Assessability of rental income received by Australian resident from the United Kingdom

Is the rental income received by an Australian resident from real property located in the United Kingdom (UK) assessable under subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes. The rental income received by an Australian resident from real property located in the UK is assessable under subsection 6-5(2) of the ITAA 1997.

The taxpayer will be a resident of Australia for the 2004-05 income year.

The taxpayer owns real property located in the UK.

The taxpayer will receive rental income from that property in the 2004-05 income year.

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer 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 the ITAA 1997 so that those Acts are read as one.

Schedule 1 to the Agreements Act contains the double tax agreement between Australia and the United Kingdom of Great Britain and Northern Ireland and the Notes to the agreement (the 2003 UK Convention). The 2003 UK Convention operates to avoid double taxation of income received by Australian and UK residents. In the case of Australia, the 2003 UK Convention has effect in relation to income or gains of any year of income beginning on or after 1 July 2004.

Article 6(1) of the 2003 UK Convention provides that income derived by a resident of Australia from real property may be taxed by the country in which the real property is situated.

Paragraph 23 of Taxation Ruling TR 2001/13 states that the phrase 'may be taxed' normally means the source country has a non-exclusive entitlement to tax the income. However, the country of residence of the taxpayer may also tax the income subject to the laws of that country, unless the double tax agreement explicitly prevents it.

As the taxpayer is a resident of Australia who owns real property situated in the UK, the rental income derived by the taxpayer may be taxed in Australia and the UK.

Article 22(1)(a) of the 2003 UK Convention provides that a credit against Australian tax payable shall be allowed for UK tax paid (in accordance with the law of Australia) where tax has been paid under UK law and in accordance with the 2003 UK Convention.

Subsection 160AF(1) of the ITAA 1936 provides that where the assessable income of a resident contains foreign sourced income and foreign tax has been paid on that income, a foreign tax credit will be allowed. The foreign tax credit allowed against Australian income tax is the lesser of: • the amount of that foreign tax paid, reduced in accordance with any relief available to the taxpayer unde the law relating to that tax, or • the amount of Australian tax payable in respect of the foreign income.

As the taxpayer is an Australian resident, the rental income received from the UK forms part of their assessable income under subsection 6-5(2) of the ITAA 1997. Where UK tax is paid in relation to the rental income, a foreign tax credit will be allowed. Note 1: If the UK tax is less than the Australian tax that will be payable, the taxpayer will be entitled to a full credit for the UK tax paid. Where the UK tax paid is greater than the Australian tax payable, the taxpayer will only be entitled to a credit equal to the value of the Australian tax payable and cannot recover any excess UK tax paid. However, under section 160AFE of the ITAA 1936, any excess foreign tax credit can be carried for a maximum of five years for application against any future tax payable on your foreign income of the same class. Note 2: The limitation on deductions for foreign income under section 79D of the ITAA 1936 needs to be considered if there is an overall loss from the rental property. The operation of section 79D of the ITAA 1936 has been amended with effect from 1 July 2001. Expenditure incurred on or after 1 July 2001 which qualifies as a 'debt deduction' within the meaning of section 820-40 of the ITAA 1997 and which is not attributable to an overseas permanent establishment of the taxpayer is no longer quarantined. A 'debt deduction' is, broadly, a deductible expense incurred in servicing and maintaining debt finance and includes interest and other related expenses (see ATO ID 2002/764).