If you arbitrarily define parts of the territory you control as not part of your territory, and its population as not your citizens (even though they are entirely subject to your jurisdiction), then you only get partial credit for being a “democracy”, at best.

If Israel were really committed to democratic ideals, they would either make all Palestinians equal citizens of the state (currently Israel, which would presumably be renamed “Palestine” the next day), or, more realistically, they would allow the Palestinian Territories to become an independent state, rather than keeping them permanently occupied and subject to Israeli military law.