CGT trap for deceased estate distributing to non-resident beneficiaries

By William Truong, Technical Services Manager

It has been increasingly common, for Australians to travel internationally for study, work and lifestyle. During COVID, while there has been less travel, we have also seen the trend of more Australians stuck living abroad. Any extended departure from Australia may suddenly result in a child, or other family members becoming a non-resident for Australian tax purposes. This may have tax implications for them in Australia. (The tax rules relating to residency of taxpayers is complex and does not form part of this article).

While Australia doesn't have an inheritance tax, if a non-resident of Australia is a beneficiary of an Australian estate, there are special capital gains tax (CGT) rules that clients would need to carefully consider in an estate plan.

Generally, for an Australian resident beneficiary of an Australian estate, CGT is typically not payable at that time at the time of inheriting an asset1, but only later when they dispose of the asset, unless an exemption applies.

However, for a non-resident beneficiary, special rules2 apply. CGT may apply to the deceased estate when an asset, that is not “taxable Australian property” (TAP), passes to a beneficiary that is a non-resident. 

Assets that are categorised as TAP include:

  • real property (ie real estate) situated in Australia, and rights to minerals or petroleum situated within Australia;
  • a non-portfolio interest (10% or greater) in certain companies or trusts that own Australian real property; and
  • assets used to conduct a business in Australia. 

Therefore, when non-TAP assets such as a portfolio of shares, pass to a non-resident beneficiary via an Australian estate, this may trigger a CGT event that can create an immediate estate tax liability or may cause capital losses attached to these assets to be forever lost. The deceased is deemed to have disposed of those assets, at market value, to the non-resident at the time of their death. Any CGT is recorded in the deceased’s final tax return (ie the ‘Date of death’ tax return). Any resulting tax payable will generally be deducted from the estate assets meaning all beneficiaries may bear the cost of this tax (even resident beneficiaries).

When TAP assets like an investment property located in Australia, pass to a non-resident beneficiary, this will not trigger any CGT liability within the estate.3

Non-resident inheriting from an Australian estate

Li (an Australian resident) dies in December 2021. His assets at the time of his death include an investment property located in Australia, some cash, and shares in an Australian company. (Assume the property and shares were purchased by the deceased after September 1985 and the shares have been determined to be non-TAP assets).

Under Li’s Will, his two adult children are to receive his estate in equal shares. One beneficiary is a non-resident of Australia for tax purposes and the other is a tax resident of Australia.

Investment property

A CGT event is not triggered when the 50% interest in the investment property passes to the non-resident beneficiary (in accordance with the Will) as the property is considered ‘Taxable Australian Property.’ 

Both the resident and non-resident beneficiary will inherit the Li’s (deceased’s) cost base (seeing as Li purchased it after September 1985).

If the beneficiaries later sell the investment property, the beneficiaries will make a capital gain or loss in Australia equal to the difference between the capital proceeds from the sale and the cost base.

Share investments

When 50% of the shares in the Australian company are transferred to the non-resident beneficiary in accordance with the Will, this will trigger a CGT event. This is because the shares are considered non-TAP assets. The cost base of these shares will be reset to the market value prevailing on the date of death of Li. The non-resident beneficiary will inherit these shares as the new cost base.

Any resulting capital gain from this CGT event will be included in Li’s final individual return (his Date of Death Return) and will be combined with his other income and taxed at his marginal tax rates. Again, any resulting tax liability will generally be paid from estate funds and may also impact the funds available for distribution to the beneficiaries.

When 50% of the shares in the Australian company are transferred to the resident beneficiary in accordance with the terms of Li’s Will, no CGT event is triggered. The resident beneficiary will inherit the cost base of these shares as originally held by Li.  At a later date, if the resident beneficiary sells these shares, a CGT event will take place under the usual asset disposal rules and tax may be payable by them personally. 

At a later date, if the non-resident beneficiary remains overseas when they are disposing of their Australian shares, generally no Australian tax is payable by that beneficiary on any capital gains arising from the sale of their shares. There may, however, be taxation implications in their country of residence.

Here are some suggested strategies to minimise the tax consequences when an estate plan includes distributing assets to non-resident beneficiaries:

  • Depending on the mix of assets within the estate, and with strategic estate planning advice, the deceased, via their Will, can choose to distribute non-CGT assets, such as cash, to non-resident beneficiaries and CGT assets to Australian-resident beneficiaries, or
  • Consider including a provision in the Will to grant the executor a power of appropriation. This gives the Executor flexibility to distribute the assets of the estate in a more tax effective manner.4
  • Consider including a provision in the Will to establish a testamentary trust upon the death of the Will maker to hold any non-TAP assets for the benefit of non-resident beneficiaries until they return to Australia. However, care is needed when selecting a trustee/s of such a trust to ensure that they are not considered non-residents for Australian tax purposes. 

When considering any estate planning options, clients are best advised to seek expert tax and estate planning advice within Australia, as well as seeking international taxation advice in the country in which the non-resident beneficiary resides.

Conclusion

CGT may impact estate planning where a Will maker is considering distributing assets to non-resident beneficiaries of Australian deceased estates. It is important for clients to be aware of and understand the tax implications that can arise when deciding how to deal with their assets within their estate.  

This article has not considered the tax implications for non-resident beneficiaries in their relevant overseas jurisdiction/s. It is essential to seek advice from tax and estate planning professionals when administering assets of a deceased estate. 

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1 Income Tax Assessment Act 1997 - Sect 128.10
2 Income Tax Assessment Act 1997 - Sect 104.215
3 However Foreign Investment Review Board Fees may apply. Please refer to recent legislative changes to the Foreign Acquisitions and Takeovers Regulations 2015 (Cth). An amendment to section 29 of the Regulations means that an acquisition by a foreign person of an interest in securities, assets, a trust or Australian land that is acquired by Will is no longer exempt from the Foreign Investment Review Board regime.
4 Please note that the various Trustee Acts in each State may also grant a power of appropriation to the Executor.


More information

If you have any questions, or would like more information, please contact the IOOF TechConnect team on 1300 650 414.

Disclaimer
The information in this section of the website is intended for financial advisers only and is not to be distributed to clients. It has been prepared on behalf of Australian Executor Trustees Limited ABN 84 007 869 794 AFSL 240023, IOOF Investment Management Limited ABN 53 006 695 021 AFSL 230524, IOOF Investment Services Ltd ABN 80 007 350 405, AFSL 230703 and IOOF Ltd ABN 21 087 649 625 AFSL 230522 based on information that is believed to be accurate and reliable at the time of publication.