Edited version of private ruling

Authorisation Number 90030

This ruling is a private ruling for the purposes of Division 359 of Schedule 1 of the

Taxation Administration Act 1953.

What this ruling is about:

1. Should the net rental income from a property situated in a foreign country be included in your Australian income tax returns?

2. Can foreign rental losses incurred in past years be applied against current or future rental income?

3. Where the rental property is owned by one person only, can the net profits and losses be shared with any other person?

4. Does retaining the net rental income in a foreign country mean that the rental income is exempt from income tax in Australia?

5. Are taxes paid in the foreign country on the rental income allowed as a credit against any Australian tax assessed?

Ruling:

1. Should the net rental income from a property situated in a foreign country be included in your Australian income tax returns?

Yes.

2. Can foreign rental losses incurred in past years be applied against current or future rental income?

Yes.

3. Where the rental property is owned by one person only, can the net profits and losses be shared with any other person?

No.

4. Does retaining the net rental income in a foreign country mean that the rental income is exempt from income tax in Australia?

No.

5. Are taxes paid in the foreign country on the rental income allowed as a credit against any Australian tax assessed?

Yes.

Year(s) of income or period(s) to which this ruling applies:

Year ended 30 June 2007

Year ended 30 June 2008

Commencement date of scheme:

1 January 2001

The scheme that is the subject of the ruling:

You acquired a house whilst working overseas. The property was purchased in your name only was because the mortgagor required each purchaser, as a condition of the loan, to take out an insurance policy indemnifying the full value of the loan and the cost of one policy was saved if there was only one owner.

You and your spouse subsequently returned to Australia. You have been a resident of Australia for taxation purposes since your return to Australia.

An attempt was made to sell the property before you returned to Australia but the value had fallen and being unable to finance the loss, it was decided to rent the property to tenants.

You have indicated that losses were incurred in each of the 2001, 2002, 2003 and 2004 calendar years as the rental income only covered the loan repayments and all other costs incurred had to be met from other sources.

In 2005 some money was received from a third party that enabled you to pay off the mortgage and cease paying the insurance policy that was required by the mortgagor.

As a result of the fall in outgoings, you have indicated that the property has generated a rental profit in the 2005 calendar year and each subsequent calendar year.

Relevant provisions:

Income Tax Assessment Act 1936 Subsection 79D(1).

Income Tax Assessment Act 1936 Subsection 160AFD(9).

Income Tax Assessment Act 1997 Subsection 6-5(2).

Income Tax Assessment Act 1997 Section 820-40.

International Tax Agreements Act 1953 Section 4.

International Tax Agreements Act 1953 Subsection Sch1-Art6(1).

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

Explanation: (This does not form part of the notice of private ruling)

1. Should the net rental income from a property situated in a foreign country be included in your Australian income tax returns?

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year. This means that a resident taxpayer should include their worldwide income in their Australian income tax return.

You returned to Australia from overseas several years ago and you are considered to be a resident of Australia from that time and the foreign rental income from your property will thus form part of your assessable income under section 6-5 of the ITAA 1997.

2. Can foreign rental losses incurred in past years be applied against current or future rental income?

Subsection 79D(1) of the Income Tax Assessment Act 1936 (ITAA 1936) provides that where the foreign income deductions exceed the assessable foreign income of the same class, the foreign income deduction is limited to the amount of assessable foreign income.

There are four classes of foreign income:

- Interest income
- Modified passive income (including royalties, dividends and rent);
- Offshore banking income; and
- Other income.

Prior to 1 July 2001, the net amount of each class of income was determined by subtracting deductions applicable to that class of income. If a loss was made, any excess of deductions over income would be quarantined and could only be offset against future foreign sourced income of the same class. For example, if a loss was made on a foreign rental property, the loss could not be offset against other income, but would need to be carried forward to future years and claimed against foreign rental income in future years.

As a result of the New Business Tax System (Thin Capitalisation) Act No 162 of 2001, the definition of 'foreign income deduction' found in subsection 160AFD(9) of the ITAA 1936 has been amended. The definition now excludes 'debt deductions' to the extent they are not attributable to any overseas permanent establishments of the taxpayer.

'Debt deductions' are defined in section 820-40 of the ITAA 1997 and are deductible costs incurred, in years commencing on or after 1 July 2001 in obtaining and maintaining debt finance. Examples include interest, amounts in substitution for interest, loan establishment fees and draw down fees.

The above changes mean that, for years commencing on or after 1 July 2001, where a person's debt deductions which are incurred in deriving assessable income (but are not attributable to an overseas permanent establishment) exceed their foreign income, the excess can be used to offset domestic income or create a loss.

Therefore, you would deduct your management fees and other rental expenses not associated with your loan from your foreign rental income to calculate your net foreign income. These expenses cannot exceed your rental income. However your interest, loan establishment fees and draw down fees associated with your overseas property can exceed your foreign income and are able to be offset against your Australian income.

3.  Where the rental property is owned by one person only, can the net profits and losses be shared with any other person?

Taxation Ruling TR 93/32 explains the topic of the division of net income or loss between co-owners of rental property. The ruling explains that the loss or income from a rental property must be shared according to the legal interest of the owners, except in those very limited circumstances where there is sufficient evidence to establish that the equitable (or beneficial) interest is different from the legal title. It goes on to explain that where taxpayers are related, that the equitable right is presumed to be exactly the same as the legal title.

A person's legal interest in a property is determined by the legal title to that property under the relevant land law legislation applicable to the situation of the property. The legal owner of the property is recorded on the title deeds for the property issued under that legislation.

It has been said that if the equitable interest does not follow the legal title, there is some basis for the profit or loss to be distributed on the basis of the equitable ownership and not the legal title. Cases where the title includes the name of a person who is a nominee or trustee must be decided on an individual basis on the evidence available to establish that fact. Authority can be found in Napier v Public Trustee (Western Australia) 32 ALR 153 where the court accepted that there was sufficient evidence to establish that the equitable interest was different to the legal title.

In your situation, however, there is no evidence available that suggests that the property was acquired in your name for any reason other than the fact that it was commercially expedient. We consider that there are extremely limited circumstances where the legal and equitable interests are not the same and that sufficient evidence exists to establish that the equitable interest is different to the legal title. We will assume where taxpayers are related, such as a husband and wife, that the equitable interest in a property is exactly the same as the legal title.

4. Does retaining the net rental income in a foreign country mean that the rental income is exempt from income tax in Australia?

As explained above, Australian resident taxpayers are liable for income tax on their worldwide income. As a result it makes no difference which country the funds are held in as the liability to income tax is determined by the act of deriving the income rather than the location of the place where the funds are sourced and held.

5. Are taxes paid in the foreign country on the rental income allowed as a credit against any Australian tax assessed?

In determining liability to Australian tax on foreign sourced income it is necessary to consider not only the income tax laws but also any applicable double tax agreement contained in the International Tax Agreements Act 1953 (the Agreements Act).

Section 4 of the Agreements Act incorporates that Act with the Income Tax Assessment Act 1936 (ITAA 1936) and ITAA 1997 so that those Acts are read as one. The Agreements Act effectively overrides the ITAA 1936 and ITAA 1997 where there are inconsistent provisions (except for some limited provisions).

Schedule 1 to the Agreements Act contains the tax treaty between Australia and the United Kingdom (UK Convention) and operates to avoid double taxation of income received by Australian and United Kingdom residents.

Article 6(1) of the UK Convention provides that income derived by a resident of Australia from real property situated in the United Kingdom may be taxed by the United Kingdom and also by Australia. However, a foreign tax credit will be allowed in Australia for any income tax paid in the United Kingdom by an Australian resident in relation to such rental income.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).