Minister of Foreign Affairs 　　　　　　　　　　　　　　　　　　　　　　　Jerusalem, 26 January, 1993 His Excellency Mr. William C. Harrop Ambassador of the United States of America in Israel 　　Excellency, I have the honour to refer to your Note of 26 January 1993 confirming the understandings stated in the Note and reached between our two governments. relating to 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, and the First and Second Protocols thereto, and to inform you of the Agreement of my Government to these understandings. 　　These understandings constitute an agreement between our two Governments on this matter, which shall enter into force on the day of entry into force of 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 and the First and Second Protocols thereto. 　　Accept, Excellency, the renewed assurances of my highest consideration. 　　　　　　　　　　　　　　　　　　　　　　　　　(s) Shimon Peres 　　　　　　　　　　　　　　　　　　　　　　　　　EMBASSY OF THE 　　　　　　　　　　　　　　　　　　　　　　　　　UNITED STATES OF AMERICA 　　　　　　　　　　　　　　　　　　　　　　　　　Tel Aviv January 26, 1993 His Excellency Shimon Peres, Minister of Foreign Affairs of the State of Israel, Jerusalem. No. 020 　　Excellency: I have the honor to refer to 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, and the First and Second Protocols thereto, and to confirm certain understandings reached between the two Governments: 　　1. In subparagraph (b) of paragraph (1) of Article 1 (Taxes Covered), the phrase "other taxes on income administered by the Government of Israel" is understood to include only taxes imposed solely under Israeli law. 　　2. In paragraph (3) of Article 1 (Taxes Covered), the phrase "political subdivision thereof" is understood to include local authorities. 　　3. In subparagraph (a)(ii) of paragraph (1) of. Article 3 (Fiscal Residence), the term "person... resident in Israel" is understood to include persons on whom taxes are imposed by Israel pursuant to the Income Tax Ordinance on income from sources outside of Israel by virtue of their being Israeli citizens. 　　4. In paragraph (3) of Article 3 (Fiscal Residence), it is understood that when one of the provisions of the Convention cited in the paragraph is operative, all other provision of the Convention necessary to apply the cited provision in the manner intended also will be operative. For instance, if a dual resident makes a dividend payment subject to paragraph (2) of Article 12 (Dividends), other articles of the Convention, such as Article 4 (Source of Income), will apply to the extent necessary to ensure proper treatment according to this Convention. 　　5. In applying the last sentence of paragraph (6) of Article 4 (Source of Income), it is understood that section 865(h) of the United States Internal Revenue Code may apply to require a taxpayer to determine the foreign tax credit separately with respect to the United States tax on gain from the sale of stock in an Israeli corporation to which the source rule in that sentence applies. 　　6. It is agreed that if the United States hereafter alters its policy regarding the provision of a tax sparing credit, or if the United States reaches agreement on the provision of a tax sparing credit with any other country, the Convention shall be promptly amended to incorporate such a provision. 　　7. Paragraph (8) of Article 6 (General Rules of Taxation) recognizes that future changes in the law or domestic policy of either Contracting State may make it appropriate to amend the Convention. Examples of changes that may justify amendment are understood to include, but are not limited to, the following: 　　(i) the decision by one Contracting State to extend favorable treaty benefits to a third country (such as a liberalization of the double taxation relief provided by foreign tax credits) so that the other Contracting State would be justified in requesting similar benefits under this Convention; and 　　(ii) changes in the domestic law of one Contracting State (such as integration of corporate and individual taxation) so that either that Contracting State or the other Contracting State could reasonably be requested to extend benefits under this Convention similar to benefits granted under treaties of that Contracting State with other countries. 　　It also is understood that the parties will consult about possible amendments to the Convention in the event that one Contracting State adopts domestic rules that treat expenses incurred within that Contracting State more favorably than expenses incurred in the other Contracting State, so long as the Free Trade Area Agreement between the United States and Israel is in force. 　　8. In paragraph (2) of Article 10 (Grants), it is understood that a grant shall not be considered to be "taxed by Israel" solely by reason of the fact that the grant is not included for Israeli income tax purposes in the basis of stock or assets. 　　9. In subparagraph (b) of paragraph (3) of Article 12 (Dividends), it is understood that there are several different ways in which an Israeli corporation may be taxable in a "pass-through" manner such that its income would be included within the scope of the subparagraph. For instance, the corporation may be exempt from tax, the shareholders may be taxable on their pro rata shares of the corporation's income, or the corporation may be entitled to deduct from its taxable income dividends paid to shareholders. 　　10. It is understood that paragraph (8) of Article 13 (Interest) has been added at the request of the United States to address a problem of domestic tax avoidance arising under the internal laws of the United States. The United States intends to include similar provisions in all of its future treaties. Israel understands that if the United States were to revise its internal laws in the future to address this problem in a manner other than by imposing tax on the recipient of the excess inclusion, excess inclusions under the revised laws would be treated as ordinary interest income in the hands of nonresident recipients and would be eligible for the exemptions from tax applicable to interest income under the laws of the United States. It is further understood that, should the United States fail to include a provision similar to paragraph (8) of Article 13 in its treaties signed subsequent to the entry into force of this Convention, without having revised its internal laws as aforestated, such a change in U.S. treaty policy would make it appropriate to amend the Convention on this matter, pursuant to paragraph (8) of Article 6 of the Convention 　　11. In paragraph (2) of Article 14-A (Branch Tax), it is understood that if Israel imposes its tax under subparagraph (b) of paragraph (2) in circumstances in which the United States will not impose its taxes under subparagraph (a), the competent authorities will consult with a view to conforming the rules under the Convention. It is further understood that a resident of a Contracting State that qualifies for benefits under the Convention shall not be subject to a branch tax imposed by the other Contracting State except in accordance with the Convention. 　　12. In paragraphs (1) and (2) of Article 15 (Capital Gains), it is understood that ownership "directly or indirectly" includes constructive ownership through related persons. 　　13. In Paragraph (3) of Article 25 (Limitation on Benefits), it is understood that the competent authority of a Contracting State may be expected to grant benefits under this Convention to a resident of the other Contracting State that fails to qualify under subparagraph (b) of paragraph (1) solely by reason of a bona-fide loan from a financial institution not resident in either of the Contracting States. 　　14. The competent authorities of the Contracting States will develop an agreed Memorandum of Understanding intended to give guidance both to taxpayers and tax authorities of our two countries in interpreting Article 25 (Limitation on Benefits). As experience is gained in administering the Convention, as amended by the Protocols, and particularly Article 25, the competent authorities may develop and publish further understandings and interpretations. 　　15. In paragraph (4) of Article 26 (Relief from Double Taxation) it is understood that, for purposes of providing relief from double taxation in the United States, the terms "stock" and "intangibles" are limited to those interests for which an election relating to foreign tax credit relief is provided under United States law. 　　16. It is understood that any reference in the Convention to a currency of a Contracting States shall be deemed to refer to the legal tender of that Contracting State as renamed or replaced from time to time. 　　I confirm these understandings on behalf of the Government of the United States of America. Upon confirmation by your Government, these understandings shall constitute an agreement between our two Governments on this matter, which will enter into force on the day of entry into force of 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 and the First and Second Protocols thereto. 　　I would be grateful if you would confirm that these understandings are shared by your Government. 　　Accept, Excellency, the renewed assurances of my highest consideration. 　　　　　　　　　　　　　　　　　　　　　　　　　　(s) William C. Harrop