1 If an in-specie distribution of 51% of the residuary estate consisting primarily of shares and managed investments is made to the non-resident beneficiary, would CGT event K3 be triggered?
Yes, CGT event K3 would be triggered. Question 2 Alternatively, if the shares and managed investments are sold and the proceeds are distributed to the non-resident beneficiary (such proceeds including capital profit) would he, or the executors of the estate, be taxed on the capital profit? Answer No, neither the executors of the estate nor the non-resident beneficiary would be taxed on any capital profit. This ruling applies for the following period : Year ended 30 June 20XX The scheme commences on: 1 July 20XX
The deceased passed away 20XX. The deceased was an Australian resident at the time of the death. The estate consists of, inter alia, large portfolios of managed investments and publicly listed shares. The deceased owned a property interest and this has been directly willed to the child, an Australian tax resident. At the time of the ruling, the shares remain in the name of the deceased, and are about to be transferred to the executors. Probate was granted by the Supreme Court of Victoria in 20XX. Under the terms of the will of the deceased, as amended by the codicils included within the probate document, the child of the deceased, that is Mr X, is to receive 51% of the residuary estate under the terms of Clause 8(c) of the will. Mr X as residuary beneficiary is a resident of Country A. It is proposed by the executors to consider either an in-specie transfer of a 51% portion of the managed investments and the shares in public companies to Mr X, or a sale of 51% of the distribution of the sale proceeds to him.
You state in your application, that you have reached a stage of final administration. The executors have made provision for any debts of the estate, including any estimated income tax liability referrable to the death year, and are ready to distribute the balance. You also state that ' It is clear in this matter that Mr X at this time has present entitlement to 51% of the residuary of the estate - even if, at this time the exact dollar amount is not ascertainable .' • You state in your application that, ' The relevant terms of the will trust are set out in clause 8(c)(1). It is submitted that the terms of Clause 8(c)(1) create a fixed and vested interest of Mr X as to 51% of the trust capital of the residuary of the estate .' • The executor does not intend to transfer the shares and managed investments to Mr X 'in specie'. Instead, they intend to sell the shares and managed investments and distribute the proceeds to Mr X. All of these assets were acquired after 20 September 1985.
Income Tax Assessment Act 1936 Schedule 2F Income Tax Assessment Act 1936 Section 272-5 Income Tax Assessment Act 1936 Subsection 272-5(1) Income Tax Assessment Act 1936 Section 272-65 Income Tax Assessment Act 1997 Section 104-215 Income Tax Assessment Act 1997 Subsection 855-10(1) Income Tax Assessment Act 1997 Section 855-20 Income Tax Assessment Act 1997 Section 855-40 Income Tax Assessment Act 1997 Subsection 855-40(2) Income Tax Assessment Act 1997 Subsection 855-40(3) Income Tax Assessment Act 1997 Subsection 995-1(1)
Question 1 If an in-specie distribution of 51% of the residuary estate consisting primarily of shares and managed investments is made to Mr X, would CGT event K3 be triggered? Summary CGT event K3 would be triggered if the shares and managed investments are not sold prior to passing to the non-resident beneficiary. Detailed reasoning Section 128-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that when a person dies, a capital gain or capital loss from a capital gains tax (CGT) event happening to a CGT asset the person owned just before dying is disregarded. However, section 104-215 of the ITAA 1997 (CGT event K3) sets out an exception to this rule if the CGT asset passes to a beneficiary in your estate who is: an exempt entity; or the trustee of a complying superannuation entity; or a foreign resident. Subsection 104-215(2) of the ITAA 1997 states that if the asset passes to a beneficiary who is a foreign resident, CGT event K3 happens only if: you were an Australian resident just before dying, and the asset (in the hands of the beneficiary) is not taxable Australian property.
A K3 event can occur when an asset of the estate passes to a non-resident beneficiary. If CGT event K3 occurs and it has not otherwise been disregarded under a provision in the Income Tax Assessment Acts, then any gain or loss made will be included in the deceased's final tax return. Taxable Australian property includes taxable Australian real property which is defined in section 855-20 of the ITAA 1997 and includes real property situated in Australia. The shares and managed investments would not be considered to be taxable Australian property. The passing of these assets in specie to the non-resident beneficiary would trigger CGT event K3. Taxable Australian property will also include an indirect taxable Australian real property interest under section 855-25 of the ITAA 1997. An indirect Australian real property interest exists where a foreign resident has a membership interest in an entity and that interest passes 2 tests (s 855-25): • the non-portfolio interest test, and • the principal asset test.
Neither of these tests are satisfied in relation to the shares or managed investment assets willed to Mr X. There is a property interest that is willed directly to the resident beneficiary. We are satisfied that the non-resident beneficiary (Mr X) does not have any direct or indirect interest in an Australian real property interest. Law Administration Practice Statement 2003/12 (PSLA 2003/12) confirms the Commissioner's longstanding administrative practice of not recognising any taxing point in relation to assets owned by a deceased person until they cease to be owned by the beneficiaries named in the will (unless there is an earlier disposal by the legal personal representative or testamentary trustee to a third party or CGT event K3 applies). In your case, the deceased was an Australian resident just before dying, and the shares and managed funds are not taxable Australian property; therefore CGT event K3 will happen if these assets pass in-specie to the beneficiary. Accordingly, a capital gain or capital loss will be crystallised in relation to these assets and would need to be included in the deceased's final return. Question 2
Alternatively, if the shares and managed investments are sold and the proceeds are distributed to Mr X (such proceeds including capital profit) would he, or the executors of the estate, be taxed on the capital profit? Summary No, neither the executors of the estate nor the non-resident beneficiary would be taxed on any capital profit. Detailed reasoning Section 128-10 of the ITAA 1997 provides that when a person dies, a capital gain or capital loss from a CGT event happening to a CGT asset the person owned just before dying is disregarded (see detailed summary of this provision under Question 1). Under Section 855-40 of the ITAA 1997, a CGT exemption is available where a capital gain or loss is made by a foreign resident on an interest in a fixed trust and that interest is not taxable Australian property. Specifically, subsection 855-40(2) of the ITAA 1997 provides that a capital gain you make in respect of your interest in a fixed trust is disregarded if: • you are a foreign resident when you make the gain; • the gain is attributable to a CGT event happening to a CGT asset of a trust (the CGT event trust) that is the fixed trust; and
• the asset is not taxable Australian property for the CGT event trust at the time of the CGT event. Would the non-resident beneficiary's interest constitute a fixed trust for the purposes of Section 855-40? The trust instrument, for the purpose of subsection 272-5(1) of Schedule 2F of the Income tax Assessment Act 1936 (ITAA 1936), consists of the testamentary trust created under the Will of the deceased. A fixed trust is defined in subsection 995-1(1) of the ITAA 1997, providing that a trust is a fixed trust if entities have fixed entitlements to all of the income and capital of the trust. The term 'fixed entitlement' is then defined in subsection 272-5(1) of Schedule 2F of the ITAA 1936. A fixed entitlement in a trust is where a beneficiary has a vested and indefeasible interest in the income or capital of the trust. To determine if the non-resident beneficiary has a fixed entitlement, it must be determined if they have a 'vested and indefeasible interest'. This term is not defined in tax legislation. The ordinary meaning can therefore be applied.
Paragraphs 13.3 to 13.9 of the Explanatory Memorandum to the Taxation Laws Amendment (Trust Loss and Other Deductions) Bill 1997 reflects what this meaning may be. A 'vested interest' means an individual has a present right to something, and 'vested indefeasible interest' means that right cannot be lost. In your case, the Will trust provides a vested interest for the non-resident beneficiary in receiving the residuary estate of the deceased's estate. There is no relevant clause in the Will that would authorise the Trustee to cause the beneficiaries' entitlement to be forfeited. Since the non-resident beneficiary that has been bequeathed within the Will has a vested and indefeasible interest in a share of the residuary estate, he has fixed entitlements in accordance with subsection 272-5(1) of Schedule 2F of the ITAA 1936. Therefore, the trust founded by the Will of the deceased is a fixed trust under section 272-65 of Schedule 2F of the ITAA 1936. Are the assets not taxable Australian property at the time of the CGT event?
The assets in question are listed Australian securities and managed investments, therefore they would not be considered taxable Australian property as prescribed under section 855-20 of the ITAA 1997 (see detailed analysis of this under Question 1). Conclusion In this case, the gain (upon sale of the shares and managed investments) is being received by a non-resident, the gain itself would be attributable to a CGT event happening to a CGT asset of the trust and the trust is a fixed trust. All requirements of subsection 855-40(2) of the ITAA 1997 have been met therefore the capital gain of the non-resident beneficiary can be disregarded.