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Ruling

Subject: Capital gains tax - deceased estate

Question 1

Should any capital gain from the sale of property acquired from an overseas deceased estate be included in your assessable income?

Answer

Yes

Question 2

Are you entitled to a foreign income tax offset if you are subject to tax in Australia on the same property?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You are an Australian resident.

Your relative who lived in Country X passed away in 200X.

Your relative was living in an apartment which they purchased before 20 September 1985.

The apartment was their main residence.

You inherited an interest of the apartment in 20XX.

The apartment was sold in the same year.

You received AU$XXXX from the sale of the apartment.

You paid an inheritance tax and a personal income tax on the sale of the apartment in Country X.

After your relative's death, the apartment was closed off for a police investigation. The apartment was then left vacant until it was sold.

Your relative left no will and therefore the matter had to go before the courts. Any remaining relatives had to be tracked down. Therefore you didn't inherit until some time after your relative's death.

During the time that the apartment was vacant, no beneficiary to your knowledge declared it their main residence.

You have paid various fees in relation to the apartment including reconnection fees.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 10-5

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 115-100

Income Tax Assessment Act 1997 Subsection 770-15(1)

Income Tax Assessment Act 1997 Subsection 960-50(6)

International Tax Agreements Act 1953 Section 4

Reasons for decision

Summary

Any capital gain that you made from the sale of the apartment should be included in your assessable income. This gain can be discounted. You are entitled to a foreign income tax offset for the personal income tax that you paid on the sale of the apartment in Country X up to your foreign income tax offset limit. You are not entitled to a foreign income tax credit for the inheritance tax.

Detailed Reasoning

Generally the assessable income of an Australian resident includes the ordinary income and the statutory income they derived directly or indirectly from all sources, whether in or out of Australia, during the income year (subsections 6-5(2) and 6-10(4) of the Income Tax Assessment Act 1997 (ITAA 1997)).

Amounts that are not ordinary income but are included in your assessable income by provisions about assessable income are called statutory income (subsection 6-10(2) of the ITAA 1997).

Section 10-5 of the ITAA 1997 lists the provisions about assessable income. Included in this list is section 102-5 of the ITAA 1997 which provides that a net capital gain is to be included in assessable income.

Capital gain

A capital gain or capital loss may arise if a capital gains tax (CGT) event happens to a CGT asset (section 102-20 of the ITAA 1997).

The most common CGT event (CGT event A1) happens if you dispose of a CGT asset to someone else. The time of the event is when you enter into the contract for the disposal or, if there is no contract, when a change of ownership occurs.

Real estate is a CGT asset under this provision. Thus the apartment in Country X is a CGT asset.

A capital gain is made from CGT event A1 if the capital proceeds from the disposal are more than the assets cost base (subsection 104-10(4) of the ITAA 1997). A capital loss is made if the capital proceeds are less than the assets reduced cost base.

Whatever you receive as a result of a CGT event is referred to as your 'capital proceeds'. For most CGT events, your capital proceeds are an amount of money or the value of any property you:

receive, or

are entitled to receive.

Acquisition date of a beneficiary

If you acquire an asset owned by a deceased person as a beneficiary, you are taken to have acquired the asset on the day the person died. Therefore you are taken to have acquired your interest in your relative's estate on the date in 200X that your relative passed away.

Cost to you of acquiring the dwelling

When you acquire a dwelling from a deceased estate, there are special rules for calculating your cost base.

The cost base is made up of a number of elements. These include:

the actual amount you paid to acquire the asset,

any incidental costs of acquiring the CGT asset (for example, agent commission, legal fees etc) and costs in relation to its disposal, including cost of transfer, stamp duty, legal fees, agent, valuer and accountant fees, and

any non capital costs associated with owning the asset (for example, rates and taxes, insurance premiums, non deductible interest on borrowings used to acquire the property), however you can only include non-capital costs of ownership if they could not have also been claimed as a deduction.

The tax which you have paid in Country X as a result of the sale of the apartment does not form part of the cost base.

Where the deceased acquired a property before 20 September 1985 the first element of the cost base for their beneficiaries is replaced by the market value of the property on the date of the deceased's death.

The first element of the cost base and reduced cost base of the dwelling is its market value at the date of death as the dwelling passed to you and the other beneficiaries after 20 August 1996 and it was the main residence of your relative immediately before her death and was not being used to produce income at that date.

Market value of asset

Where the market value of an asset needs to be determined, a person can choose to either obtain a valuation from a professional valuer or work out the market value using reasonably objective and supportable data such as the price paid for a very similar property that was sold at the same time in the same location.

To be acceptable, a valuation must specify a precise figure as the value of the asset. The Australian Taxation Office may challenge valuations where appropriate.

Exemption where dwelling (acquired from a deceased estate) sold within two years

Section 118-195 of the ITAA 1997 outlines the conditions under which the capital gain or capital loss can be disregarded in full. You disregard any capital gain or capital loss that you make from the disposal of a dwelling that passed to you as a beneficiary in a deceased estate or the trustee of a deceased estate if the dwelling:

was acquired by the deceased prior to 20 September 1985 (pre-CGT), and

was from the deceased's death until your ownership interest ended, the main residence of:

the spouse of the deceased immediately before the death,

an individual who had a right to occupy the dwelling under the deceased's will or

an individual, if the CGT event was brought about by the individual to whom the ownership interest passed as a beneficiary.

In your case, as the property was not sold within two years of your relative's death, you are not entitled to the full main residence exemption.

There is no discretion within the legislation to allow the Commissioner to extend the two year period.

Discount capital gain

Under the discount method you reduce your capital gain by the discount percentage. For individuals, the discount percentage is 50% (section 115-100 of the ITAA 1997). However, you can reduce the capital gain only after you have applied all the capital losses for the year and any unapplied net capital losses from earlier years.

As the apartment was owned by you and the other beneficiaries for more than 12 months you are entitled to use this method.

Foreign currency must be converted into Australian currency at time of the transaction

Item 5 of the table in subsection 960-50(6) of the ITAA 1997 says that if a transaction or event involving an amount of money or the market value of other property is to be taken into account under the capital gains tax provisions in Part 3-1 or 3-3 of the ITAA 1997, and the money or value is in a foreign currency, the amount or value is converted into the equivalent amount of Australian currency at the time of the transaction or event.

This means foreign currency must be converted to Australian currency at the time of each transaction or event. That is, amounts relevant to the calculation of a capital gain or capital loss (such as an amount included in an element of the cost base of an asset and capital proceeds) must be expressed in Australian currency before making the final gain or loss calculation.

Agreement regarding double taxation between Country X and Australia

In determining liability to Australian tax on foreign sourced income by a resident, it is necessary to consider not only the income tax laws but also any applicable double tax agreement contained in the International Tax Agreements Act 1953 (the Agreements Act).

Section 4 of the Agreements Act incorporates that Act with the Income Tax Assessment Act 1936 and the ITAA 1997 so that the Acts are read as one.

Australia has signed a double tax agreement with Country X which is called the Country X Agreement. The Country X Agreement operates to avoid the double taxation of income received by Australian and Country X residents.

Article YY of the Agreement deals with the alienation of real property. It states that income from the alienation of real property may be taxed in the country in which the property is situated. However, this does not preclude the net capital gain from being taxed in Australia.

Under article ZZ of the Agreement, an Australian resident for tax purposes, subject to Australian law, will be allowed a credit against Australian tax payable for tax paid in Country X on income which has its source in Country X.

Foreign income tax offset

A tax offset will be available for those foreign income taxes that are substantially equivalent to Australian income tax. That is, the foreign income tax must be levied on the taxpayer's income, profits or gains of an income or capital nature, or be similar to Australian withholding tax that is imposed in place of a tax on the net amount of income (Subsection 770-15(1) of the ITAA 1997).

The offset is based on the total foreign income tax paid, however, it is limited to the amount of Australian income tax that would have been payable on the relevant income (sections 770-70 and 770-75 of the ITAA 1997).

That is, when claiming a foreign income tax offset of more than $1,000 you need to calculate your foreign income tax offset limit. For information on this, please refer to the Guide to foreign income tax offset rules 2010-11 on the Australian Taxation Office website www.ato.gov.au. You can only claim an offset up to the amount of that cap. Any excess offset cannot be carried forward to a later income year.

Inheritance taxes are not taxes on income, profits or gains and therefore will not be eligible for a tax offset.

In your case, you have paid an inheritance tax and a personal income tax on the sale of the apartment in Country X. The inheritance tax is not a tax on income and is specifically excluded from being eligible for a foreign income tax offset. However, you are entitled to a foreign income tax offset for the amount you paid on the sale of the apartment subject to the foreign income tax offset limit.