March 25, 2021
DO YOU HAVE CHILDREN LIVING OVERSEAS? WHEN YOU LAST SPOKE TO YOUR ESTATE PLANNING LAWYER, DID YOU DISCUSS THE POTENTIAL TAX AND FIRB IMPACTS ON YOUR ESTATE?
Your estate plan should achieve two overall objectives:
1. Getting the right assets to the right people at the right time; and
2. Achieve Objective 1 in the most tax and cost-effective way possible.
When a beneficiary, usually a child, of a testator is living overseas, it adds a layer of complexity to any estate plan as capital gains tax (CGT) event ‘K3’ and Foreign Investment Review Board (FIRB) regime needs to be considered. Below we will consider these issues in turn. However, the simplest solution to both issues is the same - the best asset to give a beneficiary living overseas is cash. How easily can this be achieved in your estate?
CGT event K3
In a nutshell, where an asset of an estate (one that is not real property i.e. land) passes to a ‘foreign resident’, that passing of the asset is treated as a disposal for tax purposes, and capital gains tax needs to be paid by the estate (or the Will might provide this cost is to be borne by the beneficiary receiving the asset). If the estate is liable for the tax, there needs to be enough cash in the estate to pay the tax liability.
Let us look at an example.
Bob purchased 60% of shares in XYZ Pty Ltd (a private company i.e. not a publicly listed company) for $10,000 in 1992. In Bob’s Will signed in 2010, Bob gifted those shares to his eldest daughter, Jill, who has lived in the United States since 2017. Although Jill is an Australian citizen, she is a foreign resident for tax purposes.
Upon Bob’s death in January 2021, those shares are now valued at $100,000. Bob’s estate is liable for the tax on the increase in the value of the shares.
In this scenario, was it the intention that the estate foot the tax bill? Should Jill pay the tax? Was Bob’s intention to simply gift Jill $100,000?
We commonly see CGT event K3 create an issue where shares (either in a family company or publicly listed company) pass to a child living overseas.
Further, we have witnessed unadvised and unsuspecting executors mistakenly appropriate company shares to a foreign resident’s share of an estate, giving rise to a K3 event.
The Foreign Acquisitions and Takeovers Act 1975 (Cth) regulates the interests that foreign residents can acquire in Australian property (e.g. land, houses, securities and business).
New regulations introduced in January 2021 removed the exemption for any property transferred to a foreign resident under a Will. This means persons who are foreign residents cannot acquire an interest in Australian property gifted to them under a Will without FIRB approval. There are some specific exemptions: for example, Australian citizens do not need FIRB approval when acquiring Australian land but may require it for other property (e.g. business and entities).
There are a number of solutions here, for example, applying for FIRB approval (and paying the relevant application fee, which is no small sum), giving some other asset to the beneficiary in place of the property, selling the property and gifting the remaining cash (after tax) to the foreign resident beneficiary, or some other arrangement as agreed between the beneficiaries.
Where a FIRB application is made, the fee should generally be paid by the beneficiary receiving the property. A possibility also arises that FIRB approval might not be granted. Ideally, a properly drafted Will should contemplate the range of possibilities.
Let us look at a further example.
Following from Scenario 1, Bob owned a property in Coorparoo, Queensland valued at $800,000. Apart from the shares in XYZ Pty Ltd, it is the main asset in his estate. In addition to these shares, he has gifted a one-third interest in Coorparoo residence to Jill.
Jill did not obtain FIRB approval for the acquisition of the shares in XYZ Pty Ltd or the residence (though it is not required for the residence at this time because she is still an Australian citizen) and prefers both assets to be sold.
In this scenario, is Bob comfortable with his residence being sold? Is there an option for the other children to acquire the property from the estate, so they can keep the property and give Jill cash? Who pays the tax liability on the sale of the property?
Testamentary discretionary trusts
One of the greatest assistance you can give to your children living overseas is flexibility in the manner in which they receive their share of your estate.
Under your Will, you can pass your estate to your beneficiaries in two ways:
1. Direct gift
This is the traditional and most common way to gift property to a beneficiary under a Will. For example, “I give my shares in XYZ Pty Ltd to Jill”.
2. Testamentary discretionary trust
A trust established under your Will for the benefit of the primary beneficiary and their family. For example “I give my shares in XYZ Pty Ltd to the Jill Estate Trust”. The Jill Estate Trust is a testamentary trust established for the benefit of Jill and her family.
It is impossible to know your children’s circumstances at the time of your death. Which of the above gifting options (i.e. direct gift or a testamentary discretionary trust) works best for your children will depend on the assets of the estate, the child’s living situation and personal circumstances at the relevant time. Often the key to future planning is flexibility.
At McInnes Wilson Lawyers, we create flexibility in our clients’ estate plans by utilising testamentary discretionary trusts with an ability to ‘opt-out’ of the trust. This gives children residing overseas the option to seek advice at the time and decide whether to receive their share of the estate either directly, via a testamentary discretionary trust or a mixture of both.
Take home message
Regular review of your estate plan can save your estate and your beneficiaries’ needless expenditure on time and tax.
Seeing an estate planning lawyer to discuss these issues does not have to be complicated or confronting. We ask our clients to call us to arrange an appointment and come with the answers to the following questions in mind:
1. What are the circumstances around your child living overseas?
How long has your child been overseas? Is it their intention to return to Australia? Do they have a family overseas or in Australia?
2. Is there any particular asset that you wish to go to your child living overseas?
Consider what assets your child is likely to receive. If the main asset in your estate is the family home, how do you feel about the house being sold (if necessary) before being gifted to your child living overseas? Who do you wish to pay the tax? If a specific asset is to go to your child living overseas (e.g. shares), is it the asset itself that you want to go to them, or is it the value (meaning it could be substituted with something else, such as cash)?
3. Have you considered the use of testamentary discretionary trusts?
Flexibility is the key to dealing with children living overseas. Have you given your children the most flexible arrangements possible?
Consider whether you have gifted the assets in your estate to your children directly (in the traditional way) or to a testamentary discretionary trust? Have you given your child the flexibility to ‘opt-out’ of the testamentary trust?
If you are interested in revisiting your estate planning, please contact us for an appointment.