Our international tax series considers tax issues for non-resident beneficiaries of Australian trusts and Australian beneficiaries of non-resident trusts. The series considers the tax residency rules and income tax and capital gains tax (CGT) consequences for beneficiaries and trusts alike.
This is the fourth article of the series and focuses on taxation issues relating to non-resident beneficiaries of Australian deceased estates. The other articles of the international tax series can be accessed here.
All references are to the Income Tax Assessment Act 1997 or the Income Tax Assessment Act 1936 as relevant.
Deceased estates and trusts
A deceased estate is effectively a trust administered by the executor. Though the roles of a trustee and an executor are similar, an executor of a deceased estate has a different legal persona. However, for income tax purposes, section 6(1) defines the term “trustee” to include persons acting as executors or administrators of deceased estates.
This article will discuss the technical aspects of the taxation of non-resident beneficiaries of Australian deceased estates by way of an example.
Mr A died in July 2019. His assets at the time of his passing were his main residence in Melbourne, an investment property in Melbourne, and shares in an Australian company. The Australian company does not own real property in Australia or other taxable Australian property.
Under Mr A’s will, his two adult children receive the residue of 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.
An executor, who is resident in Australia for tax purposes, will administer Mr A’s estate.
CGT event K3
Upon the death of a resident taxpayer, under section 128-10 any capital gain or loss from a CGT event relating to a CGT asset owned by the deceased is disregarded. However, there is an exception to this for foreign residents.
That exemption is CGT event K3.
CGT event K3 happens if a taxpayer dies and a CGT asset owned by the deceased just before dying passes to a beneficiary of the deceased’s estate who is a foreign resident of Australia for tax purposes.
If the asset passes to a beneficiary who is a foreign resident, CGT event K3 happens only if the deceased was an Australian resident for tax purposes just before dying and the asset is not taxable Australian property. Importantly, in our example, this means that CGT event K3 does not happen to Mr A’s main residence and the investment property and only to the interest in the shares in the Australian company received by the foreign beneficiary.
The capital gain or loss is calculated by determining the market value of the asset on the day the deceased died less the cost base of that asset.
An asset “passes to a beneficiary” in an estate if the beneficiary becomes the owner of the asset under the will or under any other of the criteria in section 128-20. Importantly, a CGT asset does not pass to a beneficiary if the beneficiary becomes the owner of the asset because the legal personal representative (that is, the executor) transfers it under a power of sale.
Further, CGT event K3 does not happen when a non-resident acquires the asset under an application of survivorship in the relation to real property acquired under joint tenancy.
With respect to Mr A, the shares pass to the two beneficiaries under his will and Mr A will make a capital gain or loss equal to the difference between the market value of the Australian company shares just before his death and the cost base of his shares as this relates to the interest received by the foreign beneficiary.
The investment property
CGT event K3 does not happen to the investment property as that property is taxable Australian property.
If Mr A bought the investment property on or after 20 September 1985, the beneficiaries will inherit Mr A’s cost base in that property. If Mr A bought the investment property before 20 September 1985, the beneficiaries will receive a cost base for their interest in that property equal to the market value of that interest at the time of Mr A’s death.
If the beneficiaries later sell the investment property, the beneficiaries will make a capital gain or loss equal to the difference between the capital proceeds from that sale and the cost base.
The main residence
CGT event K3 does not happen to the main residence as that property is taxable Australian property.
Whether or not Mr A bought the main residence before or after 20 September 1985, the beneficiaries will receive a cost base uplift equal to the market value of the dwelling at the time Mr A died.
If Mr A bought the investment property on or after 20 September 1985, no further tax liabilities arise if the beneficiaries sell that main residence within 2 years of Mr A's death. CGT may apply if the main residence is sold after 2 years of Mr A's death, unless the Australian Taxation Office exercises a discretion to extend that period.
If Mr A bought the investment property before 20 September 1985, the 2-year limit does not apply and there are no further CGT implications.
In the 2017 Budget the Government announced that it would pass laws such that foreign residents will no longer be entitled to claim the main residence exemption for real property in Australia. We discuss this in a separate article here. If the proposed change becomes law, this may affect executors, legal personal representatives, and surviving joint tenants as discussed by the ATO here.
Under the proposed measures, the non-resident beneficiary would not be eligible for the main residence exemption with any capital gain from the disposal of the main residence after the time of death being assessable.
Shares in the Australian company
As discussed, Mr A will make a capital gain or loss from CGT event K3 equal to the difference between the market value of the Australian company shares just before his death and the cost base of his shares as this relates to the interest received by the foreign beneficiary.
If the non-resident beneficiary remains as such at the time of a later disposal of the shares, no Australian tax is payable by the Australian beneficiary on any capital gains arising from the sale of the shares.
Conversely, if the beneficiary becomes a resident of Australia, Division 855 applies such that the interest in the shares receives a cost base equal to the market value at the time the beneficiary becomes an Australian resident. Any capital gain on the later disposal of those shares would then be assessable.
The example highlights the complexity of the taxation rules for non-resident beneficiaries of deceased estates. It is essential to seek advice from a tax professional when administering assets of an estate.
Part 5 and 6 of our international series will discuss the tax implications for non-resident beneficiaries of testamentary trusts and resident beneficiaries receiving distributions from foreign trusts or foreign deceased estates.
If you would like to discuss any of the above, please contact us at Sladen Legal.