Blue Skies, Golden Sand, Foreign Taxes
Sandra Chambers Tax Manager, PCS (Private Client Services), KPMG Dublin Gillian Earley Tax Senior, PCS (Private Client Services), KPMG Dublin
With airlines adding more destinations every year, and travelling costs, if not travelling times, reducing all the time, many Irish people have chosen to invest in a property abroad. Typically they intend to use it themselves for a couple of months each year, and perhaps rent it out for the remainder. Alternatively, especially as individuals get older, the property becomes a second residence, a home away from home.
The purpose of this article is to review the tax implications of such an acquisition, in tight of the Irish treaty network and any other available reliefs.
Income Tax
If the individual intends to hold property for his or her own personal use only, then evidently income tax is not a consideration. However, if the property is rented out for part of the year, then the following points should be borne in mind:
As the person will now be possession of a Schedule D case III source income, he or she will be obliged to disclose the income on his annual tax return.
Although the wording of Section 71 (1) TCA1997 (which allows deductions from foreign income) is somewhat obscure, it is established practice that, in calculating the taxable element of foreign source income, it is permitted to deduct the same deductions that would be available if the foreign source was situate in Ireland.
Deductions available in calculating net rental income are set out in S97 (2) TCA 1997. In addition, the deductibility bank interest against foreign rental income is specifically provided by Section 71 (4) TCA 1997. However, no deduction is available in respect of any expenses incurred prior to the date the property is first let. The owner should also be able to claim capital allowances in respect of fixtures and fittings, as he or she would if the property was situate in Ireland.
The legislation does not specifically deal with the treatment of losses arising on the foreign property; in the absence of any specific relief, it is unlikely that the losses can strictly be carried forward and set against future profits of the same property. However, it is understood that it is Revenue practice to allow such relief on a concessionary basis.
Of course, having a rental income source in a foreign county may give rise to tax filing obligations in that country. The individual should seek local professional advice on this point prior to commencing letting. In addition, in some jurisdictions, the UK being a typical example, tax must be deducted by the tenant and paid directly to the revenue authorities, unless approval not to withhold is obtained.
If there is a taxable profit in the local jurisdiction, the individual will most likely be obliged to pay foreign income tax on this profit. Moreover, assuming the Irish tax profit is calculated on broadly the same lines, he or she will also be obliged to pay Irish tax on the same profit.
The OECD model treaty provides that rental income (income from immovable property) "may" be taxed in both the state where the owner is tax resident and the state in which the property is located. Where this approach is followed in Ireland's treaties, the latter state has primary taxing rights, and the Irish Revenue authorities are obliged to grant a credit in respect of taxes suffered.
However, there are several countries with which Ireland does not have a tax treaty and therefore credit relief would not be available. In this instance, Section 71 (1)(b) TCA 1997 provides that any foreign tax paid on foreign rental profit will be treated as a deduction in calculating the Irish tax liability.
Example
Tom buys a cottage in rural Transylvania. As the property is in poor decorative condition, he spends a substantial amount of money rewiring, refitting the bathrooms and kitchens and redecorating. Once this work is complete, Tom decides that, rather than commuting each weekend to Transylvania, he will rent it out for a couple of months to earn some of the investment back. He engages a local estate agent to obtain a tenant and a local lawyer drafts a lease agreement appropriate under Transylvanian law. Because Tom had not taken out a loan to acquire the property, he does not have substantial revenue expenses.
In calculating the profit subject to Irish tax, the rules that would apply if the property was a Schedule D Case V source supply. This means that relief is not available in respect of the substantial repair and maintenance costs that Tom carried out prior to the tenant taking possession of the property.
However, because Irish Revenue allows both auctioneers and lawyers fees to be deductible, even where the expenses were incurred prior to the commencement of the tenancy, these may be factored in calculating his income. He also claims capital allowances in respect of some of the expenses incurred in making the cottage habitable.
For Transylvanian purposes, a large part of the repairs are allowable, and therefore his taxable profit in Transylvania is substantially smaller than in Ireland. Unfortunately, because there is no double taxation treaty between Ireland and Transylvania, Tom is not able to use the Transylvanian income tax charge as a credit against the Irish charge, and instead it is treated as an additional expense in arriving at the Irish taxable profit.
Capital Gains Tax
S29 TCA 1997 provides that Irish resident or ordinarily resident and domiciled individuals are within the charge to Irish capital gains tax on gains arising on disposals of any worldwide assets. Moreover, most jurisdictions (with the notable exception of the UK) levy a charge to capital gains tax on the disposal of any land or buildings situate within their territory.
The typical clause in the OECD model treaty dealing with the taxation of immovable property provides that both the state in which the property is situate and the state in which the vendor is resident will have taxing rights over the gain. If there is a double tax treaty in place, and if it is applicable to Irish capital gains tax, then the foreign tax will be allowed as a credit against the Irish CGT liability.
However, in any other circumstances any tax suffered in the foreign jurisdiction is treated as an expense for the purposes of calculating the Irish capital gains tax charge, rather than as a credit (Section 828 TCA 1997).
Example
Many years ago Emma inherited a lavish chateau in Deauville, Normandy. The upkeep became prohibitive and she disposed of it at the best price in 2006. There will be a French charge to capital gains tax on the grounds that French land is being disposed of, while Ireland will levy a capital gains tax charge on the grounds that Emma is resident, ordinarily resident and domiciled within the State.
Unfortunately, although there is a double tax treaty in place between Ireland and France, it was concluded in 1966, prior to the introduction of capital gains tax in Ireland. Therefore, Emma will not be able to avail of a credit in respect of any French tax suffered. Instead, any French tax paid will be treated as a deductible expense in calculating the Irish CGT liability on the same gain.
At the time of writing, Finance Bill 2007 contains a provision allowing for unilateral credit relief in respect of capital gains tax suffered in specified countries whose treaties with Ireland predate the introduction of CGT in the State. The relief is effective from 1 January 2007 and therefore, in the example above, had Emma delayed the sale until 2007, she would not have suffered double tax on the same gain.
Capital Acquisitions Tax
Once an Irish resident individual has acquired a foreign property, then a CAT charge may arise if he or she transfers ownership of the property either by gift or via his or her will on death. Because the property is situate in a foreign state, the local revenue authorities may also have domestic taxing rights over the same gift or inheritance.
Section 107 CATCA 2003 specifically allows for unilateral credit in this situation. Therefore if an inheritance tax charge arises on the transfer of ownership in the foreign jurisdiction, it may be credited against the Irish CAT charge arising on the same transfer. The amount of the credit is the lesser of the amount of Irish tax or the amount of foreign tax. If there is a capital tax treaty in place between Ireland and the other jurisdiction, then relief is given under that treaty and not under S107.
However, the Irish CAT charge at 20% is relatively low by international standards and the charge arising in the foreign jurisdiction maybe substantially higher. It is important to investigate this issue with local professional advisers prior to acquisition, so that the acquisition can be structured in away that would minimize any subsequent gift or inheritance taxes.
Example
Edwina and Charles, who are not married, wish to buy a holiday home in Provence, France. Both are in their mid fifties, divorced and have grown up children from previous marriages. They have indicated that, should one of them pass away, that person's share of the French property should pass directly to the other. They anticipate spending an increasing portion of time in Provence, and perhaps eventually to retire there.
However, French advisers explain that, because of French forced heirship rules, Edwina and Charles will not be able to leave their respective interests in the property to each other. Instead their children from previous marriages would have the right to most of their parents' respective shares.
It is decided that the property should be bought via a French company. The French forced heirship rules would not apply to the ownership of shares. Although it is not possible to avoid an inheritance tax charge, French advisers indicate that it may be possible to avoid inheritance tax on the first death by use of particular type of clause in the agreement. For CAT purposes, however, a charge would arise on any value inherited by Edwina and Charles from each other once the applicable Group 3 threshold was utilized. Relief should be available under S107 CATCA in respect of any French tax paid. Unfortunately, as Edwina and Charles are not married, any French inheritance liability is likely to be substantially more than the Irish CAT charge.
Non-Domiciliaries
So far, we have focused on the tax treatment of a foreign asset where the owner was Irish resident, ordinarily resident and domiciled. This treatment does not apply to an Irish resident, but non-domiciled individual as he or she is able to avail of the remittance basis in respect of non-UK source income (Section 71 (1) TCA 1997} and non-UK source capital gains (Section 29 (4) TCA 1997). Therefore, unless the foreign rental income is remitted into the State by the taxpayer, the issue of the credit of foreign tax against the Irish tax charge does notarise. Similarly if the individual disposes of the property, and does not remit the sale proceeds into Ireland, then the only tax suffered will be the local foreign taxes, if any. However, the position is slightly different with regard to CAT. This is because the CAT legislation provides that an individual will be within the charge to Irish CAT once he or she is Irish resident or ordinarily resident, and has been resident in Ireland for the five consecutive years, of assessment immediately preceding the year of assessment in which the gift or inheritance takes place. This allows quite a short period of time before a non-domiciliary becomes chargeable to Irish CAT.
Example
Nadia is a non-domiciliary living in Ireland for the past fifteen years. She owns a holiday home in Spain which she uses occasionally, and an apartment in London, which is primarily used for business trips. She is widowed with one daughter, who lives in the UK.
In March 200/ Nadia disposes of the property in Spain. However, because she is not Irish domiciled, and because she arranges for the proceeds of the sale to be paid directly into her Isle of Man bank account, she does not remit the gain into Ireland and no Irish tax charge arises. She pays tax in Spain and is advised that the rate fornon residents is 18%, having been reduced from 35%. In 2012, Nadia dies unexpectedly and her daughter inherits the UK apartment.
Because she had been both tax resident in Ireland and resident for more than five consecutive tax years at the date of death, Nadia's apartment in London will fall within the charge to Irish CAT. The property is valued at over €2 million, and therefore it will also be within the charge to UK inheritance tax. As there is a capital taxes treaty in place between Ireland and the UK, this will determine which state grants credit for foreign tax paid. Article 8 will operate so that Ireland will give credit for any UK tax paid on the UK situate apartment.
Transfer and Wealth Taxes
Purchasers should also inquire as to whether they will incur any transfer taxes on the acquisition of the property similar to stamp duty in this country. They should also take advice as to whether the value of the property will subject them to wealth tax in the country in which the property is situate, regardless of the fact that they will not be resident there otherwise.
For example, in the case of Spain, non-residents are only liable to wealth tax on assets situated or deemed to be situated in Spain, but are not entitled to any deductions in arriving at that liability.
Company Shares
Rather than properties being offered for sale directly, it sometimes happens that the shares In a company, which owns the actual property, are for sale. If this happens, the buyer may need to be aware of "embedded capital gains tax". Though the shares will reflect the current value of the property, the company may have acquired the property, probably for much less, sometime previously. This means that if the company were to sell the property directly there may be a large local CGT charge arising on the difference between the original acquisition cost of the property and the sales proceeds. Although there is no way of mitigating this charge, it Is sometimes a useful negotiating point for the purchaser.
If an Irish resident individual owns an offshore company, which would be treated as a close company if it were Irish resident, then the provisions of Section 590 TCA 1997 will apply if the company were ever to sell the property. Section 590 operates to attribute the company's gain arising on the property disposal to the Irish shareholders. If the proceeds of the sale are subsequently distributed to the shareholders, within two years of the sale, then the CGT paid on the attribution may be credited against the CGT arising on the capital distribution.
If the Irish resident purchaser of the company wishes to rent out the property, it will be necessary to determine whether the income arising to the company could be assessed on the owner by virtue of S806 TCA 1997.
Finally, there is also a risk that the owner of the company could be considered, at least, a shadow director of the company. As such, he could come within the provisions of Section 57 TCA 1997 which extends an income tax charge to benefits received from foreign companies (such as where accommodation is available rent-free). It may be possible to reduce this potential charge by putting in place an appropriate rental agreement between the occupier and the company.
At the time of writing, Finance Bill 2007 indicates that such an investment will no longer potentially fall within the offshore funds legislation.
Conclusion
In summary, while the Irish tax consequences of acquiring property abroad are relatively easy to ascertain, it is always worth taking local advice prior to the acquisition so that appropriate planning regarding the structure of the ownership can be put in place.