SECOND PROTOCOL AMENDING THE 1975 TAX CONVENTION WITH ISRAEL MESSAGE FROM THE PRESIDENT OF THE UNITED STATES TRANSMITTING 　　THE SECOND PROTOCOL AMENDING THE 1975 CONVENTION BETWEEN THE GOVERNMENT OF THE UNITED STATES OF AMERICA AND THE GOVERNMENT OF THE STATE OF ISRAEL WITH RESPECT TO TAXES ON INCOME (AS AMENDED BY THE PROTOCOL SIGNED ON MAY 30, 1980), SIGNED AT JERUSALEM ON JANUARY 26, 1993 LETTER OF SUBMITTAL (PROTOCOL 2) DEPARTMENT OF STATE Washington, June 17, 1993. The PRESIDENT, The White House 　　THE PRESIDENT: I have the honor to submit to you, with a view to its transmission to the Senate for advice and consent to ratification, the Second Protocol Amending the 1975 Convention Between the Government of the United States of America and the Government of the State of Israel with Respect to Taxes on Income (as amended by the Protocol signed on May 30, 1980) signed at Jerusalem on January 26, 1993. An associated exchange of notes is submitted for the information of the Senate. 　　On November 18, 1981, the Senate gave its advice and consent to ratification of the 1975 Convention, as amended, subject to an understanding providing for Congressional access to information exchanged under the Convention. The understanding proved to be unacceptable to Israel and the Convention, as amended, did not enter into force. The Second Protocol further amends the 1975 Convention, as amended by the 1980 Protocol, in large measure to accommodate certain post-1980 provisions of United States tax law and treaty policy. The new Protocol also reflects changes in Israeli law and makes certain technical corrections to the Convention which are necessary because of the passage of time. 　　The Second Protocol replaces the language on the exchange of information appearing in the Convention and First Protocol with language used in 12 tax treaties to which the Senate has given advice and consent since 1981. In incorporating that formula in the Second Protocol, both Governments understood and agreed that the Convention, as amended, will permit General Accounting Office and Congressional tax-writing committees' access to confidential information exchanged under the Convention in connection with their performance of oversight functions. Thus, the Senate should not find it necessary to repeat the understanding in its 1981 resolution of advice and consent to the Convention and First Protocol. 　　It is hoped and expected that the Convention, as amended, will be an important impetus to Israel's economy by encouraging and facilitating greater United States private sector investment in Israel. The Convention will establish a framework which we hope will contribute to the further expansion of economic relations between the two countries on a broader and reciprocal basis. 　　Associated with the Protocol, but not forming an integral part of it, is an exchange of notes containing a number of understandings reached during the negotiation of the Protocol regarding its interpretation and application. 　　Many of the changes effected by the Protocol are minor amendments or clarifications, and are not discussed in this report. Among the more significant amendments to the Convention is a provision to assure that dividends paid by non-taxable conduit entities, such as U.S. regulated investment companies and real estate investment trusts, will not receive unjustified treaty benefits. Likewise, the Protocol will amend the interest provisions of the Convention to deny treaty benefits to so-called "excess inclusions" with respect to a residual interest in a real estate mortgage investment conduit. 　　The Convention will be amended to permit the application of branch taxes, which were introduced into U.S. law by the Tax Reform Act of 1986. Although Israel does not now impose such taxes, it has preserved the right in the Protocol to do so. Also consistent with the Tax Reform Act of 1986, the Convention will be amended to make clear that any income earned by a permanent establishment, the receipt of which is deferred until after the permanent establishment has ceased to exist, will be attributable to the permanent establishment. 　　The Protocol will replace the limited anti-treaty-shopping rules in the Convention with modern,comprehensive rules to ensure that the benefits of the Convention are limited to residents of the two countries meeting certain standards designed to prevent residents of third countries from inappropriately using the Convention. Similar standards are found in other recent United States income tax conventions. 　　The Convention will be amended to assure that the full U.S. taxing rights under the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) are preserved. The amended language also assures that Israel will be able, under the Convention, to exercise the same taxing rights in respect of real property gains as the United States. 　　The Convention allows relatively high withholding taxes at source on interest payments. The new Protocol, however, provides an election for the interest recipient to be taxed on interest income by the source country on a net basis. In addition, the Contracting States agree to consult to determine whether it would be appropriate to amend the Convention in response to changes in tax laws or treaty policies of one of the States and to endeavor to make the necessary amendments to the Convention. 　　The new Protocol contains a number of minor amendments and clarifications including the following: 　　the coverage of the non-discrimination protection will be broadened to include state and local taxes as well as national taxes; the residence rules will be modified, consistent with recent U.S. treaties, to clarify the residence, for purposes of the Convention, of U.S. citizens and green card holders who reside in third countries; and the "saving clause", under which the United States reserves its statutory taxation rights with respect to its citizens and residents, will be extended to include former citizens who have expatriated for tax avoidance purposes. The Protocol will also clarify the relationships between statutory source rules and those in the Convention for determining the foreign tax credit under the Convention. 　　The Convention and the two amending Protocols will enter into force after the expiration of 30 days following the date on which instruments of ratification have been exchanged. The provisions concerning taxes on dividends, interest and royalties will take effect on the first day of the second month following the exchange of instruments of ratification, and provisions concerning other taxes will take effect retroactively to the beginning of the year in which it enters into force if the entry into force takes place within the first half of the year. If entry into force occurs during the second half of the year, the Convention, as amended, will have effect for taxable years beginning on or after January 1 following the exchange of instruments of ratification. 　　A technical memorandum explaining in detail the provisions of the Second Protocol will be prepared by the Department of the Treasury and will be submitted separately to the Senate Committee on Foreign Relations. 　　The Department of the Treasury and the Department of State cooperated in the negotiation of the Second Protocol. It has the full approval of both Departments. Respectfully submitted, WARREN CHRISTOPHER. Enclosures: As stated. LETTER OF TRANSMITTAL (PROTOCOL 2) THE WHITE HOUSE, October 19, 1993. To the Senate of the United States: 　　I transmit herewith for the advice and consent of the Senate to ratification the Second Protocol Amending the Convention Between the Government of the United States of America and the Government of the State of Israel with Respect to Taxes on Income, signed at Washington on November 20, 1975, as amended by the Protocol signed May 30, 1980. The Second Protocol was signed at Jerusalem on January 26, 1993. Also transmitted for the information of the Senate is an exchange of notes and the report of the Department of State with respect to the Protocol. 　　The Second Protocol further amends the 1975 Convention, as amended by the 1980 Protocol, in large measure to accommodate certain post-1980 provisions of U.S. tax law and treaty policy. The new Protocol also reflects changes in Israeli law and makes certain technical corrections to the Convention that are necessary because of the passage of time. It will modernize tax relations between the two countries and will facilitate greater private sector U.S. investment in Israel. 　　I recommend that the Senate give early and favorable consideration to the Protocol and give its advice and consent to ratification. WILLIAM J. CLINTON 　　SECOND PROTOCOL AMENDING THE CONVENTION BETWEEN THE GOVERNMENT OF THE UNITED STATES OF AMERICA AND THE GOVERNMENT OF THE STATE OF ISRAEL WITH RESPECT TO TAXES ON INCOME SIGNED ON NOVEMBER 20, 1975, AS AMENDED BY THE PROTOCOL SIGNED ON MAY 30, 1980 　　The Government of the United States of America and the Government of the State of Israel, desiring to conclude a second Protocol to amend the Convention with respect to taxes on income signed on November 20, 1975, as amended by the Protocol signed on May 30, 1980 (hereinafter referred to as the "Convention") have agreed as follows: ARTICLE I 　　1. In subparagraph (a) of paragraph (1) of Article 1 (Taxes Covered) of the Convention, the words "Internal Revenue Code" shall be deleted and replaced by the following: "Internal Revenue Code of 1986 (but excluding social security taxes)". 　　2. Subparagraph (b) of paragraph (l) of Article 1 (Taxes Covered) of the Convention shall be deleted and replaced by the following: 　　"(b) In the case of Israel, taxes imposed by the Israeli Income Tax Ordinance, by the Land Appreciation Tax Law, by the Income Tax Law (Adjustments for Inflation), and other taxes on income administered by the Government of Israel (including, but not limited to, the profit tax on banking institutions and insurance companies and the income tax component of a compulsory loan)." 　　3. Paragraph (3) of Article 1 (Taxes Covered) of the Convention shall be deleted and replaced by the following: 　　"(3) For the purposes of Article 27 (Nondiscrimination), this Convention shall apply to taxes of every kind imposed by a Contracting State, or a state or a political subdivision thereof." ARTICLE II 　　1. A new subparagraph (c) shall be added to paragraph (1) of Article 3 (Fiscal Residence) of the Convention, as follows: 　　"(c) For purposes of subparagraph (b), a United States citizen or an alien admitted to the United States for permanent residence (a green card holder) who is not a resident of Israel under subparagraph (a), is a resident of the United States only if the individual has a substantial presence, permanent home or habitual abode in the United States. If such individual is a resident of Israel under subparagraph (a), he shall be considered a resident of both Contracting States and his residence for purposes of the Convention shall be determined under paragraph (2)." 　　2. In subparagraph (a) of paragraph (2) of Article 3 (Fiscal Residence) of the Convention, the phrase (as defined in section 9 (16) of the Israeli Income Tax Ordinance), his center of vital interests shall be deemed to be in Israel." shall be deleted and replaced by the following: "(as defined in section 35 of the Israeli Income Tax Ordinance), his center of vital interests shall be deemed to be in Israel;". 　　3. Paragraph (3) of Article 3 (Fiscal Residence) of the Convention shall be deleted and replaced by the following: 　　"(3) Where, by reason of the provisions of paragraph (1), a person other than an individual is a resident of both Contracting States, the competent authorities of the Contracting States shall endeavor to settle the question by mutual agreement and determine the mode of application of the Convention to such person. Until the competent authorities make such a determination, the person shall not be treated as a resident of either Contracting State except for purposes of Article 26 (Relief from Double Taxation), Article 27 (Nondiscrimination) and Article 31 (Entry Into Force) and for purposes of payments by such person covered by paragraph (2) of Article 12 (Dividends), paragraphs (2) and (3) of Article 13 (Interest) and paragraph (1)(b) of Article 14 (Royalties).' ARTICLE III 　　1. The last sentence of paragraph (6) of Article 4 (Source of Income) of the Convention shall be deleted and replaced by the following: 　　"Notwithstanding the preceding sentence, gains derived by a resident of one Contracting State from the sale, exchange or other disposition of Stock in a corporation of the other Contracting State to which paragraph (l)(e) of Article 15 (Capital Gains) applies shall be deemed to arise in that other State." 　　2. The last Sentence of paragraph (7) of Article 4 (Source of Income) of the Convention shall be deleted and replaced by the following: 　　"Notwithstanding the preceding provisions of this paragraph, remuneration described in Article 22 (Governmental Functions) and payments described in Article 21 (Social Security Payments) paid: 　　(a) from the public funds of a Contracting State or a political subdivision or local authority thereof, 　　(b) by a corporation wholly owned by a Contracting State or a political subdivision or local authority thereof, which performs functions of a governmental nature, or 　　(c) by any other body which is treated for tax purposes in the same manner as the Contracting State, a political subdivision or local authority thereof, pursuant to the laws of that State, which performs functions of a governmental nature, shall be treated as income from sources within that Contracting State only." ARTICLE IV 　　In paragraph (5) of Article 5 (Permanent Establishment) of the Convention, the portion of the last sentence beginning with the words " unless the exercise" shall be deleted and replaced by the following: 　　"unless the activities of such person are limited to those mentioned in paragraph (3), which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph." ARTICLE V 　　1. The following sentence shall be added at the end of paragraph (3) of Article 6 (General Rules of Taxation) of the Convention: 　　"for this purpose, the term "citizen" shall include a former citizen whose loss of citizenship had as one of its principal purposes the avoidance of tax, but only for a period of 10 years following such loss. For the application of this provision to a resident of a Contracting State, the competent authorities shall consult together on the purposes of such loss of citizenship." 　　2. In subparagraph (a) of paragraph (4) of Article 6 (General Rules of Taxation) of the Convention, after the words "15-A (Charitable Contributions)," the following words shall be added: 　　"paragraphs (2) and (3) of 20 (Private Pensions and Annuities) ,". 　　3. At the end of paragraph (6) of Article 6 (General Rules of Taxation) of the Convention, the following words shall be added: "or during the first three months of the following year." 　　4. Paragraph (7) of Article 6 (General Rules of Taxation) of the Convention shall be renumbered as paragraph (9), and the following paragraphs shall be inserted: 　　"(7) In applying paragraph (8) of Article 4 (Source of Income), paragraphs (1) and (2) of Article 8 (Business Profits), paragraph (5) of Article 12 (Dividends), paragraph (5) of Article 13 (Interest), paragraph (3) of Article 14 (Royalties) and subparagraph (c) of paragraph (1) of Article 15 (Capital Gains) of the Convention, any income or gain attributable to a permanent establishment during its existence is taxable in the Contracting State where such permanent establishment is situated even if the receipt of the payments is deferred until such permanent establishment has ceased to exist. 　　(8) The appropriate authority of either Contracting State may request consultations with the appropriate authority of the other Contracting State to determine whether an amendment to the Convention is appropriate to respond to changes in the law or policy of either Contracting State. If these consultations determine that the effect of the Convention or its application have been unilaterally changed by reason of domestic legislation enacted by a Contracting State such that the balance of benefits provided by the Convention has been significantly altered, the authorities shall promptly endeavor to amend the Convention to restore an appropriate balance of benefits. In addition, if there are changes in treaty policy or the domestic law of a Contracting State which make it appropriate to amend the Convention, the authorities shall promptly consult to consider such amendments." ARTICLE VI 　　Paragraph (3) of Article 7 (Income from Real Property) of the Convention shall be deleted and replaced by the following: 　　"(3) (a) Gains derived by a resident of Israel from the alienation of a United States real property interest, or from the alienation of an interest in a partnership, trust or estate, to the extent attributable to a United States real property interest, may be taxed by the United States. 　　(b) Gains derived by a resident of the United States from the alienation of a comparable interest in real property in Israel may be taxed by Israel. For this purpose, a 'comparable interest in real property in Israel' includes rights in a legal entity, the disposition of which, under Israeli domestic law, is taxed as a disposition of rights in real property; rights in any other legal entity 50 percent or more of the market value of the assets of which consist directly or indirectly of immovable property situated in Israel; and rights in a partnership, trust or estate, to the extent that the gains from the disposition thereof are attributable to real property situated in Israel or to a comparable interest in real property in Israel." ARTICLE VII 　　1. In subparagraph (b) of paragraph (2) of Article 12 (Dividends) of the Convention, the words "of either Contracting State" shall be inserted after "When a corporation". 　　2. Paragraphs (3) and (4) of Article 12 (Dividends) of the Convention shall be renumbered as paragraphs (4) and (5), and the following shall be inserted as paragraph (3): 　　"(3) (a) In the United States, subparagraph (b) of paragraph (2) shall not apply in the case of dividends paid by a United States Regulated Investment Company or Real Estate Investment Trust. Subparagraph (a) shall apply in the case of dividends paid by a Regulated Investment Company. In the case of dividends paid by a Real Estate Investment Trust, subparagraph (a) of paragraph (2) shall apply if the beneficial owner of the dividends is an individual holding a less than 10 percent interest in the Real Estate Investment Trust; otherwise the rate of tax applicable under United States domestic law shall apply. 　　(b) In Israel, paragraph (2) shall not apply to dividends paid by corporations the income of which is taxed in the manner described in sections 64 and 64A of the Israeli Income Tax Ordinance, or in a substantially similar manner. In such cases, the income shall be treated as if it were business profits from a permanent establishment taxable according to the rules of Article 8 (Business Profits)."