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Equity Trustees advising beneficiaries On tax options

Beneficiaries may not receive an equitable share of an estate thanks to the Australian tax system’s treatment of overseas residents. 

Around one million Australians living overseas  could receive a nasty tax bill if they're in line to receive an inheritance. 

The problem arises because non-residents must not only abide by the tax rates and laws of the country they live in, but also navigate the Australian taxation system. 

"It's the one thing we get the most queries about," Equity Trustees Senior Manager Taxation Services, Chris Holloway, said.

The result is beneficiaries could:

have their inheritance unknowingly reduced by the tax imposed on other beneficiaries.
receive radically different after-tax distributions from an estate even if the deceased wanted them to receive equal shares.

This situation occurred recently when an $11 million share portfolio was left equally for one beneficiary in Australia and one overseas. 

Unfortunately, a share of the portfolio's $4 million of embedded capital gains would be triggered under Australian law because half of the portfolio was being inherited by a non-resident (this is known as a CGT Event K3).  

As the will was silent, all beneficiaries would have their inheritance reduced by taxes imposed on the estate.

If the estate sold the shares, it would generate a $1.1 million tax bill for the estate to pay before distributing the cash. If the shares were split equally between the beneficiaries, it would generate a K3 capital gains tax liability to the estate of $480,000 on behalf of the non-resident.

Fortunately, Equity Trustees was able to advise the beneficiaries of another option. 

If the non-resident's half of the portfolio was comprised of shares with lower embedded capital gains, it would reduce their K3 capital gains tax liability to just $47,000. This option would reduce the tax burden and maximise the inheritance available. Both beneficiaries agreed, even though the Australian resident now had a higher embedded capital gain attached to their shares.

"The resident beneficiary subsequently sold down their inherited assets and created a large capital gain, but then donated that money into a new private ancillary fund, and therefore had the tax deduction to go with it."

Including a tax allocation clause in a will can avoid this issue. It specifies that any tax payable as a result of K3 is to be borne entirely by the beneficiary who triggered it (instead of by the estate, which means all beneficiaries).

"No one can predict the future and where your beneficiaries are at any particular point in time, so it's something to contemplate putting in your will."

This article and more appears in Edition 4 of Generation magazine – View this edition here and previous ones.

*Taylor, A., Tan, G., & McDougall, K. (2021, September 10). COVID has made one thing very clear — we do not know enough about Australians overseas.
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