly. A service does not stop being rendered to an Israeli resident because the invoice is addressed to a foreign parent. Israeli courts have been willing to read the section purposively when the commercial reality supports it, and in Tax Appeal 15803-02-18 Applause Quality Applications Ltd the Central District Court extended the customs-related carve-out from imported goods to imported services in a decision given on 7 September 2020. But an assessor starts from the opposite presumption, and the burden sits on the Israeli supplier.

The third is documentary. Regulation 12(a) of the Value Added Tax Regulations 1976 conditions the zero rate on the supplier holding a written agreement or other written document confirming the details of the transaction, and on the price, the method of payment and the currency being recorded in its books. Regulation 12A(a) then restricts the zero rate where the service relates to property located in Israel. Suppliers who invoice a foreign customer against a purchase order and an email thread, with no signed contract, fail on Regulation 12(a) alone, whatever the substance looks like.

Both of our client's suppliers had been audited within the previous three years. Neither wanted the argument. Charging VAT was the safe option for them and an expensive one for the customer, which is the ordinary equilibrium in this situation and the reason it persists for years.

In Practice: Section 30(a)(5) of the Value Added Tax Law 1976 zero-rates a service supplied to a foreign resident, defined in Section 30(c) as a body corporate registered or incorporated only outside Israel with no business or activity in Israel. Regulation 12(a) of the Value Added Tax Regulations 1976 makes the zero rate conditional on the supplier holding a written contract and recording the consideration, payment method and currency in its books. On this company's Israeli spend of roughly NIS 1.99 million over 22 months, the difference between 18% and zero was NIS 358,000, none of which a non-registered foreign company can ever deduct. The Israel Tax Authority's VAT department confirmed the position for both suppliers within seven months of the first submission.

What We Did

We cleaned up the Israeli footprint before arguing about it. The co-working licence was terminated and the desk released. The two direct contractors were re-engaged through the Herzliya supplier, so that the company's only Israeli relationships were supplier relationships. This is not cosmetic. Section 30(c) asks whether the company has business or activity in Israel, and a licensed workspace carrying the company's name is the first thing an assessor finds. Fixing it took six weeks and removed the argument entirely.

We built the residency file each supplier needed to hold. Certificate of incorporation and a certificate of good standing from the Delaware Secretary of State, both apostilled; the company's US federal tax filings; a signed declaration of foreign residency addressed to each supplier; and a schedule of the company's customers showing that none of them are Israeli. The point of the file is not to persuade us. It is to sit in the supplier's records so that when an assessor asks in two years' time, the supplier can answer without calling anybody.

We rewrote both engagements as signed agreements. Regulation 12(a) requires a written document. Each new agreement recites the customer's foreign residency, states that the services are supplied to the customer outside Israel and for its use outside Israel, sets the price in US dollars, and records the payment mechanism. Loose terms of business were replaced with something that survives an audit.

We split the marketing engagement. The agency's work was not uniform. Most of it was campaign work aimed at North American and European users, which is a service to a foreign resident and nothing else. A minority of it, about 14% of billings, was a campaign aimed at Israeli end-users of the product, and that campaign was rendered in Israel to people in Israel. We took the view that the proviso in Section 30(a)(5) applies to that slice and left it standard-rated. Advisers who try to zero-rate everything in an engagement like this are the reason assessors approach the whole section with suspicion, and a carve-out that is visible on the face of the file makes the rest of the position credible.

We corrected the past through the suppliers, not through the Tax Authority. A foreign company has no mechanism to reclaim Israeli VAT it has been charged; there is no non-resident refund scheme of the kind some European systems operate. The correction runs through the supplier: each issued credit notes against the historic invoices, re-issued them at the zero rate, refunded our client by wire, and adjusted its output tax in its periodic return. Twenty-two months of invoicing was still within the suppliers' open reporting periods. The credit notes had to mirror the rate on each original invoice, 17% before 1 January 2025 and 18% after it, which sounds trivial and caused two rounds of corrections.

In Practice: The proviso in Section 30(a)(5) of the Value Added Tax Law 1976 denies the zero rate where the agreement provides that the service is in fact also rendered to an Israeli resident in Israel, and the Israel Tax Authority applies it to the specific work rather than the whole engagement. Carving out the Israel-facing campaign left NIS 46,000 of the NIS 358,000 correctly charged at the standard rate. The remaining NIS 312,000 was refunded by the two suppliers through credit notes over eleven weeks once the position was settled, and the alternative, registering the US company as an Israeli dealer to recover input tax, would have created a permanent establishment argument under the US-Israel tax treaty for the sake of a smaller benefit.

The Outcome

Both suppliers now invoice at the zero rate. The company recovered NIS 312,000 covering 22 months, and stopped paying roughly NIS 185,000 a year on the qualifying part of its Israeli spend. The Israel-facing marketing campaign continues to carry 18%, correctly.

Seven months elapsed from the first review of the invoices to the last credit note clearing. Most of that was not legal argument. It was the six weeks to unwind the co-working licence, the four weeks for apostilled Delaware documents, and the suppliers' understandable insistence on being satisfied before they exposed themselves to an assessment.

Israeli professional fees came to NIS 38,000. The company's finance team estimates the recovery at roughly eight times the cost, and that ratio improves every year the zero rate holds.

One thing did not go the client's way. Invoices older than the suppliers' open reporting periods were not corrected, and the earliest ten months of the relationship, worth about NIS 96,000 of VAT, were left where they were.

Key Takeaways

What this case illustrates for non-residents in similar situations:

1. Israeli VAT charged to a foreign company is usually a mistake, and it is always a dead cost. There is no non-resident VAT refund scheme in Israel of the kind that exists in much of Europe. If the invoice should have been zero-rated, the correction runs through the supplier's credit note, which means the supplier has to be willing.
2. Your Israeli footprint decides the question before the contract does. Section 30(c) of the Value Added Tax Law 1976 requires a foreign corporation to have no business or activity in Israel. A co-working desk, a locally engaged contractor or a rented storage unit in the company's name will be found, and each of them hands the Tax Authority an argument you cannot easily answer.
3. Get the written contract in place before the first invoice. Regulation 12(a) of the Value Added Tax Regulations 1976 makes the zero rate conditional on documentation the supplier must actually hold. Purchase orders and email threads do not satisfy it, and no amount of commercial substance repairs a missing agreement after an audit has started.
4. Do not try to zero-rate the part of the work that genuinely benefits people in Israel. The proviso in Section 30(a)(5) exists for exactly that, and a visible carve-out protects the rest of the engagement. A supplier who has been told everything qualifies will eventually be told by an assessor that nothing does.
5. Registering in Israel to recover input tax is rarely the answer. It brings the company into the Israeli tax net and invites a permanent establishment argument under the treaty, which our guide to the US-Israel tax treaty sets out in detail. Zero-rating solves the problem without creating a presence.

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Facing a Similar Situation?

If your Israeli suppliers add VAT to every invoice and your company has no Israeli entity, there is a reasonable chance the charge is wrong and part of it is still recoverable through the supplier's open periods.

Contact us for a confidential consultation about your Israeli legal matter.