Technical Explanation (1981)

Technical Explanation (1981)

TECHNICAL EXPLANATION OP 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, D.C. ON NOVEMBER 20, 1975, AS AMENDED  BY A PROTOCOL SIGNED AT WASHINGTON, D.C. ON MAY 30, 1980

INTRODUCTION

This is a technical explanation of the Convention between the United States and Israel, signed on November 20, 1975, as amended by a Protocol signed on May 30, 1980, (“the Convention”). This explanation is an official guide to the Convention. It reflects policies behind particular Convention provisions, as well as understandings reached with respect to the interpretation and application of the Convention.

ARTICLE 1. Taxes Covered

Paragraph (1) designates the taxes of the Contracting States which are the subject of the Convention. With respect to the United States, the subject taxes are the Federal income taxes imposed by the Internal Revenue Code (“Code”). The Convention also applies to the excise tax on insurance premiums paid to foreign insurers, under section 4371 of the Code. However, the excise tax on insurance premiums is covered only to the extent that the foreign insurer does not reinsure the risks, directly or indirectly, with a person who is not entitled to exemption from such tax under this or another United States tax convention. This limitation on coverage is intended to clarify that persons not entitled to the benefits of this or another convention may not use an insurer in Israel as a conduit for the purpose of obtaining convention benefits. Moreover, as provided by paragraph (5) of Article 6 (General Rules of Taxation). The United States reserves the right to impose taxes under Code sections 531 (accumulated earnings tax) and 541 (personal holding company tax), except as provided in such paragraph (5).

United States taxes not generally covered by the Convention include the estate, gift and generation skipping transfer taxes, the Windfall Profits Tax, Federal unemployment taxes and social security taxes imposed under sections 1401, 3101 and 3111 of the Code.

In the case of Israel, paragraph (1) provides that the Convention applies to the income tax (including capital gains tax); the company tax; the tax on gains from the sale of land under the land appreciation tax law; the tax on profits levied on banking institutions and insurance companies under the Value Added Tax Law; and compulsory loans made with respect to taxable years ending before April 1, 1988, with respect to corporations that became subject thereto before April 1, 1977. This reflects the fact that compulsory loans are being phased-out from Israeli law. See the discussion of Article 26 (Relief from Double Taxation) for an analysis of the treatment of these compulsory loans for purposes of the United States foreign tax credit. Pursuant to paragraph (2), the Convention will also apply to taxes substantially similar to those covered by paragraph (1) which are imposed in addition to, or in place of, existing income taxes, after November 20, 1975 (the date of signature of the Convention).

Under paragraph (3), for purposes of Article 27 (Nondiscrimination), the Convention applies to taxes of every kind imposed at the national level.

Paragraph (4) provides that the competent authority of each Contracting State will notify the competent authority of the other Contracting State of any substantial amendment of the tax laws referred to in paragraph (1), or of the adoption of substantially similar taxes imposed in addition to, or in place of, those taxes by transmitting the texts of such amendments or statutes. Paragraph (5) provides for a similar exchange with respect to the publication of material concerning the application of the Convention, whether in the form of regulations, rulings or judicial decisions.

ARTICLE 2. General Definitions

Paragraph (1) sets out definitions of certain basic terms used in the Convention. Unless the context otherwise requires, the terms defined in this paragraph have a uniform meaning throughout the Convention. A number of important terms, however, are defined elsewhere in the Convention.

The term “United States” means the United States of America. When used in a geographical sense, the term means the states of the United States and the District of Columbia. Thus, the Convention does not apply to the possessions of the United States or the Commonwealth of Puerto Rico. The term “Israel” means the State of Israel.

When used in a geographical sense, the terms “United States” and “Israel” also include their respective territorial seas, and in general accord with the principles of section 638 of the Code, their respective continental shelves.

The term “Contracting State” is defined to mean the United States or Israel as the context requires. The term “State” means the United States, Israel, or any other national State.

The term “person” is defined as including an individual, a partnership, a corporation, an estate or a trust.

The term “United States corporation” is defined as a corporation, or any unincorporated entity which is treated as a corporation for United States tax purposes, which is created or organized under the laws of the United States, any state thereof, or the District of Columbia. An Israeli corporation is defined as any body of persons taxed as a body of persons resident in Israel under its income tax ordinance. Thus, for example, a corporation incorporated in a State other than a Contracting State which is taxed by Israel as a body of persons resident in Israel will be an Israeli corporation for purposes of the Convention. See, however, the discussion of paragraph (3) of Article 3 (Fiscal Residence) for the treatment of a corporation which is both resident of the United States and a resident of Israel.

With respect to the United States, the term “competent authority” means the Secretary of the Treasury or his delegate. With respect to Israel, it means the Minister of Finance or his delegate. The term “tax” means those taxes imposed by the United States or Israel to which the Convention applies by virtue of Article 1 (Taxes Covered).

The term “international traffic” is defined as any voyage of a ship or aircraft operated by a resident of one of the Contracting States except where such voyage is confined solely to places within a Contracting State. Thus, for example, coastal shipping along the Atlantic coast of the United States is not a voyage in international traffic. However, if a ship operated by a resident of Israel transports goods from Canada to the United States, leaving some of the goods in New York and the remainder in Norfolk, the portion of the voyage between New York and Norfolk is international traffic.

Paragraph (2) provides that any term used in the Convention which is not defined therein shall, unless the context otherwise requires, have the meaning which it has under the laws of the Contracting State whose tax is being determined. However, where a term has a different meaning under the laws of Israel and the United States or where the meaning under the laws of one of the Contracting States is not readily determinable, the competent authorities may for purposes of the Convention establish a common meaning, which may differ from the meaning under the laws of either or both Contracting States, in order to prevent double taxation or to further any other purpose of the Convention.

ARTICLE 3. Fiscal Residence

This Article sets forth rules for determining the residence of individuals, corporations, and other persons for purposes of the Convention. Residence is important because, in general, only a resident of one of the Contracting States may qualify for the benefits of the Convention. A person who, under the respective taxation laws of the Contracting States, is a resident of one Contracting State and not the other need look no further to determine his residence under the Convention. However, where a person is a resident of each of the Contracting States under its laws, paragraphs (2) and (3) of the Article must be used to determine that person’s residence for purposes of the Convention. The Convention definition is, of course, exclusively for purposes of the Convention.

Under paragraph (1), the term “resident of Israel” means an Israeli corporation (as defined in Article 2 (General Definitions)) or any other person (except a corporation or any entity treated under Israeli law as a corporation) resident in Israel for purposes of Israeli tax. Similarly, resident of the United States means a United States corporation (as defined in Article 2 (General Definitions)) and any other person (except a corporation or any entity treated as a corporation for United States tax purposes) resident in the United States for purposes of United States tax. Thus, a resident of the United States includes a resident alien individual, an alien present in the United States who elects to be treated as a resident under Code section 6013(g) or (h), and a resident citizen, but under no circumstances, a foreign corporation. A citizen of the United States or Israel is not automatically a resident of the United States or Israel for purposes of this Convention. Whether a citizen of the United States is a resident of the United States for this purpose is to be determined by the principles of the Treasury regulations issued under Code section 871.

The Convention provides that a partnership, estate, or trust is a resident of a Contracting State only to the extent that the income derived by such person is subject to tax in such Contracting State as the income of a resident. For example, under United States law, a partnership is never, and an estate or trust is often not, taxed as such. Under the Convention, in the case of the United States, income received by a partnership, estate, or trust will not qualify for the benefits of the Convention unless such income is subject to tax in the United States as the income of a resident. Thus, in effect, the treatment of income received by a partnership will be determined by the residence and taxation of its partners with respect to that income. To the extent the partners are subject to United States tax as residents of the United States, the partnership will be treated as a resident of the United States. Similarly, the treatment of income received by a trust or estate will be determined by the residence and taxation of the person subject to tax on such income, which may be the grantor, the beneficiaries or the trust or estate itself, as the case may be.

Under paragraph (2), an individual who is a resident of both Contracting States under paragraph (1) will be deemed to be a resident of the Contracting State in which he has his permanent home, his center of vital interests (closest personal and economic relations), a habitual abode, or his citizenship, in the order listed. In the case of an individual who is an “oleh” under section 9(16) of the Israeli Income Tax Ordinance, his center of vital interests will be deemed to be in Israel. If the issue is not settled by these tests, the competent authorities will decide by mutual agreement the one Contracting State of which he will be considered to be a resident.

Paragraph (3) provides that a corporation which qualifies both as a resident of the United States and as a resident of Israel under Article 2 (General Definitions) will be considered to be outside the scope of the Convention, except for purposes of paragraph (1) of Article 4 (Source of Income), Article 27 (Nondiscrimination), Article 29 (Exchange of Information), and Article 31 (Entry into Force). The rule is necessary because a corporation incorporated in the United States may be deemed under the Convention to be a resident of Israel if it is taxed by Israel as a body of persons resident in Israel because it is managed and controlled in Israel. As a resident of Israel, the United States would be obliged, absent this provision, to extend to that United States corporation the benefits provided by the Convention. Since it is contrary to United States tax policy to restrict United States taxation of United States corporations by tax conventions, this paragraph removes such corporations from the scope of the substantive taxing provisions of the Convention.

The exceptions to the exclusion of dual resident corporations are necessary to make the Convention operate as intended. Dual resident corporations are given the benefits of the nondiscrimination provisions, and the competent authorities are given the authority to exchange information with respect to such corporations. The exception for Article 4(1) permits the United States to tax dividends paid to an Israeli resident by a corporation which is incorporated in the United States and is managed and controlled in Israel. Without this exception, the United States could not tax such dividends because of paragraph (1) of Article 6 (General Rules of Taxation) which states that a resident of one Contracting State may be taxed by the other only on income from sources in the other. The exception for Article 31 (Entry into Force) assures that the Convention will enter into force for dual resident corporations with respect to those provisions for which they are covered. Situations of dual corporate residence should be infrequent.

ARTICLE 4. Source of Income

This Article contains the source rules which are to be used in applying the provisions of the Convention. Under Article 6 (General Rules of Taxation), one Contracting State may tax a resident of the other Contracting State only on income from sources within the first-mentioned Contracting State (provided, with certain exceptions, that the resident is not a citizen of the first- mentioned Contracting State).

Paragraph (1) provides that dividends will be treated as income from sources within a Contracting State only if paid by a corporation of that Contracting State.

Under paragraph (2), interest will be treated as income from sources within a Contracting State only if paid by that Contracting State, a political subdivision or a local authority thereof, or by a resident of that Contracting State. However, if interest is paid on an indebtedness incurred in connection with a permanent establishment which bears such interest, then such interest shall be deemed to be from sources within the State (whether or not a Contracting State) in which the permanent establishment is situated. This exception permits a Contracting State, under the proper circumstances, to impose a tax on interest paid by a permanent establishment therein, including a permanent establishment of a resident of a State other than a Contracting State. For example, if a resident of France has a permanent establishment in Israel which borrows money from a resident of the United States and bears the interest (i.e., deducts the interest in computing the income of the permanent establishment) the interest will be deemed to be from Israeli sources. Thus, Israel may tax such interest, subject to the limitations of Article 13 (Interest). As provided in paragraph (9) of Article 5 (Permanent Establishment) the principles of Article 5 will be applied to determine whether the resident of France has a permanent establishment in Israel. The United States will not, because of sections 861(a)(l)(C) and (D) of the Code, impose a tax on interest received by nonresident alien individuals or foreign corporations from a foreign corporation having a permanent establishment in the United States unless 50 percent or more of the gross income of such corporation from all sources for the three year period ending with the close of its taxable year preceding the payment of the interest (or such part of the period as the corporation has been in existence) vas effectively connected with the conduct of a trade or business within the United States.

In addition, the exception to the general rule of paragraph (2) of this Article will exempt interest from tax in the Contracting State in which the payor resides if the payor has a permanent establishment in a State other than a Contracting State in connection with which the indebtedness on which the interest is paid was incurred, such interest is borne by the permanent establishment and such interest is paid to a resident of the other Contracting State. This results from the restriction in Article 6 (General Rules of Taxation) that a resident of one Contracting State who is not a citizen of the other Contracting State may be taxed by the other Contracting State only on income from sources within that other Contracting State.

Paragraph (3) provides that royalties for the use of, or the right of use, property or rights described in paragraph (2) of Article 14 (Royalties) will be treated as income from sources within a Contracting State only to the extent that such royalties are for the use of, or the right to use, such property or rights within that Contracting State.

Paragraph (4) provides that income and gains (including royalties) to which Article 7 (Income from Real Property) applies will be treated as income from sources within a Contracting State only if the real property (or, in the case of property referred to in paragraph (3) of Article 7, the underlying real property) is situated in that Contracting State.

Paragraph (5) provides that income from the rental of tangible personal (movable) property will be treated as income from sources within a Contracting State only to the extent that the income is for the use of such property in that Contracting State.

Under paragraph (6), income from the purchase and sale, exchange, or other disposition of intangible or tangible personal property (other than gains described in paragraph (2) of Article 14 (Royalties)) will be treated as income from sources within a Contracting State only if such sale, exchange, or other disposition is within that Contracting State. However, gains from the sale, exchange, or other disposition of stock in an Israeli corporation to which paragraph (1)(e) of Article 15 (Capital Gains) applies will be treated as income from sources within Israel.

Under paragraph (7), income received by an individual for his performance of labor or personal services, whether as an employee or in an independent capacity, will be treated as income from sources within a Contracting State only to the extent that such services are performed In that Contracting State. Income from personal services performed aboard ships or aircraft operated by a resident of a Contracting State in international traffic will be treated as income from sources within that Contracting State if rendered by a member of the regular complement of the ship or aircraft. However, remuneration described in Article 22 (Governmental Functions) and payments described in Article 21 (Social Security Payments) paid from the public funds of a Contracting State or a political subdivision or local authority thereof will be treated as income from sources within that Contracting State only.

Paragraph (8) contains a general qualification to the preceding source rules. It provides that industrial or commercial profits attributable to a permanent establishment which the recipient, a resident of one Contracting State, has in the other Contracting State will be treated as income from sources within that other Contracting State. Industrial or commercial profits attributable to such permanent establishment may include any item of income described in paragraphs (1) through (6) if the item of income is effectively connected with the permanent establishment. See the discussion of paragraph (6) of Article 8 (Business Profits) for a discussion of the effectively connected concept.

Under paragraph (9), the source of any item of income not described in the preceding paragraphs of Article 4 will be determined by each Contracting State in accordance with its own law. However, if the source of any item of income under the laws of one Contracting State is different from its source under the laws of the other Contracting State or if its source is not readily determinable under the laws of one of the Contracting States, the competent authorities of the Contracting State may, in order to prevent double taxation or further any other purpose of the Convention, establish a common source of the item of income for purposes of the Convention.

Several of the source rules set out in this Article differ to some degree from those provided in the Code. Since Article 6 (General Rules of Taxation) provides, in effect, that the Convention will not increase a person’s overall United States tax, a taxpayer is not bound to apply the Convention rules in calculating his United States tax liability. However, a taxpayer may not make inconsistent choices between Code and Convention rules.

ARTICLE 5. Permanent Establishment

This Article defines the term “permanent establishment.” The existence of a permanent establishment is relevant under Article 8 (Business Profits) to the taxation of industrial or commercial profits and In determining the applicability of other provisions of the Convention.

Under paragraph (1), the term “permanent establishment” means a fixed place of business through which a resident of one of the Contracting States engages in industrial or commercial activity. Illustrations in paragraph (2) of a fixed place of business include a branch; an office; a factory; a warehouse; a workshop; a farm or plantation; a store or other sales outlet; a mine, quarry or other place of extraction of natural resources; a building site, or construction or assembly project, or supervision activity connected therewith and conducted within the

Contracting State where such site or project is located, where such site, project or activity continues for a period of more than six months; and the maintenance of substantial equipment or machinery, including for example, a drilling rig, within a Contracting State for a period of more than six months. As a general rule, any fixed facility or premises through which a resident conducts industrial or commercial activity for an indefinite or substantial period of time will be treated as a fixed place of business unless it is used only for one or more of the activities described in paragraph (3).

Under the building site or construction or installation project rule, the six months period begins only when work or supervision physically commences in the other Contracting State. A series of contracts or projects which are interdependent both commercially and geographically is to be treated as a single project for the purpose of applying the six months test.

Paragraph (3) specifically provides that a permanent establishment does not include a fixed place of business if it is used only for one or more of the following:

“(a) The use of facilities for the purpose of storage, display, or delivery of goods or merchandise belonging to the resident;

“(b) The maintenance of a stock of goods or merchandise belonging to the resident for the purpose of storage, display, or delivery (other than goods or merchandise held for sale by such resident in a store or other sales outlet);

“(c) The maintenance of a stock of goods or merchandise belonging to the resident for the purpose of processing by another person;

“(d) The maintenance of a fixed place of business for the purpose of purchasing goods or merchandise, or for collecting information for the resident;

“(e) The maintenance of a fixed place of business for the purpose of advertising, for the supply of information, for scientific research, or for similar activities which have a preparatory or auxiliary character, for the resident;

“(f) A building site, or construction or assembly project, or supervision activity connected therewith, where such site, project, or activity continues for a period of not more than 6 months, or

“(g) The maintenance of substantial equipment or machinery within a Contracting State for a period of not more than 6 months.”

As noted, a fixed place of business used only for one or more of these purposes will not be considered a permanent establishment under the Convention. The exception of paragraph (3)(b) relating to the maintenance of a stock of goods or merchandise for the purpose of storage, display, or delivery contains language which makes clear that goods held for sale in a store or other sales outlet are not included in the exception. This emphasizes the rule that goods held in a store or other sales outlet are not merely being held for storage, display or delivery.

Paragraph (4) provides that even though a resident of one Contracting State does not have a permanent establishment in the other Contracting State under paragraphs (1), (2), and (3), such resident will be deemed to have a permanent establishment in the other Contracting State if such resident sells in that Contracting State goods or merchandise which either were subjected to substantial processing in that Contracting State (whether or not purchased in that Contracting State), or were purchased in that Contracting State and not subjected to substantial processing outside that Contracting State.

Under paragraph (5), a person acting in one Contracting State on behalf of a resident of the other Contracting State, other than an agent of an independent status to whom paragraph (6) applies, will be deemed to constitute a permanent establishment if such person has, and habitually exercises in that first-mentioned Contracting State, an authority to conclude contracts in the name of the resident, unless the exercise of the authority is limited to the purchase of goods or merchandise for the resident.

On the other hand, paragraph (6) provides that a resident of one Contracting State will not be deemed to have a permanent establishment in the other Contracting State merely because such resident engages in industrial or commercial activity in such other Contracting State through a broker, general commission agent, or any other agent of an independent status, where such broker or agent is acting in the ordinary course of his business.

Paragraph (7) provides that a resident of one Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because such resident sells at the termination of a trade fair or convention in the other Contracting State goods or merchandise which were displayed by such resident at the trade fair or convention. The trade fair exception is not intended to apply with respect to goods in the resident’s inventory.

Under paragraph (8), the determination of whether a resident of one Contracting State has a permanent establishment in the other Contracting State is to be made without regard to the fact that such resident may be related to a resident of the other Contracting state or to a person who engages in business in that other Contracting State (whether through a permanent establishment or otherwise). What is relevant is whether the resident of the other State carries on for the resident of the first-mentioned state an activity which, within the provisions of this Article, would make the resident of the other State a dependent agent of the resident of the first- mentioned State. As defined in Article 11 (Related Persons), a person is related to another person if either person owns or controls directly or indirectly the other, or if a third person or persons own or control directly or indirectly both.

Paragraph (9) provides that the principles set forth in this Article are to be applied in determining whether there is a permanent establishment in a State other than one of the Contracting States or whether a person other than a resident of one of the Contracting States has a permanent establishment in one of the Contracting States. This is necessary for the proper application of paragraph (2) of Article 4 (Source of Income). This paragraph is not intended to extend the benefits of the Convention to persons other than residents of the two Contracting States.

ARTICLE 6. General Rules of Taxation

Under paragraph (1), a resident of one Contracting State may be taxed by the other Contracting State on any income from sources within that other Contracting State and only on such income, subject to the limitations set forth in the Convention. For this purpose, the source rules contained in Article 4 (Source of Income) are to be applied. However, if the resident is a citizen of the other Contracting State, that Contracting State may tax the resident without regard to this paragraph because of the saving clause of paragraph (3) of this Article.

Paragraph (2) contains the customary rule that the Convention will not restrict in any manner any exclusion, exemption, deduction, credit, or other allowance now or hereafter accorded by the laws of a Contracting State in the determination of a tax imposed by it, or by any other agreement between the Contracting States. Thus, if a deduction would be allowed under the Code for an item in computing the taxable income of an Israeli resident, such deduction is generally available to him in computing taxable income under the Convention. Paragraph (2) does not, however, authorize a taxpayer to make inconsistent choices between rules of the Code and rules of the Convention. In no event are the rules of the Convention to increase the U.S. or Israeli tax burden from what that liability would be if there were no Convention. Thus, a right to tax given by the Convention cannot be exercised unless that right also exists under the Code.

Paragraph (3) contains the traditional saving clause under which the United States reserves the right to tax its citizens and residents (determined under Article 3 (Fiscal Residence)) as if the Convention had not come into effect. However, under paragraph (4), the saving clause does not apply in several cases in which its application would contravene policies reflected in the Convention. These policies are specifically designed to extend treaty benefits to citizens or residents. Thus, the saving clause does not affect the provisions with respect to grants, charitable contributions, social security payments1 relief from double taxation, nondiscrimination, or the mutual agreement procedure, which are available to residents and citizens of the Contracting States. Moreover, the saving clause does not affect the benefits of the Convention provided to individuals performing governmental functions, teachers, students and trainees, and diplomatic or consular officers who are neither citizens of, nor have immigrant status in, the Contracting State imposing the tax. In the case of the United States, “immigrant status” means the individual has been admitted to the United States for permanent residence. The saving clause is reciprocal.

Paragraph (5) reserves the right of the United States to impose its personal holding company tax under section 541 of the Code and its accumulated earnings tax under section 531 of the Code notwithstanding any provision of the Convention. However, paragraph (5) also provides that an Israeli corporation will be exempt from the personal holding company tax in any taxable year unless United States residents or citizens own, directly or indirectly, within the meaning of section 544 of the Code, ten percent or more in value of the outstanding stock of the corporation at any time during the taxable year. In addition, an Israeli corporation will be exempt from the accumulated earnings tax in any taxable year unless at least twenty-five percent of the voting stock of such corporation is owned by United States citizens or residents.

Paragraph (6) provides a special rule for cases where income dealt with by this Convention is taxable to a resident of a Contracting State only if, and to the extent, it is remitted to or received by that person. In certain cases, individuals who are residents of Israel are not taxable on foreign source investment income, unless it is remitted to or received by them in Israel. If such income is received outside of Israel or accumulated by the payer, an Israeli resident may not be subject to tax on that income. If the reductions in rates or exemptions from tax were to apply to those items of income, the United States would be foregoing tax where double taxation does not in fact occur. Thus, this paragraph provides that if under the law in the other Contracting State income would only be taxed on & remittance basis, then any reduced rates of tax provided by this Convention shall apply only to the extent such income is remitted to or received by the person in that other Contracting State in the year in which it accrues to the benefit of that taxpayer. This rule applies to all persons, including individuals, corporations, partnerships and trusts or estates taxable as such.

Paragraph (7) authorizes the competent authorities of the Contracting States to prescribe regulations necessary to carry out the provisions of the Convention. For the United States, this authority is also provided by section 7805 of the Code.

ARTICLE 7. Income from Real Property

Under paragraph (1), income from real property, including royalties and other payments in respect of the exploitation of natural resources (e.g., oil wells) and gains from the sale, exchange or other disposition of such property or of the right giving rise to such royalties or other payments, may be taxed by the Contracting State in which the real property or natural resources are situated. Thus, natural resource royalties are covered under this Article and not under Article 14 (Royalties). However, income from real property does not include interest on indebtedness secured by real property (e.g., mortgages) or secured by a right giving rise to royalties or other payments in respect of the exploitation of natural resources. Such interest income is covered by Article 13 (Interest). The rule of this paragraph, however, does not confer an exclusive right of taxation on the State where the property is located.

Under paragraph (2), paragraph (1) applies to income derived from the usufruct, direct use, letting, or use in any other form of real property.

Paragraph (3) provides, consistent with U.S. law, that gains from the alienation of shares of a company the property of which consists, directly or indirectly, principally of real property situated in a Contracting State may be taxed by that State. Paragraph (4) of Article 4 (Source of Income) provides that these gains will be considered from sources within a Contracting State if the real property owned by the company is situated in that State.

This Article does not contain a provision allowing for the taxation of real property income on a net basis. This is because such treatment is already provided for under the laws of both Contracting States.

ARTICLE 8. Business Profits

Paragraph (1) sets forth the general rule that industrial or commercial profits of a resident of one Contracting State are exempt from tax by the other Contracting State unless the resident has a permanent establishment in the other Contracting State. Where there is a permanent establishment, only the industrial or commercial profits attributable to the permanent establishment can be taxed by that other Contracting State, unless the resident is a citizen of that other Contracting State. (See the saving clause in paragraph (3) of Article 6 (General Rules of Taxation).) Under paragraph (8) of Article 4 (Source of Income), industrial or commercial profits, whether otherwise treated as from sources within or without a Contracting State, which are attributable to a permanent establishment which a resident of one Contracting State has in the other Contracting State will be considered to be from sources within that other Contracting State. Thus, items of income described in section 864(c)(4)(B) of the Code attributable to a permanent establishment situated in the United States will be subject to tax by the United States. The limited “force of attraction” rule under Code section 864(c)(3) does not apply for U.S. tax purposes under the Convention.

In determining the proper attribution of industrial or commercial profits under the Convention, paragraph (2) provides that both Contracting states will attribute to the permanent establishment such profits as it would reasonably be expected to derive if it were an independent entity engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the resident of which it is a permanent establishment. Under paragraph (3), expenses, wherever incurred, which are reasonably connected with profits attributable to the permanent establishment, including executive and general administrative expenses, will be allowed as deductions in determining the industrial or commercial profits of the permanent establishment. However, in determining the amount of the deduction under paragraph (3) for expenses incurred by the head office, the deductions may be limited to the expense incurred without including a profit element for the head office.

Paragraph (4) provides that no profits shall be attributed to & permanent establishment merely because of the purchase of goods or merchandise by that permanent establishment, or by the resident of which it is a permanent establishment, for the account of such resident. Paragraph (2) of the Article does not override paragraph (4). Thus, where a permanent establishment purchases goods for its head office, the industrial and commercial profits attributed under paragraph (2) to the permanent establishment with respect to its other activities will not be increased by adding a notional figure for profits from purchasing.

Under paragraph (5), the term “industrial or commercial profits” includes income derived from manufacturing, mercantile, banking, insurance, agricultural, fishing or mining activities, the operation of ships or aircraft, the furnishing of services, and the rental of tangible personal (movable) property. The term does not include income from the rental or licensing of motion picture films or films or tapes used for radio or television broadcasting, or income from the performance of personal services derived by an individual either as an employee or in an independent capacity.

Under paragraph (6), the term “industrial and commercial profits” also includes income from dividends, interest, royalties described in paragraph (2) of Article 14 (Royalties), and capital gains and income derived from property and natural resources, but only if the income is effectively connected with a permanent establishment. See paragraph (4) of Article 12 (Dividends), paragraph (5) of Article 13 (Interest), paragraph (3) of Article 14 (Royalties) and paragraph (l)(c) of Article 15 (Capital Gains).

Paragraph (6) also contains criteria for determining whether income is effectively connected with a permanent establishment. Factors to be taken into account include whether the rights or property giving rise to such income are used in, or held for use in, carrying on an activity giving rise to industrial or commercial profits through a permanent establishment and whether the activities carried on through such permanent establishment were a material factor in the realization of the income. For this purpose, due regard will be given to whether or not such property or rights or such income were accounted for through such permanent establishment. The rules of this paragraph are similar to those found in section 864 of the Code.

Under paragraph (7), where industrial or commercial profits include items of income which are dealt with separately in other articles of the Convention, the provisions of those articles will, except as otherwise provided therein, supersede the provisions of this Article. Thus, for example, taxation of interest income will be controlled by Article 13 (Interest) and not by this Article unless the interest is attributable to a permanent establishment.

Paragraph (8) provides that the United States excise tax on insurance premiums paid to foreign insurers, imposed by section 4371 of the Internal Revenue Code, which is a covered tax under paragraph (l)(a) of Article 1 (Taxes Covered), will not apply to insurance or reinsurance premiums received by a business of insurance conducted by a resident of Israel regardless of whether that business is carried on through a permanent establishment in the United States. This provision applies only to the extent that the relevant risk ii not reinsured, directly or indirectly, with a person not entitled to relief from such tax.

Under paragraph (1) of Article 8 (Business Profits) and subparagraph (1)(a) of Article 1 (Taxes Covered) of the Convention, no insurance excise tax (or income tax) is payable with respect to premiums paid to a resident of Israel if the resident does not have a permanent establishment in the United States. In the case of an resident of Israel with a permanent establishment in the United States, the United States will not impose the insurance excise tax. (See Revenue Ruling 80-225.)

ARTICLE 9. Shipping and Air Transport

Paragraph (1) provides that, notwithstanding Article 8 (Business Profits) and Article 15 (Capital Gains), income derived by a resident of one Contracting State from the operation in international traffic of ships or aircraft, and gains derived from the sale, exchange or other disposition of such ships or aircraft, shall be exempt from tax by the other Contracting State. It should be noted that income derived by a resident of Israel would be exempt from tax by the United states even though the vessel with respect to which the income is earned is registered in a State which would not qualify for the reciprocal exemption of Code sections 872(b) and 883(a).

Under paragraph (2), this Article applies to income derived from the rental of such ships or aircraft under a full or bareboat charter if the lessor is engaged in the operation of ships or aircraft in international traffic and the rental income is incidental to such operations of the lessor. For example, if an airline which is a resident of one Contracting State has excess equipment in the winter months and leases several of its aircraft which are not required by it during that period to an airline which is a resident of the other Contracting State, that rental income of the lessor is not subject to tax by that other Contracting State.

Paragraph (2) also makes clear that the Article applies to income derived by a resident of one Contracting State from the use, maintenance, and lease of containers, trailers for the inland transportation of containers and other related equipment in connection with the operation by a resident in international traffic of ships or aircraft described in paragraph (1).

This Article is subject to the saving clause of paragraph (3) of Article 6 (General Rules of Taxation). Therefore, a Contracting State may tax income from international traffic derived by a resident of the other Contracting State without regard to this Article if such resident is a citizen of the first-mentioned Contracting State.

ARTICLE 10. Grants

This Article details the manner in which Israeli governmental grants to United States residents will be treated for United States tax purposes.

Paragraph (1) provides that for the purpose of computing United States tax, if Israel, a political subdivision thereof, or any agency of either makes a qualifying cash grant to a United States resident, then the amount of such grant will be included in the gross income of such resident unless the U.S. resident elects to exclude it. If he does not so elect, and the grant is included in income, the U.S. resident would increase his basis in the stock of the Israeli corporation by the amount of the grant. If he so elects, and if the resident is a corporation, the amount of such grant will be treated as a contribution to its capital. The electing United States resident will be considered to have contributed the amount of such grant to the Israeli corporation designated by the terms of the grant, and the resident’s basis for the stock of the Israeli corporation will not be increased by the amount of the contributed grant. The basis of the assets of the Israeli corporation (for purposes of determining the Israeli subsidiary’s earnings and profits for U.S. tax purposes) will be reduced by the amount of the deemed contribution, in accordance with rules prescribed by the Secretary of the Treasury. The Convention has no special provision with respect to a U.S. resident who acquires assets directly from the proceeds of a grant. Thus, for example, if the U.S. resident is a corporation, the rules of section 362(c) of the Code will apply and the U.S. resident will be required to reduce its basis in certain assets acquired after the contribution.

Paragraph (2) defines a qualifying cash grant as one approved by Israel for investment promotion in Israel. A qualifying grant will not include any amount which in whole or part, directly or indirectly,

(a) is in consideration for services rendered or to be rendered by either the United States resident or the Israeli subsidiary, or for the sale of goods;

(b) is measured in any manner by the amount of profits or tax liability of the investor or the Israeli corporation in which the investment is made; or

(c) which is taxed by Israel.

A grant will qualify where It is made by Israel, or a political subdivision thereof, on the basis of the enterprise meeting an approved project’s social or economic objectives, which may include, for example, creating employment, generating or conserving foreign exchange, tourism, or developing less developed regions. It is contemplated that qualifying grants may be made before commencement of an investment or after the investment has been made and may be based upon whether or not the enterprise has fulfilled the conditions of investment.

ARTICLE 11. Related Persons

This Article complements section 482 of the Code and confirms the authority of the United States under that section. Where a person subject to the taxing jurisdiction of a Contracting State (whether or not a resident thereof) and any other related person make arrangements or impose conditions between themselves which are different from those which would be made between independent persons, under paragraph (1), any income, deductions, credits or allowances which would, but for those arrangements or conditions, have been taken into account in computing the income or loss of, or the tax payable by, one of such persons, say be taken into account in computing the amount of the income subject to tax and the taxes payable by such person in that Contracting State.

Paragraph (2) sets forth an explicit formulation of the consequence of a redetermination made in accordance with paragraph (1) by a Contracting State to the income of one of its residents. In such event, the other Contracting State will, if it agrees with such redetermination and if necessary to prevent double taxation, make a corresponding adjustment to the income of a person in such other Contracting State related to such resident. If the other Contracting State disagrees with the redetermination, the two Contracting States will endeavor to reach agreement in accordance with the mutual agreement procedure in paragraph (2) of Article 28 (Mutual Agreement Procedure).

Paragraph (3) provides that for purposes of the Convention a person is related to another person if either person owns or controls directly or indirectly the other, or if a third person or persons own or control directly or indirectly both. ”Control” includes any kind of control, whether or not legally enforceable, and however exercised or exercisable.

ARTICLE 12. Dividends

Paragraph (1) provides that dividends derived from sources within one Contracting State by a resident of the other Contracting State may be taxed by both Contracting States.

Paragraph (2) limits the rate of tax in the Contracting State of source, in general, to a rate not in excess of twenty-five percent of the gross amount of the dividend paid. However, if the dividend recipient is a corporation, two special rules are provided. Under subparagraph (2)(b), where the dividend is paid out of income for a period during which the paying corporation is not entitled to the reduced rate of tax applicable to an approved enterprise under Israel’s Encouragement of Capital Investments Law (1959), the rate of tax in the Contracting State of source may not exceed twelve and one-half percent of the gross amount of the dividend paid. Under subparagraph (2)(c), a maximum rate of 15 percent of the gross dividend is provided for dividends paid for a period during which the paying corporation is entitled to the reduced rates applicable to an approved enterprise under Israel’s Encouragement of Capital Investments Law (1959). These special rate limitations only apply if during the part of the paying corporation’s taxable year which precedes the date of payment of the dividend and during the whole of its prior taxable year (if any), at least ten percent of the outstanding voting stock of the corporation was owned by the recipient corporation, and not more than twenty-five percent of the gross income of the paying corporation for such prior taxable year (if any) consists of interest or dividends (other than interest derived from the conduct of a banking, insurance, or financing business and dividends or interest received from subsidiary corporations, fifty percent or more of the outstanding voting stock of which is owned by the paying corporation at the time such dividends or interest is received). These rate limitations do not affect the taxation of profit of the company which pays the dividends.

Paragraph (3) provides that dividends paid by a corporation of one Contracting State to a person other than a resident of the other Contracting State (and in the case of dividends paid by an Israeli corporation, to a person other than a citizen of the United States) will be exempt from tax by the other Contracting State.

Paragraph (4) provides that the limitations of paragraphs (2) and (3) will not apply if the dividends are treated, under paragraph (6) of Article 8 (Business Profits), as industrial or commercial profits attributable to a permanent establishment which the recipient has in the other Contracting State. In such case, the provisions of Article 8 (Business Profits) will apply. If the recipient of the dividend is a citizen of the source Contracting State, that Contracting State may tax the recipient without regard to this Article because of the saving clause of paragraph (3) of Article 6 (General Rules of Taxation).

No definition of the term “dividends” is provided. Accordingly, each Contracting State may use the definition under its domestic law, unless the context otherwise requires or the competent authorities agree to a common meaning. See paragraph (2) of Article 2 (General Definitions).

ARTICLE 13. Interest

Paragraph (1) provides that interest derived by a resident of one Contracting State from sources within the other Contracting State may be taxed by both Contracting States. However, paragraph (2) limits the rate of tax in the Contracting State of source to a rate not in excess of seventeen and a half percent of the gross amount of the interest. If the interest is derived from a loan of whatever kind granted by a bank, savings institution, insurance company, or the like, the rate of tax in the Contracting State of source may not exceed ten percent of the gross amount of the interest.

Paragraph (3) provides that interest beneficially derived by one of the Contracting States, or by an instrumentality of that Contracting State not subject to tax by that Contracting State on its income, will be exempt from tax by the other Contracting State. Under this rule, interest income derived by the Export-Import Bank of the United States and the Overseas Private Investment Corporation (OPIC) on loans made to Israeli residents will be exempt from tax in Israel. Similarly, income derived by the Bank of Israel on loans made to residents of the United States will be exempt from U.S. tax. The exemption also applies where a resident of a Contracting State receives interest income with respect to debt obligations guaranteed or insured by that Contracting State or an instrumentality thereof.

Paragraph (4) provides that interest paid by a resident of one Contracting State to a person other than a resident of the other Contracting State (and in the case of interest paid bye resident of Israel, to a person other than a United States citizen) will be exempt from tax by the other Contracting State unless such interest is treated as income from sources within the other Contracting State under paragraph (2) of Article 4 (Source of Income).

Paragraph (5) provides that the limitations of paragraphs (2), (3), and (4) will not apply if the interest is treated, under paragraph (6) of Article 8 (Business Profits), as industrial or commercial profits attributable to a permanent establishment which the recipient has in the other Contracting State. In such a case, the provisions of Article 8 (Business Profits) will apply.

If excessive interest is paid to a related person, paragraph (6) provides that the Article does not apply to the excessive portion of the payment. The excessive portion may be taxed by each Contracting State according to its own laws, including the Convention where applicable. In the case of the United States, the excessive portion may be taxed as a dividend, in which case the provisions of Article 12 (Dividends) will apply.

Paragraph (7) defines “interest” for purposes of the Convention as income from money lent and other income which under the taxation law of the Contracting State in which the income has its source is assimilated to income from money lent.

This Article is subject to the saving clause of paragraph (3) of Article 6 (General Rules of Taxation). Therefore, interest derived by a citizen of the source Contracting State may be taxed by that Contracting State without regard to this Article.

ARTICLE 14. Royalties

Paragraph (1) provides that royalties derived by a resident of one Contracting State from sources within the other Contracting State may be taxed by both Contracting States. However, paragraph (1) limits the tax in that other Contracting State to a rate not to exceed ten percent of the gross amount of a copyright or film royalty or fifteen percent of the gross amount of an industrial royalty.

The term “copyright or film royalties” is defined in paragraph (2)(a) as payments of any kind made as consideration for the use of, or the right to use, copyrights of literary, artistic, or scientific works, including copyrights of motion picture films or films or tapes used for radio or television broadcasting. The term “industrial royalties” is defined in paragraph (2)(b) as payments of any kind made as consideration for the use of, or the right to use, patents, designs, models, plans, secret processes or formulae, trademarks, or other like property or rights. Copyright or film royalties and industrial royalties include gains derived from the sale, exchange, or other disposition of such property or rights to the extent the amounts realized on such sale, exchange or other disposition for consideration are contingent on the productivity, use, or disposition of the property or rights. If the amounts realized are not so contingent, the provisions of Article 15 (Capital Gains) may apply. The term “royalties” does not include royalties and other payments in respect of the exploitation of natural resources. Such payments are covered by the provisions of Article 7 (Income from Real Property). See also paragraph (6) of Article 8 (Business Profits).

Paragraph (3) provides that the tax rate limitations of paragraph (1) shall not apply if the royalty is treated, under paragraph (6) of Article 8 (Business Profits), as industrial or commercial profits attributable to a permanent establishment which the recipient has in the other Contracting State. In such a case, the provisions of Article 8 (Business Profits) will apply.

If excessive royalties are paid to a related person, paragraph (4) provides that the Article does not apply to the excessive portion of the royalty. The excessive portion may be taxed by each Contracting State according to its own laws, including the Convention where applicable. Thus, the excessive portion may be treated as a dividend or interest, or in whatever other manner is appropriate. But if, for example, it is treated as a dividend, the rules of Article 12 (Dividends) will be applied.

As noted under paragraph (3) of Article 4 (Source of Income), royalties (including contingent gains) will be treated as income from sources within a Contracting State only to the extent they are payments made as consideration for the use of, or the right to use, property or rights described in paragraph (2) within that Contracting State. This source rule is similar to the source rule in section 861(a)(4) of the Code.

This Article is subject to the saving clause of paragraph (3) of Article 6 (General Rules of Taxation). Therefore royalties derived by a citizen of the source Contracting State may be taxed by that Contracting State without regard to this Article.

ARTICLE 15. Capital Gains

Under paragraph (1), a resident of one Contracting State will be exempt from tax by the other Contracting State on gains from the sale, exchange or other disposition of capital assets. However, the exemption does not apply if

(a) the gain is from the sale, exchange or other disposition of property described in Article 7 (Income from Real Property) situated within the other Contracting State;

(b) the gain is from the sale, exchange or other disposition of property described in paragraph (2)(c) of Article 14 (Royalties);

(c) the gain is treated, under paragraph (6) of Article 8 (Business Profits), as industrial or commercial profits attributable to permanent establishment which the resident has in the other Contracting State; or

(d) the resident is an individual who is present in the other Contracting State for a period or periods aggregating 183 days or more during the taxable year.

For purposes of this Article and the other physical presence tests contained in the Convention with regard to an individual, the term “day” means a calendar day during any portion of which the individual is physically present in the relevant Contracting State.

Paragraph (1) contains an additional exception to the capital gains exemption which is not in previous United States conventions. Under Israeli tax law, gains from the sale of stock in an Israeli corporation are subject to tax by Israel regardless of the residence of the alienator or place where the sale occurs. The additional exception in paragraph (1) is intended to limit this rule of Israeli taxation. This exception will apply (i.e., Israel will preserve its right to tax) only if the gain is derived from the sale, exchange or other disposition of stock in an Israeli corporation by a resident of the United states who owns either actually or constructively within the twelve month period preceding the sale, exchange, or other disposition, stock possessing more than fifty percent of the voting power of the Israeli corporation, and more than fifty percent of the fair market value of the Israeli corporation’s gross assets used in its trade or business are physically located in Israel on the last day of each of the three taxable years preceding the sale, exchange, or other disposition (or, if the corporation has been in existence for less than three years, on the last day of each preceding taxable year of the corporation).

Paragraph (2) provides that the provisions of Article 7 (Income from Real Property) will apply to real property gains; the provisions of Article 14 (Royalties) will apply to certain royalty gains; and the provisions of Article 8 (Business Profits) will apply to gains attributable to a permanent establishment.

If the recipient of the gain is a resident of one Contracting State and a citizen of the other Contracting State, that other Contracting State may tax the recipient without regard to this Article because of the saving clause of paragraph (3) of Article 6 (General Rules of Taxation). Where Article 9 (Shipping and Air Transport) applies to gains derived from the sale, exchange or other disposition of property, this Article does not apply to such gains.

ARTICLE 15-A. Charitable Contributions

Article 15-A provides rules under which a resident of one Contracting State (and, in the case of the United States, a U.S. citizen) may make a gift to a charitable organization in the other State, which will be treated for tax purposes, by the State of residence (or citizenship in the case of the United States) as a charitable contribution.

Paragraph (1) deals with the U.S. tax treatment of gifts by U.S. citizens or residents to Israeli charities. It provides that if a U.S. citizen or resident makes a contribution to an organization created or organized under the laws of Israel, that contribution will be treated as a charitable contribution for U.S. tax purposes, for the taxable year in which the gift is made, if and to the extent that the contribution would have been so treated if the organization had been created or organized under the laws of the United States. This rule applies, however, only to contributions which do not exceed twenty-five percent of the contributor’s taxable income (if a corporation) or adjusted gross income (if an individual) for the year from Israeli sources.

Paragraph 2 applies, mutatis mutandis, to a gift by an Israeli resident to an American organization.

The Article determines whether any particular gift is to be treated as a charitable contribution. Whether, or the extent to which a deduction (or, in the case of Israel, a credit) is to be allowed by the country of residence for the contribution continues to be governed by the limitations in the taxation laws of that Contracting State. For example, assume a U.S. resident with $50,000 of adjusted gross income, $10,000 of which is from Israeli sources. His contributions to U.S. charitable organizations total $25,000, and he contributes $5,000 to qualifying Israeli organizations. Assume, further, that all the contributions qualify under Code section 170(b)(l)(A) and are, therefore, deductible up to fifty percent of adjusted gross income. His charitable contributions, under paragraph (1) of the Article, would be $27,500–the full $25,000 of contributions to U.S. organizations and $2,500 (twenty-five percent of $10,000) of contributions to Israeli charities. His limit for current year deductions under U.S. law is $25,000. Thus, he may deduct $25,000 in the current year and carry over $2,500 for future years. Once a contribution to an Israeli charitable organization qualifies as a charitable contribution it becomes indistinguishable from other charitable contributions. There is no need, therefore, in the example above, to determine whether the carryover of excess contributions reflects contributions to Israeli or American charities. Thus, even if the contributor has no Israeli source income in future years, his right to use the carryover is not affected.

In notes exchanged at the time of the signing of the treaty, it was agreed that an effort would be made to develop procedures to simplify the determination by one Contracting State that an organization in the other Contracting State is eligible to receive charitable contributions from residents of the first-mentioned State. The competent authorities of each Contracting State will review the procedures and requirements of the other Contracting State for certifying an organization of that other State as eligible to receive charitable contributions. If the competent authorities find that the procedures do not differ substantially as between the two Contracting States, it is contemplated that the authorities of each State will accept certification by the other and will not require recipient organizations to qualify separately in both States.

ARTICLE 16. Independent Personal Services

In dealing with the taxation of income from personal services the Convention distinguishes between “independent” and “dependent” personal services. The Convention also provides special treatment for individuals who are “public entertainers” and for amounts received for furnishing the personal services of others.

Services performed by an individual in an independent capacity are services performed for his own account where he receives the income and bears the losses arising from such services. If an individual is an independent contractor he is considered as rendering independent personal services. Generally, services rendered by physicians, lawyers, engineers, architects, dentists and accountants performing personal services as sole proprietors or partners are independent personal services.

Under paragraph (1), income derived by an individual resident of one contracting State from the performance of personal services in an independent capacity may be taxed only by that Contracting State. However, under paragraph (2), such income derived from services performed in the other contracting State may also be subject to tax in that other contracting State if the individual is present therein for a period or periods aggregating 183 days or more in the taxable year. Under the saving clause of paragraph (3) of Article 6 (General Rules of Taxation), the other Contracting State may also tax any individual who is a citizen of that other contracting State without regard to this Article.

ARTICLE 17. Dependent Personal Services

Under paragraph (1), wages, salaries, and similar remuneration derived by an individual who is a resident of one Contracting State from labor or personal services performed as an employee, including income from services performed by an officer of a corporation or company, may be taxed by that Contracting State. If such remuneration is derived from sources within the other Contracting State, it may be taxed by that other contracting State unless it is exempt from tax in that other State under paragraph (2) or under Articles 20 (private Pensions and Annuities), 22 (Governmental functions), 23 (Teachers) and 24 (Students and Trainees).

Under paragraph (2), dependent personal service income derived by an individual resident of one contracting State will be exempt from tax by the other contracting State if:

(a) the individual is present in that other contracting State for a period or periods aggregating less than 183 days in the taxable year;

(b) the individual is an employee of a resident of the first-mentioned contracting State or of a permanent establishment maintained in the first-mentioned Contracting State;

(c) the remuneration is not borne as such (i.e., as a deduction for salary payments) by a permanent establishment which the employer has in the other contracting State; and

(d) the remuneration is subject to tax in the first-mentioned Contracting State. Income of a United States citizen or resident which is excluded from tax by reason of section 911 is not considered subject to tax by the United States.

Such income may also be taxed by that other contracting state without regard to this Article if the individual is a citizen of that other contracting State, because of the saving clause of paragraph (3) of Article 6 (General Rules of Taxation).

Under paragraph (3), and notwithstanding paragraphs (1) and (2), remuneration derived by an employee (even if a resident of a State other than a Contracting State) of a resident of one Contracting State for labor or personal services performed as a member of the regular complement of a ship or aircraft operated in international traffic by a resident of that Contracting State may be taxed by that Contracting State. In addition, this paragraph is subject to the saving clause of paragraph (3) of Article 6 (General Rules of Taxation) so that the other Contracting State may tax its citizens or residents without regard to this paragraph.

ARTICLE 18. Public Entertainers

This Article provides that, notwithstanding Articles 16 (Independent Personal Services) and 17 (Dependent Personal Services), income derived by an individual resident in one Contracting State from his performance of personal services in the other Contracting State as a public entertainer, such as a theater, motion picture, radio or television artist, a musician, or an athlete may be taxed by the other Contracting State only if the gross amount of such income exceeds $400 or its equivalent in Israeli pounds for each day the individual is present in the other Contracting State for the purpose of performing such services therein. If the entertainer’s gross income exceeds $400 per day, he may be taxed on the full amount of his income, not just the amount in excess of $400.

If the individual receives a fixed amount for performing the services on more than one day, the amount received will be pro-rated over the number of days the individual performs the services. Thus, for example, if am entertainer resident in Israel receives $5,000 to perform in a series of 5 concerts in the United States on 5 different days and spends an additional 5 days in the United States in rehearsal for those concerts over a two week period, he will be considered to have received $500 for each day and thus, pursuant to this Article, he may be taxed by the United States.

Income derived from services rendered by producers, directors, technicians, and others who are not public entertainers is taxable in accordance with the provisions of Article 16 (Independent Personal Services), or Article 17 (Dependent Personal Services), as the case may be.

Under the saving clause of paragraph (3) of Article 1 (General Rules of Taxation), if the individual is a citizen of a Contracting State, that State may tax his income without regard to this Article.

ARTICLE 19. Amounts Received for Furnishing Personal Services of Others

Paragraph (1) provides that amounts received by a resident of one Contracting State in consideration of furnishing in the other Contracting State the personal services of one or more other persons, including a public entertainer referred to in Article 18 (Public Entertainers), will not constitute industrial or commercial profits under Article 8 (Business Profits) to the extent that the person for whom the services were furnished designated the person or persona who would render the services, whether or not he had the legal right to do so and whether or not the designation was made formally; the person for whom the services were furnished had the right to designate the person or persons who would render the services; or by reason of the facts and circumstances the arrangement for personal services had the effect of designating the person or persons who would render the services; and the resident of the first-mentioned Contracting State directly or indirectly pays compensation for such services to any person, other than another resident of the first-mentioned Contracting State or of that other Contracting State who is subject to tax on such compensation. If this paragraph applies, the amounts received for providing personal services of other individuals in the other Contracting State may be taxed by that other Contracting State even though not attributable to a permanent establishment. For purposes of this paragraph, income of a United States citizen or resident which is excluded from tax by reason of section 911 is not considered subject to tax by the United States.

Paragraph (2) provides that paragraph (1) will not apply if it is established to the satisfaction of the competent authority of that other Contracting state with respect to any amount received that neither the creation nor organization of the resident of the first-mentioned Contracting State (where such resident is a corporation or other entity) nor the furnishing of the services through such resident has the effect of a substantial reduction in income, war profits, excess profits, or similar taxes. The taxes referred to in the preceding sentence are those imposed by the two Contracting States.

ARTICLE 20. Private Pensions and Annuities

Except as provided in Article 22 (Governmental Functions), pensions and other similar remuneration paid to an individual will be taxable under paragraph (1) only in the Contracting State of which he is a resident. Thus, private pensions and similar remuneration derived from sources within one Contracting State by an individual resident of the other Contracting State are exempt from tax in the first-mentioned Contracting State. Pensions for Government service are dealt with in Article 22 (Governmental Functions). The term “pensions and similar remuneration” is defined in paragraph (4) am periodic payments, other than social security payments covered in Article 21 (Social Security Payments), made by reason of retirement or death and in consideration for services rendered, by way of compensation for injuries or sickness received in connection with past employment, or by reason of payments made under a plan benefitting self-employed individuals all or some of the contributions to which qualify for special tax treatment.

Paragraph (2) provides that alimony and annuities paid to an individual resident of a Contracting State will be taxable only in that Contracting State. The term “annuities” is defined in paragraph (5) as a stated sum paid periodically at stated times during life, or during a specified number of years, under an obligation to make the payments in return for adequate and full consideration (other than for services rendered). The term “alimony” is defined in paragraph (6) as periodic payments made pursuant to a written separation agreement or a decree of divorce, separate maintenance, or compulsory support which are taxable to the recipient under the internal laws of the Contracting State of which he is a resident. Thus, the term “alimony” would not include a payment which would not be taxable to the recipient under the laws of the Contracting State in which he is a resident even though such payment is made pursuant to a decree of divorce or of separate maintenance. The explicit reference to a decree of compulsory support is consistent with section 71 of the Code.

Paragraph (3) provides that child support payments made by an individual resident of one Contracting State to an individual resident of the other Contracting State will be exempt from tax

in that other Contracting State. The term “child support payments” is defined in paragraph (7) as periodic payments for the support of a minor child made pursuant to a written separation agreement or a decree of divorce, separate maintenance, or compulsory support.

This Article is subject to the saving clause of paragraph (3) of Article 6 (General Rules of Taxation). Therefore, individuals who are citizens or residents of a Contracting State may be taxed by that Contracting State without regard to this Article.

ARTICLE 21. Social Security Payments

This Article provides that social security payments and other public pensions, e.g., railroad retirement benefits, paid by one Contracting State to an individual who is a resident of the other Contracting State will be exempt from tax in both Contracting States. Payments described in Article 22 (Governmental Functions) are not covered by this Article.

Under paragraph (2) of Article 32 (Termination), this Article may be terminated by either Contracting State at any time after the Convention enters into force.

Under paragraph (4)(a) of Article 6 (General Rules of Taxation), the saving clause of paragraph (3) of Article 6 does not apply to the provisions of this Article. Thus, the exemption applies even to a citizen or resident of a Contracting State.

ARTICLE 22. Governmental Functions

Under this Article, wages, salaries, and similar remuneration, including pensions, annuities, or similar benefits, paid from public funds of one Contracting State to a citizen of that Contracting State, or to a citizen of a State other than a Contracting State who comes to the other Contracting State expressly for the purpose of being employed by the first-mentioned Contracting State, for labor or personal services performed as an employee of the national Government of that Contracting State, or any agency thereof, in the discharge of functions of a governmental nature will be exempt from tax by the other Contracting State. If the citizen becomes a citizen of, or acquires immigrant Status in, the other Contracting State, that other Contracting State may tax the individual without regard to this Article. See paragraphs (3) and (4)(b) of Article 6 (General Rules of Taxation).

Whether services will be treated as performed in the discharge of governmental functions may be determined by reference to the concept of a governmental function in the State in which the income arises. Thus, compensation paid in connection with industrial or commercial activity is treated the same as compensation received from a private employer. This Article applies only to remuneration paid by the national government or agencies of the national government of a Contracting State.

ARTICLE 23. Teachers

Paragraph (1) provides that, if a resident of one Contracting State is invited by the other Contracting State, a political subdivision or local authority thereof, or by a university or other recognized educational institution in that other Contracting State to come to that Contracting State for a period not expected to exceed two years for the purpose of teaching or engaging in research, or both, at a university or other recognized educational institution, and if such resident comes to that other Contracting State primarily for such purpose, his income from personal services for teaching or research at the university or educational institution will be exempt from tax by that other Contracting State for a period not exceeding two years from the date of his arrival in that other Contracting State.

Since a temporary visit may be of such a duration that an individual may lose his status as a resident of the Contracting State of which he was a resident at the time he became eligible for the benefits of this Article, the individual need only be a resident of such Contracting State at the beginning of his visit. However, if the individual becomes a citizen of, or acquires immigrant status in, the other Contracting State, that other Contracting State may tax the individual without regard to this Article. See paragraphs (3) and (4)(b) of Article 6 (General Rules of Taxation). If the individual’s visit exceeds a period of two years from the date of his arrival, the exemption applies only to the income received by the individual before the expiration of such two-year period.

Pursuant to paragraph (2), this Article does not apply to income from research undertaken not in the public interest but primarily for the private benefit of a specific person or persons other than the person performing the research.

ARTICLE 24. Students and Trainees

Paragraph (1) provides that an individual who is a resident of one Contracting state at the time he becomes temporarily present in the other Contracting State and who is temporarily present therein for the primary purpose of studying at a university or other recognized educational institution, securing training required to qualify him to practice a profession or professional specialty, or studying or doing research as a recipient of a grant, allowance, or award from a government, religious, charitable, scientific, literary, or educational organization, will be exempt from tax by that other Contracting State for a period not exceeding five taxable years from the date of his arrival in that other Contracting State on:

(1) gifts from abroad for the purpose of his maintenance, education, study, research or training;

(2) the grant, allowance, or award; and

(3) income from personal services performed in the other Contracting State not in excess of $3,000 or its equivalent in Israeli pounds for any taxable year.

Under, paragraph (2), an individual who is a resident of one Contracting State at the time he becomes temporarily present in the other Contracting State and who is temporarily present therein as an employee of, or under contract with, a resident of the first-mentioned Contracting State, for the primary purpose of acquiring technical, professional, or business experience from a person other than that resident of the first-mentioned Contracting State or other than a person related to such resident, or studying at a university or other recognized educational institution in that other Contracting State, will be exempt from tax by that other Contracting State for a period not exceeding twelve consecutive months, on income from personal services not in excess of $7,500 or its equivalent in Israeli pounds.

Under paragraph (3), an individual who is a resident of one Contracting State at the time he becomes temporarily present in the other Contracting State and who is temporarily present therein for a period not exceeding one year, as a participant in a program sponsored by the other Contracting State, for the primary purpose of training, research, or study, will be exempt from tax by the other Contracting State with respect to his income from personal services in respect of such training, research, or study performed in that other Contracting State in an aggregate amount not in excess of $10,000 or its equivalent in Israeli pounds.

The monetary limits provided in paragraph (1), (2), or (3) are in addition to, and not in lieu of, other exemptions provided by the Code. Thus, an unmarried resident of Israel who is temporarily present in the United States for the primary purpose of studying at a university would be entitled to exclude $3,000 of income from the performance of personal services and, in addition, would be entitled to the personal exemption allowed by section 151 of the Code, as provided in section 873(b) of the Code.

The first sentence of paragraph (4) provides that the benefits provided in paragraph (1) and the benefits provided under Article 23 (Teachers), when taken together, may extend only for such period of time, not to exceed five taxable years from the date of the individual’s arrival, as may reasonably or customarily be required to effectuate the purpose of the visit. The second sentence of paragraph (4) makes it clear that the benefits provided by Article 23 will not be available to an individual if, during the immediately preceding period, the individual enjoyed the benefits provided by paragraph (1). Thus, an Israeli individual who originally entered the United States for the purpose of becoming a student and received benefits under paragraph (1) must leave the United States and, if necessary, reestablish residence in Israel and then return at the invitation of the United States, a political subdivision or local authority thereof, or a university or other recognized educational institution for the primary purpose of becoming a teacher in order to take advantage of Article 23.

If an individual qualifies for the benefits of more than one of the provisions of Article 23 and this Article, such individual may choose the most favorable provision but may not claim the benefits of more than one provision in any taxable year as a means of avoiding the limitations provided. Thus, for example, an individual who comes to the other Contracting State for the primary purpose of studying may be able to qualify under either paragraphs (2) or (3) of this Article. However, he cannot combine the maximum exclusion limits in those two paragraphs to exclude $17,500 during the taxable year. If the individual becomes a citizen of, or acquires immigrant status in, the other Contracting State, that other Contracting State may tax the individual without regard to this Article. See paragraphs (3) and (4)(b) of Article 6 (General Rules of Taxation).

ARTICLE 25. Investment or Holding Companies

The Article provides that a corporation of one Contracting State deriving dividends, interest, royalties or capital gains from sources within the other Contracting State will not be entitled to the benefits of Article 12 (Dividends), 13 (Interest), 14 (Royalties), or 15 (Capital Gains) if by reason of special measures the tax imposed on such corporation by the first- mentioned Contracting State with respect to such dividends, interest, royalties or capital gains is substantially less than the tax generally imposed by such Contracting State on corporate profits, and twenty-five percent or sore of the capital of such corporation is held of record or is otherwise determined, after consultation between the competent authorities of the Contracting States to be owned, directly or indirectly, by one or more persons who are not individual residents of the first-mentioned Contracting State (or, in the case of an Israeli corporation, who are citizens of the United States). For purposes of applying this Article, it is intended that the requisite direct or indirect ownership be tested at the individual shareholder level. Existing Code provisions dealing with the taxation of capital gains do not make this Article applicable with respect to capital gains.

The purpose of this Article is to deal with potential abuse which could occur if one of the Contracting States provided preferential rates of tax for investment or holding companies. In the absence of this Article, residents of third countries could organize a corporation in the Contracting State extending the preferential rates for the purpose of making investments in the other Contracting State. The combination of low tax rates in the first Contracting State and the reduced rates or exemptions in the other Contracting State would enable the third country residents to realize unintended benefits.

ARTICLE 26. Relief from Double Taxation

In order to avoid double taxation, each Contracting State agrees in this Article to provide to its citizens or residents a credit against its taxes for taxes paid by such persons to the other Contracting State.

The United States agrees to allow a United States citizen or resident as a credit against United States tax an appropriate amount of taxes paid or accrued to Israel in accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle of paragraph (1)). In addition, in the case of a United States corporation owning at least ten percent of the voting stock of an Israeli corporation from which it receives dividends in any taxable year, the United States will allow credit for the appropriate amount of taxes paid or accrued to Israel by the Israeli corporation paying such dividends with respect to the profits out of which such dividends are paid. The appropriate amount will be based upon the amount of tax paid or accrued to Israel, but the credit is not to exceed the limitations (for the purpose of limiting the credit to the United States tax on income from sources within Israel or on income from sources outside of the United States) provided by United States law for the taxable year. This provision does not require the United States to maintain a per-country or overall limitation in the future so long as the general principle of a foreign tax credit remains in effect. For the purpose of applying the United States credit in relation to taxes paid or accrued to Israel, the rules set forth in Article 4 (Source of Income) will be applied to determine the source of income and the taxes referred to in paragraphs (l)(b) and (2) of Article 1 (Taxes Covered) will be considered to be income taxes. Whether Israeli taxes are paid or accrued is determined under the rules of the Code. A taxpayer may, for any year, claim a foreign tax credit under the rules of the Code. In that case, he would forego the rules of the Convention that guarantee income tax status for the specified Israeli taxes.

Paragraph (2) details the treatment for United States tax purposes of compulsory loans to Israel made by United States citizens or residents or by a subsidiary of a United States corporation. If for any taxable year a United States citizen or resident takes a credit against tax for a compulsory loan to Israel (which is included as a tax under paragraph (l)(b)(v) of Article 1 (Taxes Covered)), whether paid by such citizen or resident or by a corporation 10 percent or more of the voting stock of which is owned by such citizen or resident, then any interest received on such loan is not to be included in taxable income and no deduction is to be allowed for any interest subsequently assessed or collected by the United States; upon repayment or recoupment of the principal of the loan, the amount of the value in United States dollars received shall be treated as a refund for the year the loan was made of taxes paid to Israel for such year equal to the basis for such loan, and the amount of any tax credit taken shall be recomputed, notwithstanding the operation of any law or rule of law: any such amount in excess of such basis shall be included in taxable income for the year the repayment or recoupment is made: and no interest will be assessed or collected by the United States on any amount of tax due for the year the loan vas made except to the extent that interest was received from Israel on the loan. Thus, the United States, is to permit treatment of the compulsory loan payment as a creditable tax and will be entitled to its normal interest charges to the extent made on such loan, but not to exceed the amount actually received by the taxpayer.

Where the taxpayer has previously claimed an indirect credit for a compulsory loan payment made by a subsidiary corporation, the taxpayer at the time of payment of interest by Israel to the subsidiary will be considered to be the recipient of such Interest. The amount of the interest will be considered a contribution to the capital of the subsidiary by the taxpayer. As under section 905(c) of the Code, the recomputation and payment of tax shall be made without regard to any otherwise applicable statute of limitations on assessments. The Secretary of the Treasury will prescribe regulations he deems necessary to carry out the purposes of this paragraph, including rules for determining whether an amount included as a tax under paragraph (l)(b)(v) of Article 1 (Taxes Covered) has been taken as a credit against tax.

Under paragraph (3), Israel will allow a resident of Israel as a credit against Israeli tax the appropriate amount of income taxes paid or accrued to the United States and, in the case of an Israeli corporation owning at least ten percent of the voting stock of a United States corporation from which it receives dividends in any taxable year, will also allow credit for the appropriate amount of taxes paid or accrued to the United States by the United States corporation paying such dividends with respect to the profits out of which such dividends are paid. The appropriate amount will be based upon the amount of tax paid or accrued to the United States but will not exceed that portion of Israeli tax which such residents net income from sources within the United States bears to his entire net income for the same taxable year. For the purpose of applying the Israeli credit in relation to taxes paid or accrued to the United States, the rules set forth in Article 4 (Source of Income) will be applied to determine the source of income, and the taxes referred to in paragraphs (1)(a) and (2) of Article 1 (Taxes Covered) will be considered to be creditable taxes.

The saving clause in paragraph (3) of Article 6 (General Rules of Taxation) does not apply to this Article. Thus, the provisions of this Article may be relied upon a citizen or resident of a Contracting State.

ARTICLE 27. Non-discrimination

Paragraph (1) provides that a citizen of one Contracting State who is a resident of the other Contracting State will not be subject in that other Contracting State to more burdensome taxes than a citizen of that other Contracting State who is a resident thereof. The determination of whether there is more burdensome taxation is to be made by comparing the treatment of individuals who are in comparable positions. Thus, for example, a citizen of Israel who is a resident of the United States and who otherwise meets the requirements specified in section 911 of the Code would, under this Article, be eligible for the benefits of section 911 even though not a citizen of the United States.

Paragraph (2) provides that a permanent establishment which a resident of one Contracting State has in the other Contracting State will not be subject in that other Contracting State to more burdensome taxes than a resident of that other Contracting State carrying on the same activities. However, this does not obligate a Contracting State to grant to individual residents of the other Contracting State any personal allowances, reliefs, or deductions for taxation purposes on account of civil status or family responsibilities which it grants to its own individual residents.

Paragraph (3) prohibits one Contracting State from subjecting a corporation of such Contracting State the capital of which is wholly or partly owed or controlled, directly or indirectly, by one or more residents of the other Contracting State to any taxation or any requirement connected with taxation which is other or more burdensome than those applicable to corporations of the first-mentioned Contracting State carrying on the same activities, the capital of which is wholly or partly owned or controlled by one or more residents of the first-mentioned Contracting State.

Under paragraph (3) of Article 1 (Taxes Covered), the provisions of this Article extend to all taxes of every kind imposed at the national level.

The provisions of this Article do not override the right of the United States to impose the tax provided in Code section 897 (relating to gains derived by nonresident aliens or foreign corporations from U.S. real property interests).

The saving clause in paragraph (3) of Article 6 (General Rules of Taxation) does not apply to this Article. Thus, a Contracting State may not deny any rights conferred by this Article to its citizens and residents.

ARTICLE 28. Mutual Agreement Procedure

Under paragraph (1), when a resident or citizen of one Contracting State considers that action of one or both Contracting States results or will result for him in taxation not in accordance with the Convention, he may, notwithstanding the remedies provided by the national laws of the Contracting States, present his case to the competent authority of the Contracting State of which he is a resident or citizen. A resident (or citizen) of a Contracting State need not, although it is anticipated that in the normal situation he will, exhaust his other administrative or judicial remedies prior to resorting to the use of the mutual agreement procedure. If the claim is considered to have merit by the competent authority, that competent authority will endeavor to come to an agreement with the competent authority of the other Contracting State with a view to the avoidance of taxation not in accordance with the Convention.

Paragraph (2) requires the competent authorities of the two Contracting States to endeavor to resolve by mutual agreement any difficulties or doubts arising as to the application of the Convention. In particular, the competent authorities may agree to the same attribution of industrial or commercial profits to a resident of one Contracting State and its permanent establishment situated in the other Contracting State; the same allocation of income, deductions, credits, or allowances between a resident of one Contracting State and a related person and to the readjustment of taxes imposed by each Contracting State to reflect such allocation; the same determination of the source of particular items of income; the same characterization of particular items of income; and the mode of application of Articles 15-A (Charitable Contributions) and 29 (Exchange of Information). The list of subjects of potential mutual agreement in paragraph (2) is not exhaustive; it merely illustrates the principles set forth in the paragraph.

Under paragraph (3), in implementing the provisions of this Article, the competent authorities may communicate with each other directly and, when advisable, meet together for an oral exchange of opinions.

Under paragraph (4), in cases in which the competent authorities reach an agreement, taxes will be imposed on such income, and refund or credit of taxes allowed, by the Contracting States in accordance with such agreement. This permits the issuance of a refund or credit notwithstanding procedural barriers otherwise existing under a Contracting States law, such as the statute of limitations. However, it does not authorize additional taxes to be imposed after the statute of limitations has run.

ARTICLE 29. Exchange of Information

Paragraph (1) provides for a system of administrative cooperation between the competent authorities of the two Contracting States by requiring an exchange of information pertinent to carrying out the provisions of the Convention or preventing fraud or fiscal evasion in relation to the taxes which are the subject of the Convention. The competent authorities may exchange information in connection with tax compliance generally, not merely illegal acts or crimes. Information exchanged must be treated as secret and cannot be disclosed to any persons or authorities other than those concerned with the assessment, including judicial determination, or collection of the taxes which are the subject of the Convention. Thus, disclosure is not prohibited as a part of a public proceeding before a court or administrative body.

Paragraph (2) makes clear that a Contracting State is not obligated to carry out administrative measures at variance with the laws or the administrative practice of either Contracting State; to supply particulars which are not obtainable under the laws or in the normal course of the administration of either Contracting State; or to supply information which would disclose any trade, business, industrial, commercial or professional secret or trade process, or information the disclosure of which would be contrary to public policy.

In making the determinations necessary under paragraph (2) a Contracting State will use the standards it uses in the enforcement of its own laws by its administrative and judicial authorities, treating the tax of the Contracting State with respect to which a request relates as if it were a tax of the Contracting State requested to furnish the information and were being imposed by such Contracting State. Depositions of witnesses and copies of unedited original documents (including books, papers, statements, records, accounts, or writings) may be provided by the competent authority of a Contracting State if specifically requested by the competent authority of the other Contracting State. In addition, any information which may be furnished in accordance with this Article should not be withheld by reason of any doctrine of law under which international judicial assistance is not accorded in tax matters.

The exchange of information may be on either a routine basis or on request with reference to particular cases. The competent authorities may agree on the list of information to be furnished on a routine basis.

In an exchange of notes signed at the time of the signing of the Protocol, Israel noted that at the present time, its manpower resources and technical capabilities do not permit it to provide information on a routine basis with respect to U.S. residents receiving dividends, interest, and royalties from Israel, nor is it in a position to provide information not already existing in the Finance Minister’s files. The Government of Israel, however, does intend to remedy its manpower and technical deficiencies so that it will be able to exchange the full range of information provided for in the Convention.

ARTICLE 30. Diplomatic and Consular Officers

This Article provides that nothing in the Convention will affect the fiscal privileges of diplomatic and consular officials under the general rules of international law or under the provisions of special agreements.

ARTICLE 31. Entry into Force

This Article and Article XVI of the Protocol provide that the Convention and the Protocol are subject to ratification and provide for the exchange of instruments of ratification. The Convention and Protocol will enter into force thirty days after the date of exchange of such instruments of ratification. The Convention shall first have effect as respects the rate of withholding of tax, to amounts paid on or after the first day of the second month following the date on which the Convention enters into force, and, as respects other taxes, to taxable years beginning on or after January 1 of the year following the date on which the Convention enters into force.

ARTICLE 32. Termination

Paragraph (1) provides that the Convention will continue in force indefinitely, but that it may be terminated by either Contracting State at any time after five years from the date it enters into force. A Contracting State seeking to terminate the Convention must give at least six months’ notice through diplomatic channels. If the Convention is terminated, such termination will be effective with respect to income of calendar years or taxable years beginning (or in the case of taxes payable at source, payments made) on or after April 1 next following the expiration of the six month period. It is intended that the reference to calendar years applies only to cases where the taxable year is the calendar year.

Under paragraph (2), the provisions of Article 21 (Social Security Payments) may be terminated by either Contracting State at any time after the Convention enters into force by prior notice given through diplomatic channels.