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Authorisation Number: 1011960191236

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Ruling

Subject: Rental property in overseas country

Question 1

Do you need to include your share of the income from your overseas rental property as assessable income in your Australian tax return?

Answer

Yes.

Question 2

Do you deduct your share of the interest charged on the funds borrowed in Australia to purchase the overseas rental property, in your Australian tax return?

Answer

Yes.

Question 3

Do you transfer profits or losses from the overseas rental property from your tax return in the overseas country to your Australian tax return?

Answer

No.

Question 4

Do you need to reconcile the different end of tax year dates?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You are an Australian citizen, and are a resident of Australia for taxation purposes.

You and your spouse purchased a rental property overseas.

You and your spouse are co-owners of the overseas rental property, each of you having an equal share of ownership of the property.

Funds were borrowed to purchase the overseas rental property. You and your spouse borrowed part of the funds in Australia, and the balance in the overseas country.

The funds borrowed in the overseas country were borrowed from a financial institution of that country.

You have not withheld non-resident withholding tax from the interest you have paid to the financial institution in the overseas country.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 Section 8-1

Further issues for you to consider

We have limited our ruling to the questions raised in your application. There may be related issues that you should consider including the deductibility of interest incurred on funds borrowed from the financial institution overseas (a non-resident lender).

Please refer to the additional information in your reasons for decision for general information on the deductibility of interest expenses incurred on funds borrowed from a non-resident lender.

You may apply for another ruling on this or any other matter.

Does Part IVA apply to this ruling?

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.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

Question 1 - Assessable income

Summary

As you are a resident of Australia your share of the income from your overseas rental property forms part of your assessable income in Australia.

Detailed reasoning

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes the ordinary income derived from all sources, whether in or out of Australia, during the income year.

As you are a resident of Australia your share of the income from your overseas rental property forms part of your assessable income in Australia, under subsection 6-5 (2).

However, 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 (DTA).

Australia has signed a DTA with the overseas country where your rental property is situated.

A specific Article of the DTA deals with income from real property, including income derived from the letting of real property. It provides that the taxation authorities of the overseas country may tax any rental income that is derived by a resident of Australia from a rental property situated in the overseas country. The DTA does not exclude the rental income from also being subject to tax in Australia. The rental income from property in the overseas country may therefore be taxed in both the overseas country and Australia.

An Article of the DTA deals with the elimination of double taxation. It provides that, subject to the provisions of the laws of Australia, tax paid in the overseas country under the laws of that country in respect of income derived by a resident of Australia will be allowed as a credit against Australian tax payable on that income.

Your share of the income from your overseas rental property forms part of your assessable income in Australia, under subsection 6-5(2) of the ITAA 1997. You should note that co-owners of rental property must divide the income and expenses for the rental property in line with their legal interest in the property, regardless of any agreement between co-owners stating otherwise. In your case, you share the rental income equally with your spouse.

If tax is paid in the overseas country in relation to the income from the overseas rental property, a credit for the foreign tax paid (which is now called a foreign income tax offset) may be allowed in Australia against the Australian tax payable on that income.

For information on claiming a foreign income tax offset, please refer to the our publication Guide to foreign income tax offset rules 2010-11, which is available on our website at www.ato.gov.au

Question 2 - Deductibility of interest on funds borrowed in Australia

Summary

Your share of the income from your overseas rental property is assessable income in Australia, so you can claim a deduction in your Australian tax return for your share of the interest on the funds borrowed in Australia to purchase the property.

Detailed reasoning

Section 8-1 of the ITAA 1997 deals with general deductions, including the deductibility of interest. It states that a loss or outgoing can be deducted from assessable income to the extent to which it is incurred in gaining or producing assessable income. However, section 8-1 states that a loss or outgoing cannot be deducted to the extent that it is of a capital, or of a private or domestic nature.

Interest on borrowed moneys may be deductible where the moneys are used to acquire an income producing asset, such as a rental property. On the other hand, a repayment of the money borrowed (that is, a repayment of the principal amount borrowed) is not deductible under section

8-1 because it is capital in nature.

As your share of the income from your overseas rental property is assessable income in Australia, you can claim expenses that are allowable deductions under Australian income tax law against the rental income from overseas, in your Australian tax return. As stated above, co-owners of rental property must divide the income and expenses for the rental property in line with their legal interest in the property.

You can therefore claim a deduction under section 8-1 of the ITAA 1997 in your Australian tax return, for your share of the interest charged on the funds borrowed in Australia to purchase the overseas rental property.

Question 3 - Rental property profits or losses from your tax return in the overseas country

Summary

As Australia and the overseas country in which your rental property is situated have different tax laws, there may be differences in the net profit or net loss from the rental property for taxation purposes in the overseas country, and the net profit or net loss from the property for Australian taxation purposes. Therefore, you should not transfer profits or losses from the overseas rental property from your tax return in the overseas country to your Australian tax return.

Detailed reasoning

You have asked whether you transfer profits or losses from the overseas rental property, from your tax return in the overseas country to your Australian tax return.

As Australia and the overseas country have different tax laws, there may be differences in the net profit or net loss from the rental property for taxation purposes in the overseas country and the net profit or net loss from the property for Australian taxation purposes. For example, rental expenses which may be an allowable deduction in the overseas country may not be allowable as a deduction under Australian tax law.

Therefore, you should not transfer profits or losses from the overseas rental property, from your tax return in the overseas country to your Australian tax return.

For Australian tax purposes, you will need to declare your share of the gross rent from the overseas rental property in your Australian tax return. You will need to determine your rental expenses that are allowable deductions for Australian tax purposes and then show these deductions separately in your Australian tax return.

Please find enclosed our publications Rental properties 2011 and Guide to depreciating assets 2011, to help you determine your expenses in relation to the overseas rental property that are allowable deductions for Australian tax purposes.

Question 4 - Reconciling different end of tax year dates

Summary

You are required to disclose in your Australian tax return the amount of foreign income derived during the Australian tax year. You must apportion the foreign tax relating to that foreign income on the same basis as that used for dissecting the income between the various years concerned.

Detailed reasoning

The Australian tax year is from 1 July to 30 June, and the tax year of the overseas country in which your rental property is situated is from 1 April to 31 March.

Taxation Ruling IT 2498 addresses the issue of the foreign income and expenses to be returned for an Australian year of income where foreign accounts and/or tax apply on a different basis. The Ruling provides detailed guidelines as to the acceptable methods of declaring foreign income in Australian tax returns. It addresses the particular problems encountered with foreign tax years being on a different basis to that of the Australian tax year ended 30 June.

IT 2498 states that the general rule is that an individual taxpayer will be required to disclose in his or her Australian tax return the amount of foreign income derived during the Australian tax year. For example, where a foreign country's tax assessment is raised on a calendar year basis, the foreign income to be included in the return of income for the Australian 2010-11 year of income would be ascertained by analysing the income of the foreign years of income ended 31 December 2010 and 31 December 2011 and calculating the foreign income which was derived by the taxpayer between 1 July 2010 and 30 June 2011. The foreign income derived during the period 1 July 2010 to 30 June 2011 would be translated into Australian dollars at the relevant exchange rate.

Taxation Ruling IT 2527 contains procedures in relation to claims for foreign tax paid. It states that taxpayers who are required by IT 2498 to make a dissection of their foreign income derived during a foreign tax year between two Australian tax years must apportion the foreign tax relating to that foreign income on the same basis as that used for dissecting the income between the various years concerned. The Ruling states:

The net amounts on which tax is assessed (or levied) for Australian and foreign tax purposes will not always be the same. For instance, certain deductions may be allowable under the Assessment Act which are not deductible under the income tax law of the country of source. The reverse may also be the case. Irrespective of whether this situation occurs, the foreign tax credit to be allowed is to be the actual amount of foreign tax paid in respect of the foreign income included in the taxpayer's assessable income for the year of income.

Additional information

You have not requested advice in relation to the deductibility of interest incurred on the funds borrowed in the overseas country, so a private ruling has not been made on this issue.

However, you should be aware that there are special rules that apply to the deductibility of interest expenses incurred on funds borrowed from a non-resident lender. The following paragraphs contain general information in relation to these rules.

Non-resident withholding tax

Withholding tax is payable on interest derived by a non-resident unless an exemption applies, under subsection 128B(2) of the Income Tax Assessment Act 1936.

Where interest is paid by a resident to a non-resident, withholding tax applies except where the interest is wholly incurred by the resident as an expense of carrying on a business overseas at or through a permanent establishment.

· Under section 12-245 of Schedule 1 of the Taxation Administration Act 1953, payers of interest are required to withhold tax if:

· the recipient has an address outside Australia, or

· the payer is authorised to pay the interest at a place outside Australia.

Payers are required to withhold tax from interest paid to non-residents, and remit the withheld amounts to the Tax Office. A payer must be registered for withholding before they withhold tax from interest paid to non-residents.

The rate of withholding tax on interest paid to non-residents is generally 10%.

For more information on withholding tax from interest paid to a non-resident, refer to our fact sheet: PAYG withholding from interest, dividends and royalties to non-residents, which is available on our website at www.ato.gov.au

Deductibility of interest paid to a non-resident lender

A deduction for interest incurred on funds borrowed from a non-resident lender would generally be allowable where the funds are used for an income producing purpose.

However, under section 26-25 of the ITAA 1997, a deduction is not allowed for the interest paid to a non-resident if the withholding tax requirements have not been met.