A recent District Court VAT case has caused a stir in the real-estate world and may affect many Israeli investors in real estate located outside Israel. Value Added Tax (VAT) is a crude but effective tax; it raises more tax revenues than income tax but people rarely pay sufficient attention it. The general rule is that a business charges its customers "output" VAT, pays "input" VAT on its expenses and pays the balance (output VAT minus input VAT) to the VAT Authority every month, usually. This assumes the input expenses are incurred in generating sales "output transactions," which are subject to Israeli VAT. The standard rate of VAT is 15.5 percent, but exports are usually subject to VAT at 0%; this is better than an exemption because the business can still reclaim input VAT on its expenses and even receive a VAT refund. Gazit Globe case So what went wrong in the Gazit Globe case in the District Court? Gazit Globe is an Israeli company that acquires, develops, manages and improves rental properties. The VAT Authority claimed it was necessary to review the economic substance of the Israeli company's activity, not only its legal form ("substance over form" doctrine). Because most of the properties are located outside Israel and held via foreign subsidiary companies of the Israeli company, most of its expense "inputs" relate to overseas activity that does not generate taxable "output" transactions in Israel. Therefore, the VAT Authority disallowed 75% of the input VAT claimed each month by the Israeli company. The Israeli company claimed that the foreign rental activities were carried out by its foreign subsidiaries, not by the Israeli company itself. The Israeli company's activities in this regard consisted of providing its subsidiaries general advice, economic-financial advice and analysis used in finding real-estate investment opportunities in Israel and abroad, pursuant to intercompany agreements. The District Court said it was clear the Israeli company's activities are subject to VAT. The key issue was whether the inputs of the Israeli company should be linked to the outputs of its foreign subsidiaries. The court accepted the VAT Authority's position that the activity of the Israeli company effectively related to the properties outside Israel, and it did not merely provide services to the foreign subsidiaries. Therefore, the court ruled that only 25% of the Israeli company's input VAT on its expenses can be recovered. Comment This is an unfortunate result; let's hope it will be appealed. The "substance over form" doctrine is meant to be used to unwind sneaky, complex tax planning, not to penalize common commercial transactions devoid of tax planning. Also, if the foreign subsidiaries are resident in countries that have an income-tax treaty with Israel, it might be argued they are being indirectly discriminated against if they have to bear the resulting VAT burden. The anti-discrimination article in some tax treaties applies to all taxes, including VAT. As always, consult experienced professional advisers in each country at an early stage in specific cases. firstname.lastname@example.org Leon Harris is an international tax specialist.