iscover How to plan inheritance fairly where children live abroad
TaxDetermining how to distribute various assets through an estate can become more complicated when one of the beneficiaries lives overseas, due to the tax treatment of capital gains.
Most parents want to ensure each of their children is treated fairly when it comes to distributing an inheritance. Family disputes and even challenges to a Will can arise if children feel they have been disadvantaged compared with their siblings.
Deciding how to distribute various assets via an estate can become more complicated when one of the beneficiaries lives overseas, due to the tax treatment of capital gains. This hidden trap can have serious tax consequences for all beneficiaries if it is not proactively addressed.
Tax on capital gains
The tax implications of inheriting an asset depend on whether it was acquired by the deceased before or after the introduction of CGT on September 20, 1985.
Post-CGT assets are charged on the increase in value of the asset from the time a person acquires it until the time they dispose of it. A CGT asset is any property or investment subject to those capital gains rules.
When a person dies, the CGT assets they owned just before dying are still subject to CGT.
If all CGT assets are passing to people who are Australian tax residents, the CGT doesn’t need to be paid immediately and is instead paid by the beneficiary (the asset’s new owner) when they come to sell the asset.
The situation is different if one of the beneficiaries is a foreign resident for tax purposes at the time of the parent’s death. This triggers what’s known as CGT event K3 and failing to pre-empt it can have serious ramifications for all beneficiaries – not just those who live overseas.
Overseas children
The options for parents, and the consequences of failing to take action, are best explained using an example.
Consider Jenny, who’s estate is worth $2,000,000, which includes $1,000,000 in unrealised capital gains. Jenny wishes to distribute her estate equally to her two children – Scott and Charlotte – when she dies. Charlotte lives overseas.
Unless Jenny includes specific directions on how tax arising from the distribution of the Will should be treated, CGT event K3 will automatically process when she dies, generating a CGT bill of between $83,000 and $117,000 (depending on the marginal tax rate) which is covered by the estate. This reduces the amount that is passed on to her children.
Each child then receives their share of the inherited assets – worth between $958,500 and $941,500 each.
As the new owner of Jenny's CGT assets and a non-resident for tax purposes, Charlotte will not have to pay CGT in Australia when she sells the assets.
But Scott, as a tax resident, will need to pay CGT when he sells. This means he will effectively be paying more tax on the inherited assets than his sister paid.
How to make it fair
To avoid this situation, Jenny could potentially put an allocation clause in her will along the following lines:
Notwithstanding any other provision of the Will, I direct that any tax arising by virtue of section 104-215 of the Income Tax Assessment Act 1997 (Cth) in respect of any gift made under this Will is to be borne by the beneficiary receiving this gift. In this regard by Executors will:
a) reduce the amount of this gift by the amount of that tax, or
b) as a condition precedent to the transmission of the gift, obtain a reimbursement from the beneficiary for the amount of the tax.
With an allocation clause, CGT event K3 is still processed on the date of Jenny’s death, generating a tax bill of $83,000 to $117,000. But this is covered only by Charlotte as the overseas beneficiary. Charlotte can choose to have her inheritance reduced by the amount of the tax or to pay the CGT bill directly herself.
As the resident beneficiary, Scott is not impacted by a tax that he didn't trigger and won’t “double-dip” on CGT when he eventually sells his inherited investment.
The exception to the rule
It’s important to note that CGT event K3 doesn't apply to taxable Australian property – including land and real estate.
This is because foreign residents must pay CGT to the Australian Taxation Office when they sell taxable Australian property – just like Australian residents. CGT is collected by the ATO when the foreign resident sells the asset rather than upfront when they receive it as an inheritance.
A considered approach to CGT event K3 can make a meaningful difference to how fairly an estate is ultimately shared. By planning ahead and seeking informed advice, parents can ensure overseas residency doesn’t inadvertently advantage or disadvantage any child. Leaving clear instructions in a Will can help protect family harmony and preserve the intentions behind a lifetime of asset building.
Chris Holloway, senior manager, Taxation Services at Equity Trustees
