Issue
Is rental income received by a taxpayer who is a dual resident of Australia and the United States (US) from real property situated in the US included in the taxpayer's assessable income under subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?
Decision
No. Rental income received by a taxpayer who is a dual resident of Australia and the US from real property situated in the US is not included in the taxpayer's assessable income under subsection 6-5(2) of the ITAA 1997.
Facts
The taxpayer is a citizen of the US.
The taxpayer is a resident of Australia for taxation purposes.
The taxpayer is a resident of the US for taxation purposes.
The taxpayer maintains residences in Australia and the US which are available to the taxpayer at all times continuously.
The taxpayer spends time in Australia and the US during the year.
The taxpayer's personal and economic ties are predominantly in the US.
The taxpayer receives rental income from real property situated in the US.
Reasons for Decision
Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.
Rental income is ordinary income for the purposes of subsection 6-5(2) of the ITAA 1997.
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 (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.
Schedule 2 to the Agreements Act contains the double tax convention between Australia and the US (the US Convention). Schedule 2A to the Agreements Act contains the United States Protocol (the US Protocol). The US Convention and the US Protocol operate to avoid the double taxation of income received by Australian and US residents.
The US Protocol entered into force in Australia on 13 May 2003 and has effect in respect of income tax other than withholding taxes for any year of income beginning on or after 1 July 2004. For withholding taxes on dividends, interest and royalties, it has effect from 1 July 2003.
As the taxpayer is a dual resident of Australia and of the US, it is necessary to consider the tie breaker rules in the US Convention.
Article 4(2) of the US Convention sets out the tiebreaker rules for residency for individuals. The tiebreaker rules ensure that the individual is only treated as a resident of one country for the purposes of working out liability to tax on their income under the US Convention. The tiebreaker rules do not change a taxpayer's residency status for domestic law purposes.
Article 4(2) of the US Convention provides that if an individual is a resident of both Australia and US, they shall be deemed to be a resident of the State: (a) in which they maintain a permanent home (b) if the provisions of (a) do not apply, in which they have an habitual abode, or (c) if the provisions of (a) and (b) do not apply, with which their personal and economic relations are closer.
Article 4(2) of the US Convention further provides that in determining an individual's permanent home, regard shall be given to the place where the individual dwells with their family, and in determining the country with which an individual's personal and economic relations are closer, regard shall be given to their citizenship (if the individual is a citizen of one of the countries).
The terms 'permanent home', 'habitual abode' and 'personal and economic relations' are otherwise undefined in the US Convention. Article 3(2) of the US Convention provides that any term not defined shall, unless the context otherwise requires, have the meaning which it has under the law relating to taxes of the country applying the US Convention.
Taxation Ruling TR 2001/13 discusses the Commissioner's views about interpreting double tax agreements. Paragraph 104 of TR 2001/13 provides that the OECD Model Tax Convention and Commentary will often need to be considered in interpreting double tax agreements.
The OECD Commentary provides that in relation to a 'permanent home': (a) for a home to be permanent, an individual must have arranged and retained it for his or her permanent use as opposed to staying at a particular place under such conditions that it is evident that the stay is intended to be of short duration. The dwelling has to be available at all times continuously and not occasionally for the purposes of a stay, which owing to the reasons for it is necessarily of short duration (eg travel for pleasure, business travel, attending a course etc) (b) any form of home may be taken into account, including a house or apartment belonging to or rented by the individual and a rented furnished room.
As the taxpayer maintains residences in both countries which are available at all times continuously for the taxpayer's permanent use, the taxpayer has a permanent home in Australia and in the US.
In relation to a habitual abode, the OECD Commentary provides that all stays in each country, regardless of the purpose for the stays, must be considered in order to assign a preference to a particular country. Further, the comparison must be made over a sufficient length of time for it to be possible to determine whether the residence in each country is habitual and to also determine the intervals at which the stays take place.
This is not simply a test of where a person stays more frequently but also looks to whether living in a particular country is normal or customary having regard to the taxpayer's circumstances.
As the taxpayer and the taxpayer's family spend time at their homes in Australia and the US as part of their usual pattern of activity, the taxpayer has a habitual abode in both countries.
In relation to a taxpayer's personal and economic relations, the OECD Commentary provides that regard should be had to factors such as family and social relations, occupation, political, cultural or other activities and place of business.
The taxpayer has personal and economic ties with Australia and the US. Coupled with the fact that the taxpayer is a US citizen, it is considered that the taxpayer's personal and economic ties are closer with the US than with Australia.
Accordingly, the taxpayer will be treated as a resident of the US for the purposes of applying the provisions of the US Convention.
Article 6(1) of the US Convention provides that income from real property may be taxed by the country in which such real property is situated.
While Article 6(1) of the US Convention allocates a non-exclusive taxation right to the US based on the location of the real property (that is, its source), it does not expressly address Australia's taxation rights.
Paragraph 23 of Taxation Ruling 2001/13 provides guidance on the interpretation of the phrase 'may be taxed' in an article of a DTA:
What the phrase 'may be taxed' normally means is that the country mentioned (the source country) has a non-exclusive entitlement to tax the income. Under normal international tax principles, the other (residence) country may also continue to tax its residents (where its domestic law so provides) on the income, wherever sourced, unless the DTA explicitly prevents it from doing so.
This supports the view that Article 6(1) of the US Convention provides the residence country with a taxing right. Accordingly, where both the country of source and country of residence for treaty purposes are the same, the other Contracting State is prevented from taxing the income because it has not been allocated a taxing right.
Accordingly, Article 6(1) prevents Australia from taxing rental income derived from real property situated in the US by a taxpayer who is treated solely as a resident of the US under the tie-breaker rules in Article 4(2) of the US Convention.
Therefore, the US sourced rental income received by the taxpayer does not form part of the taxpayer's assessable income under subsection 6-5(2) of the ITAA 1997.