Article X of the Protocol makes two amendments to Article 15 (Capital Gains) of the

Convention, which provides that gain derived by a resident of a Contracting State from the sale, exchange or other disposition of a capital asset shall be exempt from tax in the other Contracting State, except in certain enumerated cases.

Paragraph 1 of Article X of the Protocol amends subparagraph (a) of paragraph (1) of Article 15 of the Convention which cross refers to Article 7 (Income from Real Property) in order to better describe the rights of the situs state to tax gain attributable to real property under that Article. The amendment is necessary in light of the clarifying changes to Article 7 made by Article VI of the protocol.

Paragraph 2 of Article X of the protocol amends subparagraph (e) of paragraph (1) of Article 15 of the Convention in order to modify the cases in which Israel may tax gain derived by a U.S. resident from the sale, exchange or other disposition of shares in an Israeli corporation. Although the subparagraph is worded reciprocally, it does not provide any additional taxing rights to the United States. Under the Code the only gain (other than gain that is effectively connected with a U.S. trade or business) from the disposition of shares in a U.S. corporation by a nonresident alien or foreign corporation that the United States taxes is gain from the disposition of shares in a United States Real property Holding Corporation, and that taxing right is granted

by Article 7 of the Convention.

Under subparagraph (e) of paragraph (1) of Article 15 of the Convention as amended by the protocol, Israel may tax a U.S. resident on gain from the disposition of shares in an Israeli corporation provided the U.S. resident owned, either directly or indirectly, at any time during the 12-month period prior to the sale, shares possessing at least 10 percent of the voting power of the corporation. This gain is treated as foreign source income for purposes of determining the limitation on the U.S. foreign tax credit under Article 4 (Source of Income) as amended by Article II of the Protocol and Article 26 (Relief From Double taxation) as amended by Article XIII of the protocol. Prior to amendment by the protocol, the required ownership threshold was higher (more than 50 percent of the corporation's voting power during the 12-month period prior to the sale) and there also was a requirement that a substantial portion of the corporation's assets was used to carry on business in Israel for the three taxable years prior to the disposition.

Paragraph 3 of Article X of the protocol adds a new paragraph (2) to Article 15 which limits the gain that Israel may tax under subparagraph (e) of paragraph (1) to the amount of boot received in an otherwise tax-free reorganization of a U.S. affiliated group. In order for the provision to apply three conditions must be satisfied. First, the transferor and the transferee must be resident in the same Contracting State (the United States). Second, the transferor and the transferee must own directly or indirectly 80 percent or more of the voting rights and value of the other, or a company resident in the same Contracting State as the transferor and the transferee must own directly, or indirectly through companies resident in the same Contracting State, 80 percent or more of the vote and value of the transferor and transferee. (This condition would be satisfied by a U.S. affiliated group.) Finally, the transferee's basis, for purposes of determining gain or loss in the State in which it is resident, must be determined, in whole or in part, by reference to the transferor's basis (i.e., the transaction must be a tax-free reorganization under Section 368 of the Code so that the transferee's basis is determined under section 362(b) of the Code.

If these three conditions are satisfied then the gain that Israel may tax under subparagraph (e) is limited to the amount of cash or other property received by the transferor, which is the Same as the amount of gain that would be recognized under section 356(a) of the Code and taxed by the United States. In the event a larger amount of gain may be taxed in the transferor's State of residence, then the other Contracting State may tax the gain in accordance with its domestic law (applied consistently with the Convention). However, if the carryover-basis rule of section 362(b) of the Code applies to a transaction then the Limitation of section 356(a) of the Code must also apply, so that this is not a possibility under U.S. law at this time.