Wills and estates: tax & property law implications for non-resident estate beneficiaries
Australia's multicultural profile continues to evolve, both socially and commercially. While migration to Australia is providing many cultural opportunities we are also seeing trends in skilled workers leaving Australian shores and capitalising on an increasingly mobile, global labour market.
As a result, it is becoming more common for individuals to want their estate passed to non-resident beneficiaries (be they family or friends). The non-resident status of intended beneficiaries of an estate poses some interesting challenges when advising on estate planning, for example:
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how do Australian practices in estate planning for an Australian resident client, impact upon the beneficiary in a foreign jurisdiction. For example, how do you identify whether there are tax laws (income taxes or a death duties regime, or both) in the foreign jurisdiction that could adversely affect the beneficiary;
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are there any adverse Australian tax implications of estate assets passing to a non-resident.
This Bulletin highlights some of the Australian tax implications of certain estate assets passing to a non-resident beneficiary under the Will of an Australian resident.
Example 1: Australian Will-Maker and Non-resident Beneficiary
Under her Will, widower Mrs X leaves the entirety of her estate to her only child Y, who is a non-resident of Australia, now living and working in London. Mrs X's estate includes:
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a share portfolio that has an underlying capital gain of $200,000.00
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a rental property in Australia with an underlying capital gain of $100,000.00; and
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her residential home valued at $600,000.00.
Has CGT event K3 occurred?
In general terms, CGT event K3 happens in circumstances where:
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an Australian resident dies;
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a CGT asset of the deceased passes to a beneficiary of the deceased's estate;
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the estate beneficiary is a non-resident of Australia;
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the asset is not real estate in Australia or an interest in real estate in Australia.
Where these four conditions are satisfied and, prior to the death of an Australian resident person, the market value of the asset:
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Exceeds the asset’s CGT cost base then A capital gain will arise
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Is less than the CGT cost base then A capital loss will arise
… and the taxable capital gain, or capital loss, will need to be included in the "date of death" tax return for the deceased.
In the example above, CGT event K3 would apply, requiring the "date of death" tax return for Mrs X to include the capital gain in respect of the share portfolio ($200,000 less any available discounts).
Estate planning for the share portfolio?
Mrs X could consider establishing an Australian resident testamentary trust under her Will for the benefit of her child Y so as to ensure that the share portfolio in fact passes to a resident entity beneficiary, not a non-resident beneficiary.
If the shares are subsequently sold by the testamentary trust the CGT laws will, of course, apply in the usual way.
Under the current Australian CGT laws, individuals who own "CGT assets" for more than 12 months prior to the occurrence of a CGT event in respect of the asset (most commonly a sale of the asset), can benefit from a 50% reduction in the amount of the capital gain to include in their assessable income.
However with respect to non-residents, the Australian CGT laws have only limited application. In short, the benefit of a 50% reduction in the amount of the capital gain is only available if the non-resident owns Australian real estate or an interest in Australian real estate.
The Federal budget announcement – 8 May 2012
During the 2012 Federal Budget, there was an announcement which proposed to abolish the CGT 50% discount for non-residents in respect of capital gains that accrue after 7.30pm on 8 May 2012 in respect of CGT assets (relating to ownership or an interest in Australian real estate).
Capital gains that have accrued on the non-resident's CGT assets prior to that time will still have the benefit of the 50% discount if the non-resident obtains a valuation of the CGT asset as at 8 May 2012.
The Budget proposal will have a significant impact on the tax liability of non-residents that hold real estate (or an interest in real estate) in Australia. Subsequently, there are important considerations for non-resident beneficiaries of the estate of an Australian resident, arising from this proposal.
When Mrs X dies, her Australian real estate passes to her child Y. CGT event K3 does not apply to the Australian real estate (this is the good news) and the usual CGT rules apply.
That is, Y inherits:
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the investment property on the date of death of Mrs X and has a deemed cost base for that property equal to the cost base that Mrs X has for that asset; and
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the residential home on the date of death of Mrs X and has a deemed cost base equal to the market value of that property at the date of death of Mrs X.
When Y subsequently sells the investment property or the residential home, they will be subject to the Australian CGT laws in the usual way. If a sale of the residential home is completed within two years of the death of Mrs X then, under a specific exemption dealing with the main residence, any capital gain arising from the sale will be ignored.
Apart from the specific exemption for the main residence, Y could be in the position of realising a capital gain from the subsequent sale of these assets outside of the two year period - and this is where the Budget proposal will have an adverse impact on Y.
Y will not benefit from the current 50% CGT discount on the sale of the properties.
Estate planning for the real estate ownership and interests
There are a number of options available to Mrs X in considering how to plan her estate.
Firstly, Mrs X should obtain a valuation for her real estate as at 7.29pm on 8 May 2012 so that the CGT discount can be applied to the capital gain that accrued on the properties prior to that time.
Secondly, an Australian resident testamentary trust might again provide a solution. Mrs X could establish an Australian resident testamentary trust under her Will to hold the real estate. When the real estate is subsequently sold it will be sold by an Australian resident entity (being the trust) not by a non-resident entity (being Y).
There is, of course, no draft legislation relating to this proposal as yet and the legislation, when it is prepared, could include a claw-back provision that will deny the 50% discount where a non-resident receives a trust distribution that relates to the capital gain derived by the trust from the sale of Australian real estate. This would be the same sort of claw-back provision that currently applies to deny the 50% to companies that receive distributions of discount capital gains from a trust.
All this remains to be seen and the devil will be in the detail. Inevitably, complex legislation will be the result of trying to achieve the Budget objective.
At this stage, the message is clear; consider your estate planning options if you intend to benefit non-resident beneficiaries with your estate assets and be ready to act when legislation on this matter is finalised.
Authors: Andrew Frankland & Chris Tsovolos