An Israeli company pays a foreign supplier every month for access to a cloud platform. No software is downloaded, no source code changes hands, no copy passes to the company, and there is no right to reproduce, distribute or modify. There is a connection to the supplier's server and use of its functionality. In accounting terms this is a current expense. In tax terms it raises a question that is anything but simple: does an obligation to withhold tax at source arise on the payment.

The exposure is not theoretical. If the answer is yes and nothing was withheld, the assessing officer may issue the company a withholding assessment for the use of an intangible asset, and since the tax cannot in practice be pushed back to the foreign supplier, it falls on the paying company.

The distinction everything turns on

The dispute runs between two classifications. Royalties. The Tax Authority tends to treat a subscription payment as the grant of a right to use software, and royalties attract withholding. Business profits. The taxpayer position is that this is a service, and that in the absence of a permanent establishment of the supplier in Israel there is no liability and no obligation to withhold.

The distinction looks technical and is in fact binary. Copyright is a bundle of rights: copying, publication, public performance, broadcasting, making a derivative work, and rental. A payment is royalties where it is given in return for exploiting one of those rights. Using the protected work, by contrast, is not exploitation of copyright. Reading a book is not use of the copyright in it. Listening to music is not. Nor, in itself, is running software.

That distinction is recognized in the OECD commentary on Article 12, under which rights that are technically incidental to operating the software do not turn the payment into royalties. The practical test is therefore whether the customer exploits the intellectual property commercially or merely consumes the output. A company given access to a programming interface in order to build its own product, or a licence to build a white label product, sits on one side of the line. A company that subscribes to a service and uses it as it is sits on the other.

The problem: the governing circular was written before the cloud

The central administrative document in Israel on the question is Income Tax Circular 13/2001. It distinguishes four categories of software transaction.

Artificial intelligence tools are the sharpest illustration

Thousands of Israeli companies now pay a monthly subscription for remote access to artificial intelligence tools. No software is downloaded, there is no copy, there is no code, and there is no right to copy, distribute or modify. The user sends a request and receives an output.

An attempt to place that transaction in one of the four categories shows that it fits none of them. No copyright was acquired, no copy was sold, no bundle of rights was granted, and the fourth category was carved out. The scale on which these tools are used turns the gap from an academic curiosity into a question that touches a great many companies.

What is worth doing

Until an updated administrative position takes shape, a company contracting with a foreign cloud supplier is advised to do the following.

Where to go next

Last updated: 28 August 2026

The above is a general survey only and does not constitute legal or tax advice. The law and the administrative position change from time to time.