JERUSALEM, July 4 (Reuters) - Israel's Jerusalem municipality approved a plan on Monday to build hundreds of new homes for Jews on annexed land in the occupied West Bank, a council member said.

Elisha Peleg told Reuters that the city planning commission had approved building plans for 900 new units in Gilo, an urban settlement built on land Israel captured in a 1967 war and unilaterally annexed to Jerusalem.

About 500,000 Israelis live in the West Bank and East Jerusalem, among 2.7 million Palestinians. The World Court has ruled Israeli settlements in occupied territory illegal.

Palestinians say the enclaves could deny them a viable state.

I see no difference between Gilo and any other neighborhood in Jerusalem. There is no planning or political problem with this and Jews have the right to build anywhere in the city, said Peleg, a member of the planning commission.

The proposals still need approval from the Interior Ministry and construction is not likely to start for a year or two, Peleg said.

The Palestinians want a capital at Jerusalem for the state they hope to establish in the West Bank and Gaza Strip.

They say Israeli settlement building around the city, such as at Gilo, home to 40,000 Israelis between Arab East Jerusalem and the West Bank city of Bethlehem, will cripple the viability of any state they set up.

Nabil Abu Rdainah, a spokesman for Palestinian President Mahmoud Abbas, said the approval shatters any attempt to lay down foundations that can lead to a real peace.

In 2009, U.S. President Barack Obama said the building project, then at an early planning stage, would harm prospects for peace. A U.S. attempt last year to broker a restart in peace talks between Israel and the Palestinians stalled almost as soon as it had begun.

(Writing by Maayan Lubell; additional reporting by Ali Sawafta in Ramallah; Editing by Kevin Liffey)