The Israel Tax Authority (ITA) has released Circular 03/2026, providing the professional framework for implementing the 2025 Economic Efficiency Law. This circular marks a dramatic paradigm shift: the transition from decentralized enforcement across different tax systems (Income Tax, VAT, and Real Estate Tax) to a unified "Integrated Fiscal Enforcement" doctrine. Under this new regime, a procedural failure in one tax area may lead to the automatic denial of substantive rights in another, creating a double-taxation exposure for non-compliant entities.
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The Bottom Line:
The new circular establishes that violations of the "Cash Law" or failure to comply with digitalization requirements (the "Israel Invoices" model) will no longer result in mere financial penalties. The primary innovation lies in the automatic disallowance of expenses for income tax purposes and the denial of input tax deductions for VAT on the same transactions. For modern corporations, this necessitates full synchronization between ERP systems and real-time reporting requirements, as any deviation will lead to a direct increase in the company’s effective tax rate.
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Key Regulatory Changes and Findings

• Sanction Synchronization: Denial of expense recognition (under Section 32 of the Ordinance) for transactions conducted in violation of the Cash Law or without a valid "Allocation Number."
• Acceleration of "Israel Invoices": The timeline for reducing the reporting threshold has been moved forward. As of May 31, 2026, every invoice above 5,000 NIS will require an ITA-issued allocation number as a condition for VAT and expense deduction.
• Withholding as a Condition for Deduction: Expenses subject to Withholding Tax (WHT) will not be deductible unless the tax was actually withheld and transferred to the ITA.
• Expanded Detailed Reporting: The threshold for detailed VAT reporting has been lowered to an annual turnover of 500,000 NIS, bringing tens of thousands of SMEs into the circle of full transparency.
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1. The Paradigm Shift: Integrated Enforcement

Historically, tax systems in Israel operated in silos. A taxpayer who violated the Cash Law faced an administrative sanction but could still claim the business expense for income tax purposes. Circular 03/2026 ends this separation. The legislator has adopted a doctrine where an expense incurred in violation of the law is not recognized. This synchronization is designed to create a multi-system deterrent, ensuring that paying a "fine" is no longer viewed as a manageable business cost compared to the tax savings of the expense.
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2. Disallowance of Expenses for Cash Law Violations
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The amendment to Section 32(16A) of the Ordinance stipulates that an expense paid in violation of the Law for the Reduction of the Use of Cash (currently above 6,000 NIS for B2B transactions) will be disallowed.
Professional Note: The disallowance is not triggered by the mere suspicion of a violation, but by the actual imposition of an administrative sanction by the ITA. The circular clarifies that if a sanction is overturned in court, the expense will be recognized retroactively with interest and indexation, highlighting the strategic importance of appealing administrative penalties.

3. "Israel Invoices" Model: Digitalization at Scale
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The ITA has identified the invoice allocation model as its most effective tool against fictitious invoices. The circular details the accelerated rollout:

• As of January 1, 2026: The mandatory threshold for an allocation number is 10,000 NIS.
• As of May 31, 2026: The threshold drops to 5,000 NIS.
  Substantive Implication: New Section 32(18) dictates that an invoice requiring an allocation number that fails to obtain one will not be recognized as an expense for income tax. This creates a "double penalty"—the loss of the VAT input deduction and the loss of the tax-deductible expense, significantly increasing the transaction cost.
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4. Withholding Compliance (Section 32A)

The circular clarifies the conditions for allowing expenses subject to WHT. Reporting the expense is no longer sufficient; the cumulative condition is the actual transfer of the withheld tax to the Assessing Officer. However, the ITA maintains discretion to allow the expense if it is proven that the tax was paid by the recipient or if a valid exemption existed at the time of payment.
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Practical Takeaways for Executives

1. Procurement and Internal Controls: Implement strict protocols prohibiting cash payments above legal thresholds. The current tax damage (fine + disallowed expense) makes such transactions economically unviable.
2. Technological Upgrades: Organizations must ensure their ERP and accounting systems support real-time verification of ITA allocation numbers. By May 2026, even relatively small transactions (5,000 NIS) will require this digital handshake.
3. Vendor Risk Management: Withholding compliance is now a critical risk factor. Beyond verifying a vendor's WHT certificate, companies must ensure the internal process for transferring those funds to the ITA is flawless to protect the deductibility of the expense.
4. Preparation for Detailed Reporting: Businesses with turnovers between 500,000 and 2.5 million NIS that were previously exempt from detailed reporting must immediately adjust their accounting workflows to avoid non-compliance sanctions.
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FAQ

Q: Can I obtain an allocation number retroactively for an invoice issued without one?
A: The circular allows for an application to the ITA for a retroactive number, but this does not change the original reporting date and may involve a detailed audit of the circumstances surrounding the delay.

Q: How does the disallowance of expenses affect loss-making companies?
A: Disallowing an expense reduces the company’s carried-forward losses. This will result in higher tax payments in the future years when the company returns to profitability.

Q: Does the Cash Law apply to transactions with foreign suppliers?
A: The Cash Law applies to transactions within Israel. However, for international transactions, reporting and withholding aspects must be examined in accordance with tax treaties and Section 170 of the Ordinance.

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