n Articles and Rulings

Liability of Foreign Residents and Entities for Israeli Value Added Tax on Professional Services Rendered in Connection with the Foreign Registration of Intellectual Property Rights Created in Israel

Jeremy Cohn, Adv
Chairman International Tax Practice Group

Background

A foreign corporation owns a subsidiary in Israel, which itself employs inventors. Under an oral agreement with the parent corporation, an patent attorney based in Israel prepares and registers patents in the United States., the rights to which are assigned by the inventors directly to the parent (foreign, non-Israeli) corporation, in which process he incurs value added input tax. None of the patents are intended to be registered in Israel.

The Legislation

The professional patent registration services are clearly a service provided in Israel, by a business usually conducted in Israel, and is therefore solidly within the ambit of the Value Added Tax Law, 5735 - 1975 (the "VAT Law"). The services provided are unquestionably liable to V.A.T., and therefore, regardless of the rate of tax, all input tax is deductible.

The issue at stake in the matter at hand is whether the applicable rate is the usual 17%, or whether these activities are liable at zero rate.

Section 30 of the VAT Law provides in pertinent part as follows:

"30. (a) These are transactions which shall be taxed at zero rate:…

* * *

(5) provision of service to a foreign resident, excluding a service laid down by the minister of finance for this purpose; a service shall not be considered as provided to a foreign resident when the object of the agreement is the provision of a service in practice to a resident of Israel in Israel, .…"

The Minister of Finance has executed his authority under the VAT Law by promulgating the V.A.T. Regulations, 5736 - 1976, which in relevant part provid as follows:

"12A. (a) For the purpose of section 30 (a)(5) of the law zero rate shall not apply to a service provided in relation to property situated in Israel… ."

A foreign resident corporation, for the purposes of VAT Law, §30 is defined in §30 (a)(2) as "a corporation registered outside Israel and which is not required to submit a notice in accordance with §60." Section 60, in turn, deals with a foreign resident who has "business or activity also in Israel." We have assumed for purposes of this Memorandum that the foreign corporation in question here conducts no business or activity in Israel other than through its wholly owned subsidiary.

One further observation is in order: Section 12 of the VAT Regulations lays down certain technical requirements, in the absence of which zero rate is not applicable. These include entering into the books of the trader (in this case, the patent counsel) the cost of the transaction, manner of payment and currency paid. Further, the trader is required to have a contract or other written document confirming the details of the transaction.

Analysis

Beyond the technical reservations mentioned above, we may now infer that in order to qualify for zero-rate tax the transactions under consideration must satisfy two further conditions not explicitly set out in Section 30 of the VAT Law: (1) The recipient must be a foreign resident; and (2) and the service must not be provided in relation to property in Israel.

The first issue to be addressed is whether the work performed by patent counsel is rendered "in practice to a resident of Israel in Israel." The answer to this question in turn depends on whether the intellectual property rights of the local inventors were assigned to the foreign parent corporation prior to the commencement of the services rendered by Israeli patent counsel. If the services in question were in fact performed before the assignment took effect, then notwithstanding the fact that payment is made by the foreign corporation, because of its interest in acquiring the rights to the patent prior to submission, the V.A.T. office would appear to have substantial cause to claim that the service is provided "in practice to a resident of Israel in Israel" as envisaged by Section 30(a)(5) of the law. The result will be that the service is not zero-rated. Conversely, were the services rendered after the industrial property rights have come to rest legally in the hands of the foreign corporation, the ultimate beneficiary of the service would be the foreign corporation, thus satisfying this prong of the statutory test.

Turning now to the nature and situs of the object of the service, let us first consider whether these inventions are "property." "Property" is defined in Section 1of the VAT Law as "goods or land", and the definition of "goods" includes "rights, benefits, and other artificial property, including - knowledge… ."

There is no question that a registered patent, together with other types of intellectual property, would be considered "goods" under the VAT Law and therefore also "property" for our purposes. In the present case, however, we are required to determine whether the idea itself, or its expression on paper, constitute "knowledge" and therefore also "goods" and "property"; because, if they do, then they would appear to be situated in Israel, thereby precluding a zero rating for VAT purposes.

The term "knowledge" is not itself defined in the VAT Law. Furthermore, we are not aware of any judicial or administrative precedents that would appear to shed light on the matter. What is more, although the subject has certainly not been conclusively determined, the weight of academic opinion certainly does not preclude an interpretation whereby the object of the patent application is considered to be "knowledge." See D. Elkins, Taxation of Intellectual Property, 31 CHOSHEN LEMISHPAT 43 - 44 (1993); Y. Putschebutsky, Ownership of Knowledge etc., 34 HAPRAKLIT 433; Y. Tedeski, Business Secrets, 35 HAPRAKLIT 5. Moreover, in the last decade, the courts have been particularly aggressive in defining as "property" all manner of rights and benefits. See Sekurist, Civ. App. 61/86, Missim II/4, V - 102; Rozine, Civ. App. 418/86, 93 (I) P.D.(I) 837 [JEREMY CHECK THIS CITE. IT DOES NOT LOOK RIGHT]; Rosenberg, V.A.T. App. 1395/93, Missim X/1, V - 178; Speer, V.A.T. App. 10/94, P.A.M. II/1, 20).

The only conclusion on this point is that it cannot be said with certainty that we are not dealing, in our case, with "goods", and therefore with "property." We return to this point below.

It is proper, at this point, to note that in the Rozine case President Shamgar expressed the opinion that zero rating in accordance with §30(a)(5) applies only where the service is provided abroad. However, not only was this statement obiter dicta, and therefore not binding, but it has been roundly criticised wherever academically considered, not least because it makes §30(a)(7) superfluous. See Nimdar & Keinan, V.A.T. on Export of Services", Missim XI/2, I-1. This statement has not been adopted by the V.A.T. Office either, and can, therefore, probably be safely ignored.

Leaving the nature of the service aside for the moment, we turn to the question of its situs. While a registered patent is "property" and is deemed located at the place of registration, "knowledge" is not so easy to locate geographically. This is because knowledge does not represent a right capable of enforcement or protection in any particular geographical or legal location.

Here too, neither legislation nor precedent is of avail. Elkins, supra, 200 - 205 reaches the conclusion that such knowledge simply has no specific situs, and we cannot fault his reasoning. On the other hand, an activist court expounding the protection of beneficial economic interests might not inconceivably site the information handled by patent counsel in Israel. In the present case, even assuming that ownership of the intellectual property has been effectively transferred to the foreign corporation before the professional services have been performed, there is a risk that an activist court might hold the situs of the knowledge to be in Israel where the information was born in Israel and has never left here.

The Position of the V.A.T. Office

In spite of the uncertainty regarding the nature and situs of the object of the patent application, the V.A.T. Office have agreed, by letter of 21 March 1995 to the Association of Patent Attorneys, that any service provided to a foreign resident prior to registration of a patent in Israel in order to file the application here, and whilst the application is pending, but not including court proceedings, will be zero rated. All other services are liable to the full rate.

Although not specifically mentioned, we believe that this must apply a fortiori to registration abroad. Nevertheless, and particularly in view of other uncertainties, once the real obstacles mentioned above have been removed, we would suggest that it would be in order to request a ruling, all the more so if an adverse assessment after the fact would leave patent counsel out of pocket without recourse to his client.

Conditional upon satisfactory resolution as to whether the recipient of the service in the present case is really a foreign resident, this answers not only the question regarding preparation of patents for registration abroad, but also the question of registration in Israel.

Summary and Conclusions

Provision of services to a foreign resident is liable to V.A.T. at zero rate, as long as the services are not provided, in practice, to a resident of Israel in Israel, and as long as they do not relate to "property" (which includes "knowledge") situated in Israel. Certain technical requirements, including a written confirmation regarding the nature of the services to be performed also apply.

Where the foreign resident is a corporation with business or activity in Israel, zero rate does not apply.

The assignment whereby the foreign corporation acquires the rights to the patents must clearly provide that all right, title and interest to the invention have been transferred to the foreign corporation. Were the local inventors to retain any residual rights in the intellectual property, zero rate exemption may not apply.

Although one can argue that the object of the application is not "property", and that even if it is, it is not situated in Israel, the arguments are not conclusive, and opposite opinions are possible. Neverthless, for the moment, the V.A.T. Office has accepted that services provided to a foreign resident prior to registration of a patent in Israel will be zero-rated. This would appear to apply a fortiori to registration abroad, but for greater certainty, a ruling should be sought.

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