In a post COVID world, we have largely returned to circumstances which may mean that one or some of your loved ones are living overseas and may be a non-resident of Australia for tax purposes.

A critical aspect in your estate planning is ascertaining whether any of your beneficiaries are considered a non-resident for tax purposes. If they are there, this may trigger a CGT Event K3.

What is a CGT Event K3 and how does it work?

Generally speaking, when an Australian taxpayer dies, there is no capital gains tax triggered.

However, there is an exception to this.

Where a non-resident for tax purposes receives an asset subject to capital gains tax from an Australia deceased estate, CGT Event K3 is triggered (unless the asset is ‘Taxable Australian Property’).

To broadly clarify, ‘Taxable Australian Property’ includes:

1. Real property – such as a house, apartment or land
2. An indirect interest in Australian real property (for example, where the deceased person held 10% or more of shares in a company that mostly holds Australian real property).

Accordingly, where the assets are considered Taxable Australian Property, CGT Event K3 is not triggered.

However, where the assets of the deceased estate include a share portfolio (which is an asset subject to capital gains and losses), and under the deceased’s Will, the shares will pass to a non-resident for tax purposes, then CGT Event K3 is triggered.

Generally speaking, a tax resident is liable to pay capital gains tax upon the disposal of a capital gains tax asset in Australia. If the beneficiary is a tax resident, upon inheriting a share portfolio they would not pay any capital gains. The beneficiary would be liable for any capital gains tax upon their sale of any shares they receive (which may occur at some point in the future).

Conversely, a non-resident for tax purposes is not paying tax in Australia. Accordingly, if they receive the benefit of a share portfolio from a deceased estate, any capital gains tax liability attaching to those shares will escape the scope of the Australian Taxation Office.

The result of CGT Event K3 being triggered is that the executor of the estate becomes responsible for addressing any capital gains tax that arises from the CGT Event K3.  

Practically speaking, the tax event is considered to take place immediately prior to the deceased’s death, based on the market value at that point in time. The executor is responsible for including the resultant capital gains tax from the event in the deceased’s last income tax return.

Example

As an example:

John at the time of his death owns property (which is his principal place of residence) and a share portfolio worth approximately $10 million.

In his Will, John names his three children, Sally, Jeremy and Lauren as beneficiaries in equal shares, and Sally is the sole executor.  Jeremy has been living and working in the United Kingdom for the past 10 years.  Jeremy is non-resident for tax purposes in Australia.

In this example, a CGT Event K3 does not occur in relation to John’s principal place of residence (as this is Taxable Australian Property).

However, a CGT Event K3 is triggered in relation to Jeremy’s one third interest in the share portfolio.

Sally, as executor, will be responsible for reporting the capital gains tax liability resulting on the one third of the share portfolio being transferred to Jeremy. Sally will need to instruct John’s accountant to include this liability in John’s last income tax return (prior to his death).

Issues arising from CGT Event K3

Without a considered estate plan, if CGT Event K3 is triggered, it can have a significant impact on your estate and disrupt the interests of the other beneficiaries.

Taking the example above, Sally, as executor of John’s estate, will have an increased tax liability to pay for John’s last income tax return (as it will include any capital gains tax arising from the one third of the share portfolio being transferred to Jeremy).

What occurs if John’s estate has insufficient cash to pay the resulting tax liability from the CGT Event K3? Perhaps John’s principal place of residence will have to be sold (which will form part of the residue of the estate), and an amount of the proceeds will have to be used to pay the CGT liability arising from the one third of the share portfolio transferred to Jeremy. This outcome would unfairly impact on the interests of Sally and Lauren.

Your estate planning in light of a non-resident beneficiary

It is critical that your estate plan considers whether you have, or might have in the future, a beneficiary in your Will that is a non-resident for tax purposes. If this is the case, it is important that consideration is given to:

1. Who is responsible for paying the resulting capital gains tax liability that may be incurred as a result of the CGT Event K3. It is necessary to consider whether the beneficiary has the means to cover such a tax liability, and if they do not, then the testator may have to reconsider naming the non-resident beneficiary of the non-Taxable Australian Property.
2. Whether a testamentary trust should be included in your Will where your trustee holds the shares on trust for the non-resident beneficiary. This will allow for the trustee to sell the shares at a particular time (that may be advantageous), pay the resulting capital gains tax, and pay the proceeds of sale to the non-resident beneficiary.
3. Ensuring your Will contains a power that allows the executor of your estate to appropriate assets of the estate having regard to the capital gains tax liability that may result from CGT Event K3 being triggered.

If you have any questions regarding the above information, please contact our team today to discuss.