Of course in the 1700's around a third of the population was killed by smallpox, then in 1783 a quarter of the population were killed by the volcano erupting and over half the livestock on the island dying off. But let's say that even with these disasters Britain still annexes Iceland, let's say with a little bit of a hand-wave or something the British still take it.
Maybe, England can use Iceland as a convict dumping ground instead of Australia ! But then, what happens of Australia ?
Some answers can be found here :
History of Australia (Wikipedia)
A French colony in Western Australia, based on French claims put in 1772. They settle at OTL Eagle Bay (Cape Leeuwin),south of OTL Perth. Why there ? It looks nice and has a subtropical climate !
And a Swedish colony around 1786, at the Swan River ! Not sure: I would rather locate them at Coles Bay (Tasmania), a place easier to reach, with a temperate climate. I choose Coles Bay because, from the map at Google, I find the Swan River rather difficult to reach.
And, for a good measure, throw in a smaller British colony at Botany Bay, smaller because now some of convicts are moved to Iceland !
Later, with the European settlements, Dutch and Portuguese colonies may appears further north.
Well, some interesting prospect here !
It reminds me a old thread by Donald H Tucker (aka (P)Teranodon), postulating that convicts have been send to the Russian shores of the Black Sea. If my memory is good, it appeared in the previous instance of this forum ! A search in the Old Board archive let me suppose the thread was created prior to 2002 !
Oups !
Mr Tucker (aka Pteranodon) has published its thread on soc.history.what-if. The thread is available here:1776 Transporting English convicts to Russia.
From the same location, another thread concerning Australia: Australia not settled by the British ... and others!!