An Israeli company paying a foreign supplier for access to a cloud platform, for a software licence or for an application programming interface has to decide whether it must withhold tax at source. The obligation to withhold arises under domestic law, in sections 164 and 170 of the Income Tax Ordinance. Its rate, and sometimes its existence, are set by the tax treaty between Israel and the supplier's state of residence.

If the payment is royalties as defined in article 12 of the particular treaty, the source state has a taxing right, sometimes at a capped rate and sometimes at zero. If the payment is business profits under article 7, the source state may tax only where the supplier has a permanent establishment there, and without one there is no liability and no duty to withhold. Alongside these two, some treaties carry further routes, among them technical services. What decides the matter is therefore the royalty definition in the specific treaty, and that definition is not uniform across Israel's treaty network.

What to check in each treaty

The definition across Israel's treaties

"Treaty rate" is the ceiling Israel as source state may withhold; the lower of the treaty rate and the domestic rate applies. "Domestic rate in supplier state" is the rate that state imposes on royalties leaving it, and it matters for payments in the opposite direction, from the foreign supplier to Israel. The verification column distinguishes a row whose definition was checked against the treaty text from a row where only the rate was confirmed. Rates follow PwC Worldwide Tax Summaries for Israel, updated 1 January 2026. Rates and treaty texts change from time to time.

The five treaties that name software expressly

Of the treaties checked against their text, five name software expressly: Japan, Singapore, Luxembourg, Hungary and Canada. In those treaties there is no need to examine whether computer software falls within "literary work", because the term appears in the definition itself.

That inclusion does not turn every payment for software into a royalty. The underlying distinction holds: a royalty is paid for exploiting the copyright, meaning the right to copy, distribute, modify or perform in public, while payment for the use of a protected copy or for access for one's own purposes is not a royalty. A cloud transaction that confers no right in the intellectual property is not a royalty even under a treaty that names software.

The Israel and Canada treaty makes the point. The definition names software, and the rate set for software royalties is nonetheless zero, and the Canadian tax authority treats shrink-wrap software as income that is not a royalty.

The equipment limb, and the exposure of an infrastructure deal

Nine of the treaties extend the royalty definition to payment for the use of industrial, commercial or scientific equipment: Japan, Singapore, Hungary, Canada, Brazil, the United Arab Emirates, the Netherlands, China and Australia. Five do not: Luxembourg, India, France, Ireland and the United States. For Greece, Switzerland, the United Kingdom, Germany and Malta only the rate was confirmed and the definition has not yet been checked against the treaty text.

In a cloud infrastructure deal, where the customer takes computing power, storage and bandwidth, a source state may argue that this is use of equipment and therefore a royalty, without entering the copyright question at all. The 1992 update to the OECD Model removed the use of equipment from the royalty definition, and since then it is treated as business profits under article 7, but the treaties Israel signed before that were not amended to match.

On the export side the exposure is greater, and for a structural reason. A treaty limits liability and does not create it: it is a shield and not a sword. Israeli domestic law has no royalty category built on equipment, so the equipment limb of a treaty creates no liability here. An Israeli company selling cloud infrastructure to a customer in a state whose treaty covers equipment may nonetheless meet withholding in the customer's state, while in Israel there is no income classified as a royalty against which the credit can be set.

Technical services, and two different mechanisms

India has a standalone provision, article 13, taxing payment for technical services at ten per cent even where the supplier has no permanent establishment and even where the payment is not a royalty. The Brazilian protocol works differently: it brings technical assistance and technical services inside the royalty definition itself, so that the payment is taxed as a royalty under article 12. In both of these states the argument that the payment is for a service does not on its own displace the duty to withhold.

The treaties with a narrow definition

In Ireland and the United States the definition covers neither software nor equipment, and there is no separate technical services route. A transaction that confers no right in the intellectual property stays outside the royalty definition, falls into the business profits article, and turns on whether a permanent establishment exists. Without one in Israel there is no liability and no duty to withhold. In the United Kingdom, Germany and Malta the treaty rate is zero, so the classification question does not change the amount withheld even without opening the definition.

The United States Treasury regulations completed in January 2025 provide that a cloud transaction is a services transaction, software as a service included, and did away with the multi-factor test that appeared in the proposed regulations. Separate proposed regulations on the source rules were published the same day and have not been completed.

A state with no treaty

Against a supplier in Cyprus, where no treaty exists, Israeli domestic law applies in full and the rate withheld on royalties paid to a foreign company is 23%. No treaty ceiling limits it and no mutual agreement procedure balances it. In dealings with suppliers in states with no treaty, the classification question carries twenty three per cent of the consideration.

The multilateral instrument and the principal purpose test

Eighteen of the states surveyed here have ratified the multilateral convention implementing the BEPS measures, the MLI. The United States is not a party to it, so the Israel and United States treaty is unaffected. Israel signed and ratified, and the MLI entered into force for Israel in 2019.

The MLI does not change the royalty definition and does not decide the classification question. What it adds is the principal purpose test, a minimum standard that applies even where only one of the states adopted it without reservation. Under that test a treaty benefit is denied where obtaining the benefit was one of the principal purposes of the arrangement. Implementation of the multilateral convention in Israel is set out in Income Tax Circular 01/2022.

How a treaty is read

Three instruments operate at different levels. The OECD Model and the UN Model are the template for the treaty's content. The MLI is the binding instrument that amends existing treaties. The Vienna Convention on the Law of Treaties is the interpretive tool that applies to all of them.

Israel is not a party to the Vienna Convention, but the interpretive rules in articles 31 and 32 reflect customary international law, and the Israeli courts have applied them as such. Article 31 requires interpretation in good faith, according to the ordinary meaning of the words and in the light of the treaty's object and purpose. Article 32 permits recourse to supplementary means of interpretation, among them the OECD Commentary, which Israeli case law has recognised as a central interpretive tool.

Alongside these stands article 3(2) of the treaties themselves, under which a term not defined in the treaty takes its meaning from the law of the state applying it. Where the treaty definition does not name software, the interpreter therefore returns to Israeli domestic law, and there no general definition of "royalties" exists. The Ordinance uses the term in section 2(6), in a list confined to a dwelling house, land and an industrial building. Section 2(7), covering other assets, catches income from any asset that is not a dwelling house, land or an industrial building, including income from an intangible asset, without defining the term. The reference to domestic law does not therefore produce a definition that can be relied on.

The scope of the definition, beyond the rates

The core of the definition in the OECD Model is narrow: use of a copyright, a patent, a trade mark, a design, a secret formula or process, and know-how. Around that core the systems move along several axes. The Israel and Japan treaty extends also to sale, meaning to a transfer of the right and not only to its use. The Israel and Thailand treaty covers cinematograph films and broadcast tapes. The Israel and Brazil treaty is the broadest of all, with equipment and with technical services in the protocol.

Israeli case law has also broadened the term. In the Ideal Tours case it was held that royalties may cover payment for the use of goodwill and of a trade name, and ancillary services as well. That reading goes beyond the narrow OECD core.

In an entirely different context, in customs law, the test is another one: a royalty payment is examined by the condition of sale, meaning whether payment to the owner of the intellectual property is a condition of buying the goods, and if it is, it is added to their customs value. That test sits with the World Customs Organization and is applied in Canada, the United States and New Zealand. The term "royalty" is therefore not uniform even within Israeli tax law itself.

The royalty definition in domestic law, compared

Most of the systems examined distinguish exploitation of the copyright from use of a copy or of a service, and conclude that a cloud transaction is not a royalty. Australia is the exception. Israel is the only one of these with no answer in either direction.

The UN Model and article 12B

The 2021 UN Model created a separate category for automated digital services, cloud services included. The provision gives the customer's state of residence a taxing right at a gross rate agreed bilaterally, without a permanent establishment requirement and without classifying the payment as a royalty, with an option to be taxed on a net basis. None of Israel's treaties has adopted it.

When each state classifies differently

Classification is made in each state under its own law and its own reading of the treaty. An Israeli company may classify a cloud transaction as a service and withhold nothing, while the supplier's state of residence classifies the same payment as a royalty and expects a credit for withholding that was never made. That is a conflict of qualification, and the result is double taxation or double non-taxation. The mutual agreement procedure in article 25 of the Model is available, but it is slow and agreement at the end of it is not assured. The classification follows the text of the particular treaty and the reading each of the two states gives it, and the description on the invoice does not settle it.

What to do in practice

Where to go next

Last updated: 5 September 2026

The content of this page is general information only. It does not constitute legal or tax advice and should not be relied upon in making decisions. The law, the withholding rates and the treaty texts change from time to time.