Australia: Avoiding landmines: Estate planning and CGT event K3

Last Updated: 15 February 2019
Article by Matthew Gunn and Jacqueline Brown

Most Australians would not be familiar with the capital gains tax (“CGT”) event K3.  Any such readers can be forgiven for this, as the arcane rules surrounding CGT events can be difficult terrain for even experienced tax and estate planning professionals to navigate. This short article will highlight (in plain English!) a few of the ways in which CGT event K3 can impact your estate and why consideration of its effects should be a key part of your estate planning map.

According to the Income Tax Assessment Act 1997 (Cth), CGT event K3 can occur when a person dies and a certain type of CGT asset they owned just before dying, passes to a beneficiary who (among other things) is a foreign resident for tax purposes (non tax resident). K3 only occurs in this scenario if the asset is not taxable Australian Property (“TAP”).  TAP broadly covers ownership of and interests in real estate so the relevant assets here are things like share portfolios, bank accounts and managed investments.

If a capital gain has been made on any assets that are not TAP and pass to a non-tax resident beneficiary, the estate will be liable for the tax to be paid.  This can cause further problems if the will has not been drafted to allocate any applicable CGT to a particular asset: other beneficiaries of the estate may be affected by the CGT attached to a gift they are not receiving.

The real sting to the K3 event is that the rule applies to estates structured to include a testamentary trust.  A testamentary trust works just like a family or discretionary trust, is contained in the will and is active once the executor has completed the administration of the estate and transferred the estate’s assets to the trust.  The ultimate transfer of assets from the testamentary trust to a beneficiary (which may be many years down the track) will attract K3.

K3 will also operate in the circumstances where the trustee of the trust is a non-tax resident (another point to watch out for) and where just one of the beneficiaries or even potential beneficiaries of the trust is a non-tax resident.  As Australians are increasingly likely to live and work overseas at some point in their lives (think of the pre-uni gap years), this increases the chances that a future beneficiary could be a non-tax resident and may trigger event K3.

K3 is a potential landmine that may not always be possible to avoid, but special care should be taken when drafting the terms of the will or testamentary trust to at least allow a trustee to exclude a potential beneficiary if they are a non-resident and ensure the executor has a power of appropriation to sell CGT assets if necessary.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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