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When someone overseas inherits from a will, other beneficiaries can end up footing the tax bill.
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How to take CGT sting from assets bequeathed to a foreign resident
26 May 2023
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10 minute read
One of the benefits of using a trust is that when an asset passes to an executor or beneficiary on the death of a trustee, any capital gain or loss is deferred until disposal of the asset.
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Remember that an executor is generally taken to be the trustee of the estate when they administer the estate – they hold the assets, subject to payment of the debts, on trust for the beneficiaries.
However, there is an exception to this rule known as a CGT Event K3. In this case, a foreign-resident beneficiary inherits a CGT asset that is not land or an interest in land and is therefore not considered “taxable Australian property” (TAP). This will trigger a CGT event immediately, creating a tax liability for the estate or sacrificing a latent capital loss.
Why is this an issue?
Suppose that you pass away and your foreign-resident daughter, who works and lives in the US long-term, inherits 10,000 CBA shares (at a market value of $90 per share) that you bought for $30 per share. Your estate just made a taxable capital gain of $600,000. Capital gains tax will be payable with the tax liability falling upon your estate.
However, your estate does not have those CBA shares to fund this liability as those shares are now in your daughter’s hands, thus (unexpectedly) diminishing the remainder of the estate available for distribution.
In short, beneficiaries that are not tax residents of Australia at the time of inheritance can create estate tax issues, and everybody else who stands to inherit in the estate pays for it. The Australian resident beneficiaries will be upset because they will be paying the tax for a person living in another country.
How can you get around this?
With careful planning and consideration, the application of a CGT Event K3 can be managed or perhaps altogether avoided.
Remember that CGT event K3 will only apply if the beneficiary is a foreign resident when the CGT asset “passes” to the beneficiary (s104-215(1)).
The ATO takes the view in TD 2004/3 that where a CGT asset is bequeathed to a beneficiary in settlement of their entitlement under the will (and assuming that the executor of the estate has no discretion as to its distribution), the asset will “pass” to the beneficiary (whether or not the assets is later transmitted or transferred to the beneficiary) when the beneficiary becomes absolutely entitled to the asset as against the estate’s trustee. That happens when all the debts of the estate have been paid following the period of the estate’s administration.
This is the relevant point in time that the status of foreign residency is to be considered – not when the will was signed and not when probate was granted, but when the debts have been paid.
You can use your will to gift the taxable Australian property to the non-resident beneficiary. In this case a CGT event K3 is avoided, and the non-resident will acquire the property at the same cost base as it was in the hands of the deceased. It is only any subsequent disposal by the non-resident that will be subject to CGT.
While the Trustee Act 1925 (NSW) gives a trustee a power of appropriation, consider specifically including a power of appropriation in your will. This will alert the beneficiaries to take tax advice and to communicate to the trustee which assets they want to receive, and any adverse tax outcome can be borne by the beneficiaries on terms that they all agree on.
Under the will, the non-resident beneficiary could be required to compensate the estate for the capital gains tax triggered under the CGT Event K3, or the resident beneficiaries could receive an equalising payment from the estate for the tax they have to pay.
You can transfer the asset under your will to an Australian resident testamentary trust.
Practice Statement PS LA 2003/12 “Capital gains tax treatment of a trustee of a testamentary trust” provides the Commissioner will not depart from the longstanding administrative practice of treating the trustee of a testamentary trust in the same way a “legal personal representative” is treated for the purposes of Div 128 – that is, the transfer from the executor to the testamentary trust does not trigger CGT.
This way, any distributions of income to a non-resident will be taxed, however the taxation of the capital gain is deferred until such time as the non-TAP asset is disposed of.
Alternatively, if the asset is held in an Australian resident inter vivos trust, the asset will not form part of the deceased estate. Succession can be achieved by passing control of the trust to those whom you wish to benefit from the trust. As long as the asset is in Australia, or the trustee is in Australia, there will be no tax liability until disposal of the property.
Leigh Adams is special counsel at Owen Hodge Lawyers.
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