CGT Event K3: More than meets the eye
By Kirk Wilson
When an Australian resident dies owning assets that are not taxable Australian property and these assets pass to a foreign resident, CGT event K3 generally applies. But there are further factors to consider when dealing with this tax matter.
There's a lot more to CGT event K3 than meets the eye.
On the face of it, the event merely applies to make the deceased subject to CGT when a CGT asset is bequeathed to a foreign resident (or an exempt entity or a superannuation fund) - instead of the usual rollover rules that apply on the death of a taxpayer.
Specifically, under CGT event K3, the deceased will be treated as having disposed of the asset just before death for its market value at that time - and will be required to account for any capital gain or loss from that deemed realisation in their date of death tax return.
However, there are several aspects to the operation of CGT event K3 that can make it quite fluid and somewhat problematic for taxpayers and their advisers.
And these aspects of its operation centre on the fact that CGT asset passes to a foreign resident and that an exception applies for taxable Australian assets (and pre-CGT assets).
MEANING OF "PASSES"
Putting aside the often difficult issue of determining if, or when, a taxpayer is a foreign resident (especially in this increasingly globalised world), the key issue is what does it mean for a CGT asset to "pass" to a foreign resident.
This is because CGT event K3 will only apply if the beneficiary is a foreign resident when the CGT asset passe to the beneficiary (s 104-215(1)).
It also means that even if the beneficiary is a foreign resident at another time, such as when the will is written or when the deceased died, they may not necessarily be a foreign resident at the time when the CGT asset will pass to a beneficiary of the estate:
- if the beneficiary becomes its owner under the will (or the will as varied by a court)
- under intestacy laws
- where it is appropriated to the beneficiary in respect of an interest in the estate
- or under a deed of arrangement to settle a claim over the estate (see s 128-20(1)).
Moreover, the ATO takes the view in TD 2004/3 that where a CGT asset is bequeathed to a beneficiary in settlement of their entitlement under the will (for example where the executor of the estate has no discretion as to its distribution), the asset will to the beneficiary when the debts of the estate have been paid following the period of the estate's administration.
At this time, according to TD 2003/3, the beneficiary will become absolutely entitled to the CGT asset regardless of when (or if) the CGT asset is actually transferred of transmitted to the beneficiary. And whether the beneficiary is a foreign resident at this time will be a question of fact (and law) - and perhaps a difficult one at that. in short, TD 2004/3 provides that a CGT asset can pass to a beneficiary prior to its transfer if the beneficiary becomes absolutely entitled to the asset as against the trustee. It also states that there is nothing in s 128-20 that makes passing of the CGT asset dependent upon the acquisition of its legal ownership by the beneficiary.
Taxable Australian Property
The Second somewhat fluid issue to consider it that "CGT event K3 happens only if... the asset (in the hands of the beneficiary) is not taxable Australian property" (see s 104-215(2)). this is because taxable Australian property will remain subject to Australian CGT regardless of its owner's residency status.
(Note that taxable Australian Property includes real property located in Australia, an indirect Australian real property interest, a CGT asset used in carrying on a business through a permanent establishment in Australia an option to acquire such assets ( see s 855-15)).
However, a problem lies in relation to indirect Australian real property interest (ie certain defined shares or trust interests). This is because it can be difficult to determine whether a share or trust interest is such an indirect Australian real property interest at a given time in view of its definition.
Moreover, for CGT event K3 purpose, it is vital to know whether a share or trust or trust interest is an indirect Australian real property interest at a particular time because "CGT event K3 happens only if... the asset (in the hands of the beneficiary) is not taxable Australian property". Presumably, this includes it status at the time it "passes" to the foreign resident.