Here’s a way to avoid triggering CGT!
Testamentary discretionary trusts are great estate planning tools because they can offer tax minimisation, asset protection and flexibility.
A testamentary discretionary trust is a type of trust created under a will, comes into existence only upon the administration of the deceased estate and has four elements: the trustee(s), the assets, the beneficiaries and the discretion.
This article focuses on the implications of Capital Gains Tax (CGT) and the use of a testamentary discretionary trust to avoid triggering a CGT event.
Capital Gains Tax is triggered on the disposal of an asset
When an asset passes to a beneficiary under a will or to the executor or the trustee of a testamentary trust this does not constitute a disposal for tax purposes (except in the case of passing to tax exempt entity that does not have DGR status and except when passing to a foreign person).
In most instances there is no Capital Gains Tax when an asset is transferred from the trustee of a testamentary trust to a beneficiary.
The liability for Capital Gains Tax is triggered when the beneficiary who has received the asset subsequently disposes of it.
The trustee can by transferring the asset to a beneficiary on a low or nil income reduce the Capital Gains Tax liability.
Also by holding the assets of an estate within a trust presents the beneficiaries with an opportunity to defer the need for the sale of assets (and therefore Capital Gains Tax).
The house that Grandad bought cheaply on the banks of the Brisbane River in 1990 is now worth $4 million.
The house can pass from Grandad to his son to his grand-daughter through the testamentary discretionary trust under Grandad’s will without triggering a CGT event.
The good news for trustees is that on 10 April 2014, the Australian Taxation Office (ATO) confirmed that it will continue its longstanding administrative practice of treating a testamentary trustee like an executor, i.e. in the same way that a ‘legal personal representative’ is treated for the purposes of Division 128 of the Income Tax Assessment Act 1997.
The impact of this is that there is no Capital Gains Tax (CGT) payable from:
- the deceased to the executor or testamentary trustee;
- the testamentary trustee to the beneficiary (unless it is a sale).
Please note, these concessions only apply to assets owned at the date of death.
Assets acquired by an executor after the date of death do not qualify, and this can be an issue for life interests.
The issue of CGT and testamentary trustees arose following the former Labor Government’s announcement in the 2011-12 Budget that it would amend the CGT provisions in order to provide greater certainty for taxpayers by fixing technical deficiencies, removing anomalies and addressing unintended outcomes in the law.
However, the current Government has so far indicated that this amendment will not be proceeding.
The result of this ATO clarification is that the taxation advantages of testamentary trusts are preserved for the time being.
Splitting the gain.
The other advantage of a testamentary trust is that any Capital Gains Tax liability incurred upon selling an asset can be split among the beneficiaries, known as “splitting the gain”.
For example, suppose two grandsons decide to sell the house that has been given to them through the trust.
The sale of the house incurs a $500,000 capital gain and a $250,000 Capital Gains Tax liability.
If there was no trust, each son, both in the top tax bracket of 49% (including the Medicare levy) would be facing paying an extra $61,250 in tax for the year.
Because the asset was owned by the trust, the sons can split the capital gains tax across other beneficiaries – their wives and children.
Each son has two children, and the maximum tax-free threshold plus rebate to their two children is about $21,000 each per year.
Let’s say their wives do not work, then they could receive $37,000 at a tax rate of 32.5%, paying a tax liability of $3,500 each.
This means the remaining liability of $46,000 each, taxed at the highest rate, would only incur a tax liability of $22,540 each.
The ability to spread the tax means that the liability faced by each son is reduced by 40%.
There is also the possibility that a trust allows for stamp duty relief, although this depends on the jurisdiction.