Income Tax on Immovable Rental Property

TEXT BY: NICOLE D. E. ECHOBARDO LL.M, TAX ASSISTANT AT MEIJBURG & CO CARIBBEAN AND QUINCY N. LONT LL.M, SENIOR TAX MANAGER AT MEIJBURG & CO. CARIBBEAN.

One of the fundamental tax matters that never seems to go out-offashion is the taxation of income derived from immovable properties.

Lately it has been a worldwide trend to let your immovable property to third parties via online platforms such as Airbnb, Booking.com, Agoda etc. Income derived from immovable properties located in Curaçao falls in principle under the following sources of income: - A. Income from Business Enterprise (active) B. Income from Immovable Property (passive)

Looking forward to earning income from your rental property? In the following, we will provide you with necessary information to consider when evaluating and improving your current or future property rental income position for income tax purposes. Please note, that the information provided in this article is limited to the tax consequences for individ ual taxpayers that receive their rental income derived from their own immovable property and not in the name of a company organized as a legal entity, such as an N.V. or B.V. According to the income tax legislation of Curaçao, all revenues received from immov able properties located in Curaçao by an individual must be declared in the personal income tax return. This includes any payment, e.g. advance rent, lease and cash, received for the use or occupation of your rental property. Even if you are not a resident of Curaçao, but you do receive rental income from an immov able property located in Curaçao, you are considered a foreign taxpayer for Curaçao income tax purposes and therefore the received revenues are subject to taxation. Furthermore, the scope of the taxable rental income is not limited to ownership, for instance income derived from subletting immovable property is also deemed a taxable income. The following

are examples of immovable properties that are more commonly rented out:

• House • Apartment • Studio • Room • Building • Land • Berth • Parking lot

In order to determine the tax consequences of receiving rental income as an individual from immovable property, a distinction should be made between ‘active’ rental activities versus ‘passive’ rental activities. Contrary to the assumption of many, the passive letting of an immovable property to third parties is also taxable. Both active and passive rental activ - ities are subject to income tax at the progres- sive rates, at a maximum of 46.5% (in 2017). Although the tax rate for both activities is the same, the taxable base could differ, resulting in a difference in the effective tax burden.

Active rental activity The Curaçao income tax legislation does not explicitly outline the term business. However, it is generally acknowledged that for tax purposes a business is an organization of capital and labor which aims to make profit by participating in the economic market. In this respect it must also be reasonable that profits could actually be expected from this activity. Therefore, in case a taxpayer realizes inciden - tal profits this occurrence should not automat- ically result in the activity being deemed an active business enterprise. As a criterion for your rental or management activity, to qualify as an active business enter - prise, the activity must be of such extent that it goes beyond the boundaries of regular asset management. To a certain extent the profit - ability of the activity will also be taken into account before determining if such activity should qualify as an active business enterprise. Working on a regular and continuous basis in such a manner that substantial time is spent on the rental activity are key factors in determin - ing the tax status of the rental activity. For example, the number of hours spent on main - tenance, administration, financial and contract management duties are crucial. Once your rental activity qualifies as a busi - ness enterprise based on the aforementioned criterions, it could be argued that you are enti - tled to deduct the necessary costs made to keep your rental property in good operating condi - tion. However, business profits made with the

sale of your immovable property would also be taxable for personal income tax purposes at the progressive income tax rates, at maximum of 46% (in 2017). In this respect necessary costs are the common expenses that are generally accepted, such as:

• Depreciation costs • Interest costs and costs of loans • Advertising • Improvement • Repairs and maintenance • Utilities • Broker fees • Taxes • Insurance premiums

Passive rental activity In general, if revenues received from a rental property do not qualify as proceeds of the other sources of income, such as: active busi ness enterprise, labor, capital gains or periodical payments, they are automatically deemed to be a passive activity. In determining the taxable income from this passive activity, the deductible expenses are in essence limited to 35% of the revenues, except interest costs and costs of loans, e.g. death risk insurance premiums. This implies that the actual costs incurred to keep the rental property operational are not automatically deductible and in fact 65% of the received revenues would be deemed to be taxable income. For instance, damages caused and expenses incurred by a tenant are in prin ciple not deductible. However, under strict circumstances it is possible to take additional operational expenses and inhabitant’s expenses into account, such as broker fees and utilities, when determining the taxable income derived from a rental property. Although actual costs and expenses made are not deductible, gains on sale of the immovable property are exempt from income tax. For completeness’ sake, please note that excess interest costs could also be tax deductible against positive income derived from the rental property in the five subsequent years, in case this interest expense is accepted for tax purposes and results in taxable losses.

Active vs. Passive It might seem beneficial for your property rental activity to be deemed as an active busi ness activity, since the actual costs made are deductible. However, business profits made with the rental and sale of your immovable property are subject to income tax, whilst gains on sale from a passive rental activity are exempt from income tax. For the sake of clar

ity, please note that for the calculation of your taxable income from business rental activities, 100% of the revenues are taxable, contrary to the aforementioned, deemed 65% income for the passive rental activity. Therefore, it is not necessarily beneficial for your property rental activity to be deemed an active business activity.

Furthermore, in a recent Court ruling in a Sint Maarten case, the ongoing debate regarding the qualification of property rental activities as active business enterprise versus passive activity has been further clarified. Since, the Sint Maarten income tax legislation is, to a certain extent, similar to the Curaçao income tax legislation, this case is also relevant for the Curaçao tax practice. The individual taxpayer was of the opinion that he was operating a business with his rental property activity. However, the Inspectorate of Taxes argued that the property rental activity must be deemed as a passive rental activity and therefore refused the deduction of all the costs declared. The individual concerned did not succeed in proving the Inspectorate of Taxes wrong, essentially because according to the Court the taxpayer’s declaration of him spending twenty hours a week on the property rental activity, without further proof of evidence, was not credible. Therefore, the aforemen tioned requirements for the activity to qualify as an active business enterprise, in particu lar: “beyond the boundaries of regular asset management” has not been met. This ruling by the Court of First Instance serves as a confir mation of our understanding of the criterions that make the distinction between ‘active’ and ‘passive’ rental activities. Also, please be advised that in the event that the Inspectorate of Taxes successfully proves that you, as a rental property owner, intention ally did not report all received revenues (in particular, payments received from Airbnb, Booking.com, Agoda, etc.) or deducted costs which were not actually incurred, a 100% penalty of the non-declared amount could be imposed. Furthermore, a fine of ANG 2,500 can be imposed by the Tax Inspector for not submitting the income tax return (on time). As described above, how your property rental activity qualifies for income tax purposes could have significant impact on your personal financial situation. For instance, on a short term it might seem beneficial for your property rental activity to qualify as an active business, since the actual costs and expenses (especially maintenance costs) are deductible, however on the long term, for instance if you sell the immovable property in the capacity as entre preneur the profits are taxable. While it could have been beneficial if the property rental activity was deemed passive, so that it could be argued that the sales profit might remain exempt from personal income tax in Curaçao. For completeness’ sake, please note that although this article sheds light on the income tax consequences of letting an immovable property, it must be taken into account that revenues received with the exploitation of an immovable property as such, are in principle also subject to Sales tax at the current rate of 7%, unless it regards long-term rental to indi vidual residents.