Edited version of private advice

Authorisation Number: 1051534781906

Date of advice: 24 June 2019

Ruling

Subject: CGT Event K3

Question 1

Will the transfer of property to a DGR under provisions of the Last Will and Testament result in the occurrence of a CGT event K3?

Answer

Yes.

Question 2

Will any gain arising from the CGT event K3 be disregarded under section 118-60 of the Income Tax Assessment Act 1997?

Answer

Yes.

Question 3

Will sections 78(2) - (4) of the Income Tax Assessment Act 1936 apply to deny the deduction to the Taxpayer?

Answer

No.

This ruling applies for the following period:

1 July 2018 to 30 June 2020

The scheme commences on:

15 November 2016

Relevant facts and circumstances

The Last Will and Testament

The Last Will and Testament (the Will) of the deceased was the final testamentary disposition of the deceased.

A copy of the Will was provided with the Private Ruling Application.

The Will dealt with the assets of the Estate as follows:

·        Specific pecuniary legacies were bequest under the Will and payable.

·        Pursuant to the Will, named individuals were given entitlement to occupy the deceased's home as their principal place of residence during their respective lifetimes. Furthermore, it was provided that all expenses in respect of rates, strata levies, insurances, Land Tax and maintenance of the property be borne by the Estate of the deceased.

·        The residual balance of the estate, after payment of specific legacies and entitlement was to be gifted in equal proportions to DGR1 and DGR2, pursuant to the Will.

As at the date of death, the assets held by the deceased included residential real estate, cash and shares in public companies.

Therefore, it is proposed that the residential real estate be transferred to both the DGRs.

As a result of claims made against the Estate, the following arrangements were entered into:

·        As provided by order of the Supreme Court, an amount was to be paid by the Estate to a claimant to cover personal legal costs. A further cash gift was agreed to be paid to this claimant by the DGRs upon them selling the property. Legal costs incurred by the Executors in relation to this claim, were also funded by the Estate.

·        To compensate the named individuals for the release of their entitlement to occupy the property for their lifetimes as prescribed in the Will, a cash payment was made to them in accordance with the subsequent separate agreement made between the parties.

·        An agreement has been made in principle for indemnities to be provided by both DGRs to cover future claims and other expenses of the Estate as there are not sufficient liquid assets (ie: cash) to settle these current claims or any potential claims. Hence a payment will need to be made by the DGRs to satisfy the indemnity. No other party will be obligated to settle any current or potential future indemnity.

Beneficiaries to the Estate

The claimant is the only child of the deceased, and was originally excluded from the Will. On the basis of the Supreme Court order, he was paid a cash sum but can no longer make any additional claims against the Estate.

The individuals were unrelated to the deceased.

DGR1 is a public benevolent institution based in Australia. In accordance with the Australian Charities and Not-for-Profit Commission (ACNC) DGR1 is a registered charity and a deductible gift recipient (DGR).

DGR2 is a public ancillary fund who provides grants to an Institute of Medical Research, an Australian based medical research institute. In accordance with the ACNC, DGR2 is a registered charity and a DGR.

The Estate has been instructed by the beneficiaries that upon receipt of the property, it will be sold through an open market auction process, with the sale being made to the highest bidder.

The beneficiaries have a standard process for dealing with bequests of property. This involves:

·        obtaining an independent valuation of the property;

·        appointing an auctioneer / real estate agent;

·        advertising the property in accordance with standard sale procedures.

It is the Executors' strong preference that the property by transferred to the DGRs who will organise the sale of the property. DGR2, in particular, is used to dealing with the sale of properties, has a standard process for dealing with bequests and has the skills and resources to organise and execute the sale. The Executors are concerned with additional personal risk if they were to sell the properties themselves, particularly the potential risk if the beneficiaries formed a view that due process was not taken and potential maximum value was not achieved on the sale. In addition, the Executors would need to make significant time and resource investment to organise the sale, as they do not have the same level of infrastructure to organise the sale as the DGRs.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 78

Income Tax Assessment Act 1936 subsection 78A(2)

Income Tax Assessment Act 1936 subsection 78A(3)

Income Tax Assessment Act 1936 subsection 78A(4)

Income Tax Assessment Act 1997 Division 30

Income Tax Assessment Act 1997 section 30-15

Income Tax Assessment Act 1997 Division 50

Income Tax Assessment Act 1997 subsection 104-215(1)

Income Tax Assessment Act 1997 subsection 104-215(3)

Income Tax Assessment Act 1997 subsection 104-215(4)

Income Tax Assessment Act 1997 subsection 104-215(5)

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 subsection 109-5(2)

Income Tax Assessment Act 1997 section 118-60

Income Tax Assessment Act 1997 subsection 118-60(1)

Income Tax Assessment Act 1997 section 128-20

Income Tax Assessment Act 1997 subsection 128-20(1)

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Question 1

Summary

The transfer of property to a DGR under provisions of the Last Will and Testament of the deceased will result in the occurrence of a CGT event K3.

Detailed reasoning

CGT event K3

Section 104-215(1) of the Income Tax Assessment Act 1997^[1] states that:

CGT event K3 happens if you die and a CGT asset you owned just before dying passes to a beneficiary in your estate who (when the asset passes):

(a)       is an exempt entity; or

(b)       is the trustee of a complying superannuation entity; or

(c)       is a foreign resident.

Meaning of exempt entity

An "exempt entity" is defined in section 995-1 as an entity whose income is exempt from income tax because of Division 50 or a Commonwealth law other than the Income Tax Assessment Act 1997.

It is considered that the DGRs are exempt entities pursuant to Division 50 as they are both registered charities with the ACNC and have received endorsement from the Commissioner.

Time at which the entity must be a "tax-advantaged" entity

Section 104-215(1) specifies that the entity must be a "tax-advantaged" entity at the time when the asset passes to them. When an asset "passes" to a beneficiary is set out in section 128-20.

Meaning of asset "passing" to a beneficiary

The exemption rules for the transfer of an asset from the executor of a deceased estate to a beneficiary require the asset to have "passed" to the beneficiary. Section 128-20(1) provides that an asset is taken to have "passed" to a beneficiary when the beneficiary becomes the owner of the asset in any of the following circumstances:

·        under a Will or a Will varied by court order;

·        by operation of intestacy law;

·        by appropriation to a beneficiary;

·        under a Deed or arrangement; or

·        by absolute entitlement.

A Will or a Will varied by court order

An asset passes to a beneficiary where it has been bequeathed specifically to the beneficiary. Also it would include an in specie distribution to the beneficiary which is made in order to satisfy their entitlement to a share of the deceased estate. This is provided it is done in accordance with the terms of the Will or the Will as varied by a court order. If a Will is varied by a court order, the same rules apply regarding the time of acquisition and the cost base of the bequeathed assets.

It is considered both DGRs were both "tax-advantaged entities at the time when the assets pass to them in accordance with the Will and the variation made by the Supreme Court.

Non-application to cash appropriations

Cash appropriation would not fall within the terms of CGT event K3. This is because cash is not a CGT asset within the meaning of section 108-5.

The DGRs will only be receiving real property under the terms of the Will.

Time of event - Just before you die

CGT event K3 happens immediately prior to the death of the taxpayer: section 104-215(3). This means that CGT event K3 applies to the deceased rather than the estate: see note to section 104-215(4). As a result, the capital gain or capital loss is returned in the taxpayer's date of death return.

The tax advantaged beneficiary is taken to have acquired the asset when the taxpayer dies (section 109-5(2)).

As such, the capital gains from the gifting of the real property will need to be shown in the deceased's date of death return.

Capital gain or capital loss

Section 104-215(4) states that a capital gain arises to the deceased taxpayer if the market value of the asset on the day of death is greater than the asset's cost base, while a capital loss will arise if the market value of the asset on the day of death is less than the asset's reduced cost base.

As a result of the operation of section 104-215(4) any capital gain or capital loss forms part of the tax return for the deceased taxpayer to the date of death. Note that, a capital loss can be used to offset any capital gains of the deceased and that any unused capital losses of the deceased cannot be used by the trustee of beneficiaries of the estate.

Therefore all capital gains will need to be included in the deceased's date of death return.

Exceptions

Section 104-215(5) provides the usual exceptions for pre-CGT assets. Specifically it provides that a capital gain or capital loss will not arise under CGT event K3 for assets of the deceased acquired before 20 September 1985.

The note to section 104-215(5) provides that an exception applies if the CGT asset forms a testamentary gift of property under the Cultural Bequests Program: see section 118-60. This would include a scenario where the CGT asset forms a testamentary gift of property to a DGR because the testamentary gift of property would have been deductable to the deceased under section 30-15 had it been made by the deceased before they died.

This is further considered in response to question 2 below.

Question 2

Summary

Any gain arising from the CGT event K3 will be disregarded under section 118-60.

Detailed reasoning

Exemption from CGT for Testamentary Charitable Gifts of Property

Section 118-60(1) states that:

A capital gain or capital loss made from a testamentary gift of property that would have been deductible under section 30-15 if it had not been a testamentary gift is disregarded.

The conditions for exemption of CGT gain under section 118-60(1) are as follows:

·        the gift must be property;

·        the deductible gift recipient must be in Australia.

In general, a deduction is allowed for gifts to deductible gift recipient (DGR) organisations listed in items 1 and 2 of the table in section 30-15. The relevant part is set out below.

Note: Effective from 1 July 2006, there is no value threshold for this exemption.

Both DGRs, have received endorsement from the Commissioner and are both in Australia.

Therefore the capital gain the deceased derived from the transfer of her real property to the DGRs will be disregarded under section 118-60.

Question 3

Summary

Sections 78(2) - (4) of the Income Tax Assessment Act 1936 (ITAA 1936) will not apply to deny the deduction to the Taxpayer.

Detailed reasoning

Certain gifts not to be allowable deductions

Section 78 of the ITAA 1936 was repealed as inoperative by No 101 of 2006, section 3 and Schedule 1 item 86, effective 14 September 2006.

Therefore, section 78A was introduced to overcome a number of tax avoidance schemes devised to exploit the gift deduction provisions of Division 30 Income Tax Assessment Act 1997 (ITAA 1997).

Section 78A of the ITAA 1936 does not apply to deny deductions for genuine gifts made under ordinary circumstances[2]. However, it may apply to deny deductions for gifts involving the obtaining of any benefit, right, or privilege by the giver or the giver's associate. Section 78A(3) can operate to deem a giver or giver's associate to have received a benefit under various circumstances.

Section 78A(2) of the ITAA 1936 tells us that a gift of property made by a donor to a fund, authority, institution or person is not an allowable deduction under Division 30 if:

·        the gift is expected to be less than then value when the gift was made; or

·        if the fund, authority, institution or person will incur a detriment because of the transfer; or

·        if the donor will obtain a benefit because of the transfer; or

·        if the donor will receive any property directly or indirectly because of the transfer.

The deceased made the transfer of the property to the DGRs, through the operation of CGT event K3. The transferees, i.e. the DGRs will not incur a detriment because of the transfer, nor will the gift be expected to be less value as they will receive the properties in their entirety. The deceased or the estate will not be receiving a benefit or other property as a result of the transfer. Therefore it is considered that section 78A(2) will not apply.

Section 78A(3) of the ITAA 1936 provides that a gift of property made by a donor to a fund, authority, institution or person is not an allowable deduction under Division 30 if the fund, authority, institution or person does not receive an unconditional right to retain custody and control of the property to the exclusion of the donor.

It is considered that section 78A(3) will not apply because when the property is transferred to the DGRs the Last Will and Testament will give the transferees an unconditional right to retain custody and control of the property to the exclusion of the deceased and the estate.

Section 78A(4) of the ITAA 1936 provides that a deduction under Division 30 will still occur if the value of the property transferred is less than market value because the estate incurred reasonable expenses to effectuate the transfer.

It is considered that section 78A(4) will apply to allow the deduction under Division 30 as it is likely the estate will incur reasonable expenses to effectuate the transfer of the property to the DGRs.

Conclusion

In conclusion, CGT event K3 will apply to the deceased directly and be as though she transferred the property to the DGRs herself at the time of her death. Therefore any capital gains made will need to be reflected in her date of death return.

Section 118-60(1) will then apply to disregard those capital gains as the property is being transferred to endorsed DGRs.

Section 78A will not apply to deny any deductions made in respect of those capital gains.

[1] All references are to the Income Tax Assessment Act 1997 unless otherwise stated.

[2] Taxation Ruling TR 2005/13: Income Tax: tax deductible gifts - what is a gift.