6. Drafting Wills – factoring tax into account when dividing assets among beneficiaries

When the time comes to prepare a Will, you or your client may decide to leave particular assets to specific beneficiaries. When doing this, it pays also to consider the tax liability that the beneficiary may be faced with when they eventually sell the asset that they inherit, as you may unintentionally leave one beneficiary with a higher tax liability than the other.

Current at 1 January 2022

6. Drafting Wills – factoring tax into account when dividing assets among beneficiaries

When the time comes to prepare a Will, you or your client may decide to leave particular assets to specific beneficiaries. When doing this, it pays also to consider the tax liability that the beneficiary may be faced with when they eventually sell the asset that they inherit, as you may unintentionally leave one beneficiary with a higher tax liability than the other.

Current at 1 November 2021

Where a beneficiary inherits an asset such as the testator’s main residence or another asset purchased pre-CGT (i.e. before the introduction of capital gains tax on 20 September 1985), the beneficiary may be entitled to significant tax benefits/concessions when they eventually sell this asset. On the other hand a beneficiary who inherits an asset that the testator had purchased post-CGT, may have a significant inherent tax liability attached to the asset.

Let’s look at an example

Joan has two rental properties to bequeath to her children, Amy and Ben and believes both properties have approximately the same market value. Joan purchased House A (before the introduction of the CGT) and House B in 1998 (post-CGT). She leaves House A to Amy and House B to Ben.

For the purposes of our example, we will assume that the beneficiaries decide to hold their properties for three years, sell at the same time, and they do not have any personal carried forward capital losses to offset against their respective capital gain.

The following table shows that Amy would only have a capital gain of $25,000 as she inherited a pre-CGT asset with a cost base equal to the value of the property when Joan died. Meanwhile, Ben has a whopping $165,000 capital gain as he inherited Joan’s cost base for the property (based on market value in 1998). The tax payable by Amy and Ben would be at their respective marginal tax rates.

House A
Pre CGT asset
House B
Post CGT asset
Market value at date of death
$400,000
Testator purchase price
$120,000 in 1998
Beneficiary’s sale proceeds
$450,000
Beneficiary’s sale proceeds
$450,000
Gross Gain
$50,000
Gross Gain
$330,000
50% Discount
$25,000
50% Discount
$165,000
Net Gain added to Amy’s taxable income
$25,000
Net Gain added to Ben’s taxable income
$165,000

 

It is worth noting that the main residence of the testator would be exempt from CGT if sold within two years of the date of death of the testator, potentially providing an even a larger tax benefit.

WILL DRAFTING

In drafting a Will that you intend will address inherent tax issues, you should consider the approach that the Courts are likely to take to its interpretation.

For example, in Todd v Todd & Ors [2021] SASC 36, the executors sought advice pursuant to section 69 of the Administration and Probate Act 1919 (SA) as to whether any inherent capital gains tax liability attached to properties that the deceased owned should be taken into account in determining the value of each beneficiary’s share of her estate.

The deceased appointed her children as executors of her estate and left them her four properties as follows:

  • Clarence Gardens property – to Wendy

  • Hawthorn property – to Yvonne

  • Goolwa property – to Bronwyn and Alexander as tenants in common

  • Millswood property – to be divided between the four children in such a manner so as to ensure that each of her four children received an equal value of bequests.

Further, clause 11(1) of the Will relevantly provided: ‘… that all benefits given by this my Will and any Codicil shall be paid delivered or retained free from all duties whatsoever which (whether presently or presumptively or prospectively payable) shall be paid out of my estate in the same manner as my funeral and testamentary expenses and debts shall be payable so that there shall be no subsequent adjustment or apportionment thereof as between any of the beneficiaries of this my Will.

Bampton J held that the latent capital gains tax liability in respect of the properties should not be taken into account in determining the value of the individual bequests:

  1. The value of the three properties bequeathed under Joan’s Will should not depend on the tax affairs of the person to whom they are bequeathed, nor is there any taxing event that arises upon such bequests. It is incorrect to say that a property bequeathed to a person in the highest bracket of income tax payable for a given year would have a higher value had it been bequeathed to a person who had nil taxable income. Such a proposition ignores the fact that CGT liability in respect of a property shall only arise when (and if) that property is disposed of, and only then will the resultant tax payable (if any) be able to be determined. As such, to value property on the basis proposed by the executors, Wendy and Bronwyn would present a nearly impossible task, as it would involve hypothesising the implications of an event which involves too many variables (including, of course, the fact that the likelihood of such event occurring cannot be discerned on the evidence).
  2. The meaning of value in clause 8 imports the ordinary meaning of value as described in Spencer. That is, each property is valued, as at the finalisation of Joan’s estate, at what a person desiring to buy the property would have had to pay to a vendor willing to sell it for a fair price but not desirous to sell.
  3. On the natural and ordinary meaning of the words in Joan’s Will, latent CGT liability in respect of the three properties is not to be taken into account in determining the value of the individual bequests under clause 8.
  4. The words “presently or presumptively or prospectively” in clause 11 must be construed narrowly. The phrase has no work to do in respect of CGT liabilities as on my construction “duties” in clause 11(1) does not include latent CGT liabilities which crystallise only upon disposal of property. On the facts of this case, where there is no evidence of immediate sale, CGT liabilities on the three properties are unknowable and unascertainable.

In reaching her decision, her Honour rejected arguments that these liabilities should be taken into account because that is the practice in family and commercial law cases.

Other interpretative issues were considered in Craven v Bradley (2021) VSC 344.

 

 

Feel free to contact our team should you want to discuss this topic further and potentially have clients who may be in this situation.

 

 

This publication is not intended to be and should not be used as a substitute for taking taxation advice in any specific situation. The information in this publication may be subject to change as taxation, superannuation and related laws and practices alter frequently and without warning.  Neither BNR Partners Pty Ltd, our employees or agents are responsible for any errors or omissions or any actions taken or not taken on the basis of this publication.