This article was published in this month's edition of the Law Society Journal of NSW.
Peter and Patricia have instructed you to prepare their wills. They rent the family home but own two commercial properties, each worth about $3 million and subject to a mortgage of $2.5 million. They have a share portfolio, which they started to acquire during the 1990s. Finally, they also have a self managed superannuation fund with a policy on Peter’s life for $2.5 million – to pay off the debt.
Peter and Patricia have 3 children – Michael, Bruce and Rachel. The boys live in Australia but Rachel has lived in the UK for many years. Family harmony is pretty good.
Peter tells you that on the advice of his financial planner he has made a binding death nomination for the life insurance (in the super fund) to go to his estate. Peter recalls the planner saying it would be best for Patricia to receive the death benefit but Peter worries about the debt so wants you to fix that in his will.
They want the children to inherit equal value after they have both gone. Michael uses one of the commercial properties in his business and Bruce the other. The idea is that each receive the building they use (debt free thanks to Peter’s life policy) with Rachel inheriting the share portfolio. All gifts are to be subject to a cash adjustment for equality of value.
You duly prepare the wills, have them signed with Peter and Patricia going off happy with your prompt attention and reasonable fee. As they leave they tell you they are off for their bucket trip down the Amazon with an adventure company and ‘what a comfort is to know our affairs are in order – just in case, because you never know do you?’
Well, as it happens, a few months later Rachel calls from London to tell you that tragedy has struck. Peter and Patricia’s boat was attacked by an Amazonian Rainforest crocodile. Peter was taken and Patricia, though rescued, died 6 months later. How awful you say – but the perils are not only in the Amazon....
A few days later, Henry, the long-time family accountant, asks for a copy of the will and very soon afterwards calls back to say: ‘why on earth didn’t you talk to me when the will was made?’
When he comes to your meeting with Rachel, Michael and Bruce you find out what the perils were.
Peter’s life insurance
Instead of Peter’s $2.5 million being available to reduce the debt, a tax of at least 17% on the proceeds must be paid by the estate. Further, because Peter was under 65 when he died, a portion of the proceeds will be taxed at 32%. Section 302-10(2) of ITAA 1997 provides that where an executor receives a death benefit it will be tax-free only if the proceeds must go to a death benefit dependent - usually the surviving spouse. But the will you made requires it to be paid to a creditor. Michael and Bruce are furious and ask why on earth the death benefit didn’t pass to Mum?
If it did, there would be no tax to pay - and of course Mum would have paid off the debt. Rachel is also furious because her share of the estate is reduced by one third of the tax paid.
Normally property passing under a will is CGT free so that the beneficiary inherits the CGT characteristics of the testator, but not where assets other than – effectively – real estate pass to a non-Australian resident. Rachel – a non-Australian resident – inherited a portfolio of listed company shares. In this case CGT event K3 operates as if the assets were sold just before the testator dies (s 104-215). This means the capital gains tax on the increase in value of the share portfolio since purchase is payable by the estate, as an estate expense, and therefore shared between Michael, Bruce and Rachel.
Rachel is happy but Michael and Bruce are furious (again) and ask why on earth didn’t you make the gift to Rachel subject to her paying the CGT on the shares?
Michael and Bruce’s inheritance
Both the commercial properties are valued at $3 million.
But Henry explains that while both properties were bought in late 1985 for $500,000, Michael’s was bought in July and Bruce’s in October. CGT applies
to properties acquired after
19 September 1985. While both properties pass CGT free, Michael’s cost base is market value at his parents’ deaths - $3 million - but Bruce’s cost base is the cost to his parents in
October 1985 – $500,000.
So, as at the date of death, Bruce already has an accrued capital gain of $2.5 million while Michael’s accrued capital gain is 0.
Michael is sympathetic but Bruce is furious (yet again) and says: ‘why on earth didn’t you put in the will that the accrued capital gain be deducted from the market value when working out the legacy for equality?’
Michael furious 3 times, Bruce furious twice and Rachel furious once, but also happy once. Oh well, you sigh – it could have been worse - I could have been with Peter when the crocodile got him!
This article is general information only and should not be relied on without obtaining further specific information.