It has been increasingly common, for Australians to travel internationally for study, work and lifestyle. The proverbial gap year has become the "two or more gap year". Baby boomers are living the South-of-France extended dream. A return to a post-COVID world may continue the general trend of more and more Australians living abroad. Any extended departure from Australia can suddenly result in a child, sibling or parent becoming a non-resident for Australian tax purposes.
It follows that many Wills have named family residing overseas as estate primary or default beneficiaries. Many more Wills name Australian beneficiaries who may at the time of a death, be a tax non-resident. Without careful planning, these could trigger the hidden tax trap that is CGT Event K3.
Death duties does not exist in Australia. Technically this is true, but in practice it is a lie - it is hidden in the CGT rules. Capital gains and losses pass through estates where beneficiaries inherit assets. The operation of the CGT rules usually result in not only inheriting the asset, but also inheriting the deceased's 'beginning point' on that asset for a later CGT calculation. The tax happens later when the beneficiary sells the asset.
So, the general rule is that death does not trigger a tax liability... unless the hidden CGT Event K3 occurs.
CGT Event K3 occurs when a tax non-resident beneficiary inherits a CGT asset that is not "Taxable Australian Property" (TAP). To that extent, the deceased estate is deemed to have triggered a CGT event that can create an immediate estate tax liability or cause a latent utilisable capital loss to be forever lost.
In broad terms, the definition of TAP principally covers Australian real property as well as direct and indirect interests in them. An investment property is a TAP and therefore a tax non-resident beneficiary will not trigger CGT Event K3 on inheriting it. On the other hand, a share portfolio and managed investments are not TAP, and therefore a tax non-resident beneficiary will trigger a CGT Event K3 and upfront tax on the unrealised capital gains is payable by the estate on that beneficiary inheriting it.
Suppose that you passed away and your tax non-resident daughter, who works and lives in the US long-term, inherited 10,000 CBA shares (at 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. This adds to the hidden tax trap that is CGT Event K3.
In short, beneficiaries that are not tax residents of Australia at the time of inheritance creates current estate tax issues, and everybody who stands to inherit in the estate pays for it.
With careful planning and consideration, the application of CGT Event K3 can be managed or perhaps altogether avoided. We suggest two different strategies, though it is not exhaustive:
- consider using Australian-structured testamentary trusts to hold the non-TAP assets for the benefit of your non-resident beneficiaries. The ATO's long-standing administrative practice in PSLA 2003/12 is to defer the taxing point of your CGT assets when it is distributed to the testamentary trust until a beneficiary (of the testamentary trust) receives those CGT assets or when the CGT assets are actually sold.
However, care is needed to ensure that the trustees of those trusts are not themselves non-residents for Australian tax purposes as this does not avoid the CGT Event K3 tax trap from being sprung!
- consider including a provision in your Will to grant the executor a power of appropriation. Under this power, an executor has the flexibility to appropriate and/or sell any CGT asset of the estate to satisfy the non-resident beneficiary's entitlement in the estate.
Certainly, what is necessary is a clause in the Will that will allow an executor to balance any Australian tax liability caused by a CGT Event K3 beneficiary against the assets they will be inheriting.
It is important to be aware of and understand the tax implications that can arise from how you choose to leave your estate. CGT Event K3 is just one of those tax implications that applies in the context of "non-resident beneficiaries". This article shows that this can be managed. When you know of and appreciate the impact of these tax consequences of your estate plan, you can make better estate planning decisions to deal with those consequences ultimately for those who you choose to leave your estate to.
This article has not considered the tax implications for your non-resident beneficiaries in the relevant overseas jurisdiction(s). We recommend that specific tax advice in those jurisdiction(s) is sought.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.