Almost everyone dreams of one day owning their own holiday home, which they can use switch off and relax. For those dreamers with aspirations, it usually materializes through hard work and dedication.
In practice, we often have client who are US residents with real properties situated in Australia or Australian residents with real properties situated in the US. The purpose of investing in foreign real property will not always be the same.
However, in terms of Article 6 of the US/Australia DTA (Income from Real Property) the tax treatment will be the same. Article 6 is in reality a sourcing provision, which means that the country where the real property is situated, will have the primary taxing rights. This aligns with both Australia and US domestic law, where income from real property is treated as being sourced where the real property is located.
In this week’s blog we will be looking at the tax implications in the context of Article 6 of the US/Australia DTA when earning income from real property situated in the other jurisdiction.
INTERPRETING ARTICLE 6 OF THE DTA – INCOME FROM REAL PROPERTY
Article 6 of the DTA states the following:
Income from Real Property
(1) Income from real property may be taxed by the Contracting State in which such real property is situated.
(2) For the purposes of this Convention:
(i) a leasehold interest in land, whether or not improved, shall be regarded as real property situated where the land to which the interest relates is situated; and
(ii) rights to exploit or to explore for natural resources shall be regarded as real property situated where the natural resources are situated or sought.
The US and Australia taxes their residents on a worldwide basis and hence the reason why Article 6 is heavily relied upon by US and Australian residents with foreign rental properties.
In the context of Article 6, it is important to understand what constitutes real property, also referred to as immovable property, in other treaties.
The definition of real property is determined under the law of the country in which the property in question is located. Regardless of source country law, however, the concept of real property includes the following elements:
- Property accessory to real property (immovable property);
- Livestock and equipment used in agriculture and forestry;
- Rights to which the provisions of general law respecting landed property apply;
- Usufruct of real property (immovable property); and
- Rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources, and other natural resources.
Ships and aircraft, however, are not regarded as real property (immovable property).
When relying on a specific provision in a DTA to determine the allocation of the taxing rights between the two countries, one of the most important distinctions to understand is the following –
- ‘income that may be taxed by a contracting state’ and;
- ‘income shall only be taxable by a contracting state’.
Article 6(1) uses the wording may be taxed and therefore does not confer an exclusive right of taxation on the State where the property is located. It simply provides that the situs State (the country where the property is situated) has the primary right to tax such income, regardless of whether the income is derived through a permanent establishment in that State or not. The country where the income producing real property is situated, is obliged to allow a resident of the other country to elect to compute that income on a net basis as if the income were business profits attributable to a permanent establishment in the source country. This is permitted in terms of IRC §871(d) and §882(d) as well in the absence of any treaty provision.
Article 6(2) incorporates the rule that a leasehold interest in land and rights to exploit or explore for natural resources constitute real property situated where the land or resources, respectively, are situated. Except for those cases, the definition of real property is governed by the internal law of the country where the property is situated.
Even though Article 6 is quite straight forward, there are various other domestic nuances to take into account when calculating your foreign rental income for either US or Australian tax purposes.