Article VIII of the Protocol amends Article 13 (Interest) of the Convention. Paragraph 1

of Article VIII adds a new subparagraph (b) to paragraph (2) of Article 13, designating paragraph (2), as it appeared in the Convention, as subparagraph (a) of paragraph (2). Subparagraph (b) provides an alternative rule for the taxation of interest at source. Subparagraph (a) provides for withholding at source at either a 17.5 or 10 percent rate, the latter applying to interest on loans made by financial institutions. The gross-basis withholding tax of subparagraph (a) will not apply if, under subparagraph (b), the interest recipient elects to be taxed by the source State on its net interest income, under-the rules of Article S (Business Profits), as though the interest income were industrial and commercial profits, attributable to a permanent establishment in the source State. The paragraph further provides for the adoption by each competent authority of rules far determining and reporting taxable income under this provision. Each competent authority also may adopt procedures requiring the provision by the taxpayer of adequate books and records for determining the proper amount of net income. The U.S. competent authority will provide rules for the apportionment of expenses, as would be required under Article 8, in determining net income for purposes of U.S. source basis tax.

Paragraph 2 of Article VIII of the Protocol adds a new paragraph (8) to Article 13 (Interest). Paragraph (8) provides that the reductions in tax at source for interest provided for in paragraph (2), and the exemption at source provided for in paragraph (3), do not apply to an excess inclusion with respect to a residual interest in a U.S. real estate mortgage investment conduit (REMIC). This class of income, therefore, will remain subject to the statutory 30-percent U.S. rate of tax at source under paragraph 1. This provision is consistent with the policy of sections 860E(e) and 860G(b) that excess inclusions with respect to a real estate mortgage investment conduit (REMIC) should bear full U.S. tax in all cases. Without a full tax at source foreign purchasers of residual interests would have a competitive advantage over U.S. purchasers when these interests are initially offered for sale. Also, absent this rule the U.S. FISC would suffer a revenue loss with respect to mortgages held in a REMIC because of opportunities for tax avoidance created by differences in the timing of taxable and economic income produced by these interests.

Paragraph 10 of the Exchange of Notes relates to paragraph (8) of Article 13 (Interest). It reflects the understanding that paragraph (8) was added at the request of the United States to address a problem of domestic tax avoidance arising under U.S. internal law, and notes that the United States intends to include similar provisions in all of its future treaties. The Exchange of Notes also acknowledges that the United States possibly could revise its internal laws in the future to address this problem in a manner other than by imposing tax on the recipient of the excess inclusion so that an excess inclusion under the revised laws would be treated as ordinary interest income in the hands of nonresident recipients and would be eligible for the exemptions from tax applicable to interest income under the lads of the United States. In that case such exemption would, notwithstanding paragraph (8), apply to an Israeli recipient of an excess inclusion. It is further noted that if the United States fails to include a provision similar to paragraph (8) of Article 13 in any tax treaty signed subsequent to the entry into force of this Convention, without having revised its internal laws in the manner suggested in the preceding sentence, such a change in U.S. treaty policy would make it appropriate to amend the Convention on this matter, pursuant to paragraph (8) of Article 6 of the Convention.