CGT event K3 was brought in by the Income Tax Assessment Act 1997 (section 104-215). It affects CGT assets which are not classed as ‘Taxable Australian Property’ and which, broadly speaking, fall into one of three categories:
- Collectables (such as artwork, jewellery, antiques)
- Personal use assets (such as boats, furniture, electrical goods)
- Other assets (which can include shares, units in a unit trust, cryptocurrency or foreign currency).
A CGT event K3 is triggered when an asset which falls into one of the groups above, is transferred to a tax-exempt entity, such as a non-resident (a person who lives overseas), a charitable trust, or a not-for-profit society, association or club. ‘Transferred’ means that legal ownership of that asset had passed from the estate to the beneficiary.
Let’s take a look at one common scenario in which CGT event K3 applies.
Scenario – Non-resident beneficiary
Let’s say a father passes away, leaving an estate consisting of cash assets ($200,000) and listed equities ($1 million). For the equity portfolio, there is an unrealised capital gain at date of death of $300,000. (‘Unrealised capital gain’ refers to profit on stocks that have not yet been sold and therefore cannot be taxed, since the profit has not yet been ‘realised’.)
The beneficiaries of the father’s estate are his three daughters – two of whom live in Australia, the third in the UK where she is a non-resident for Australian tax purposes. All three beneficiaries choose to have the assets transferred to them. , Because the third daughter has non-resident status a K3 event is triggered.
What does this mean exactly? It means that because one beneficiary is a non-resident, her share of the deemed capital gain (one third of $300,000 = $100,000) needs to be disclosed in her father’s ‘date of death tax return’, which is the final individual tax return that’s always completed by a deceased person’s estate. This generates an additional tax payable of, say, $37,200.
Because the estate is responsible for paying the bills of the person who has died – including their final individual tax assessment – all three beneficiaries of the estate are liable to pay the $37,200. This is where a K3 event becomes problematic, since the two resident daughters can reasonably argue that as Australian taxpayers, they did not trigger the K3 and therefore should not have to bear the additional tax which represents a $12,400 loss each on their inheritance.
However, there are some ways to deal with this.
K3 tax clause
One way to negate the impact that a K3 event has on an estate is to insert a clause into the will specifying 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 of its beneficiaries).
This is done by way of reducing the non-resident’s end distribution – in the case above, by $37,200 – thus cancelling out the loss incurred by the other, resident beneficiaries.
An example of this clause is:
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 in respect of any gift made under this Will is to be borne by the beneficiary receiving this gift. In this regard my Executors will:
- reduce the amount of this gift by the amount of that tax, or
- as a condition precedent to the transmission of the gift, obtain a reimbursement from the beneficiary for the amount of the tax.
Cherry-picking and gifting assets
More broadly, capital gains tax on assets – including tax triggered by a K3 event – can be reduced by cherry-picking particular assets to go to particular beneficiaries. In one case of an $11 million asset portfolio, there was a total of $4 million embedded capital gain at date of death, with two beneficiaries – one resident and one non-resident. Depending on which of three approaches was taken, the resulting tax incurred was enormously different: