Tax on dying of a broken heart… 2 years on

‍‍A new private ruling gives a glimmer of hope to beneficiaries of an estate in a ‘double death’ scenario.

Generally, a capital gain or loss arising from the death of an Australian resident owner of a capital gains tax (CGT) asset is disregarded under Division 128 of the Income Tax Assessment Act 1997 (Cth) (ITAA97).¹  In particular:

• any capital gain or loss made by the deceased on the devolution of the asset to their legal personal representative (LPR) or the passing of an asset to a beneficiary of the estate is disregarded;²  and
• any capital gain or loss made by the LPR on the passing of the asset to a beneficiary is disregarded.³

Instead, the capital gain or loss is deferred (or ‘rolled-over’) until a subsequent disposal of the property by the LPR or beneficiary, with the LPR or beneficiary being deemed to have acquired the asset as at the deceased’s date of death at a cost base determined in accordance with the legislation.⁴

The Commissioner of Taxation (Commissioner) treats the trustee of a testamentary trust in the same way as an LPR for the purpose of Division 128.⁵  

Significantly, Division 128 only applies in respect of assets owned by the deceased ‘just before’ they died.⁶  This gives rise to difficulties in the context of a ‘double death’ scenario, where the beneficiary of a deceased estate dies before the CGT asset passes to them.

The double death conundrum

‍As discussed in the article ‘Tax on dying of a broken heart’ (published in the April 2021 issue of this journal),⁷  the roll-over may not apply where CGT assets pass from a deceased estate to the estate of a beneficiary and then to the beneficiaries of this second deceased estate. In this regard, the article demonstrates, through a case study involving the passing of assets from one elderly spouse to the other (who died before probate was obtained for the first deceased estate) and then to their adult child, the following:

• if the second deceased owned the asset jointly with the first deceased before the first deceased’s death: the roll-over applies to disregard a capital gain or loss on the passing of the asset to a beneficiary of the second deceased estate; and
• in all other cases: the roll-over does not apply on the passing of the asset to a beneficiary of the second deceased estate.

(For the purposes of the case study, it is assumed that all individuals are residents of Australia for tax purposes.)

The reason that the roll-over applies in respect of jointly owned assets is that, for property law purposes, the second deceased would have become the sole owner of the asset upon the first deceased’s death by operation of the principle of survivorship. For CGT purposes, this means that the second deceased would have become the owner of the first deceased’s CGT asset (being a notional 50% share in the asset)⁸  immediately upon the first deceased’s death and therefore owned that share (in addition to their original notional 50% share) ‘just before’ they died, thereby satisfying the requirement in section 128-15(1)(b). This means that the roll-over would apply on the second deceased’s death when this asset passes to the second deceased’s beneficiaries.

In contrast, where the asset is not an asset that was jointly owned by the first and second deceased, the second deceased did not own the relevant CGT asset ‘just before’ their death. Rather, all the second deceased had was a right to due administration of the first deceased’s estate which does not amount to a CGT asset equivalent to the asset to be inherited.

Treasury and Commissioner’s interpretation

Until recently, both the Treasury and the Commissioner interpreted the legislation in the above manner. In this regard:

• Treasury identified this as a technical deficiency in the law and proposed an amendment to the legislation to permit the roll-over to apply in the case of double death by deeming the second deceased to have owned the asset just before their death (this proposal was subsequently abandoned);⁹  and
• the Commissioner considered whether they could exercise their remedial power to address the issue, but ultimately decided that it was not appropriate to do so, as it would be inconsistent with the intended purpose or object of the relevant provision.¹⁰

Private ruling on double death

Early last year, a private ruling was issued by the Commissioner on the CGT implications arising from a double death situation.¹¹  The ruling potentially signals a shift in the Commissioner’s approach to the matter.

The facts in the ruling are broadly as follows:

• the first deceased (who was the second deceased’s parent) owned land that had been acquired prior to 20 September 1985 (i.e. the land was a pre-CGT asset);
• the first deceased died prior to 20 September 1985 without a will (i.e. on a pre-CGT date);
• the second deceased died after 19 September 1985 with a will (i.e. on a post-CGT date);
• by operation of the intestacy rules at the time of the first deceased’s death, the second deceased was to inherit a certain percentage share of the land;
• the second deceased’s will gave the residue of the estate to the second deceased’s sons in equal shares;
• letters of administration for the first deceased estate were issued after 19 September 1985 (i.e. on a post-CGT date);
• the land was sold some time after the deaths of both the first deceased and the second deceased (i.e. on a post-CGT date); and
• while not explicitly stated in the ruling, it would appear that:
  o the LPR of the first deceased estate was the registered proprietor of the entirety of the land immediately before it was sold;¹²  and
  o had the second deceased’s share in the land been registered in their name prior to their death, that share would have fallen into the residue of their estate and passed to their sons as tenants in common in equal shares in accordance with their will.

In that ruling, the Commissioner was asked to rule on when the estate of the second deceased estate acquired the share in the land and whether that share was a pre-CGT asset.

The Commissioner ruled that the LPR of the second deceased estate acquired the share in the land as at the second deceased’s date of death (i.e. a post-CGT date) by operation of section 128-15(2) and that the share was a post-CGT asset in the LPR’s hands. The Commissioner’s reasoning was as follows:

• the LPR of the first deceased estate was deemed to have acquired the land when the first deceased died (i.e. on a pre-CGT date) such that the asset was a pre-CGT asset in their hands;¹³
• the share in the land to which the second deceased had been entitled had ‘passed’ to the second deceased within the meaning of section 128-20(1)(b) (i.e. by operation of intestacy law) as at the date of death of the first deceased, such that the second deceased had owned the share just before their death;¹⁴  and
• as the second deceased had owned the share in the land just before their death, section 128-15(2) applied to the devolution of the asset to the LPR of the second deceased estate.

Implications of the private ruling

‍As all tax practitioners are aware, private rulings should be approached with caution as they are only binding on the Commissioner in respect of the relevant taxpayer (should the taxpayer rely on it) and not the public at large. However, they can give insight into how the Commissioner is likely to apply the law to a particular set of circumstances, which can be particularly valuable where the relevant circumstance does not appear to have been contemplated by the drafters of the legislation and there are no cases or public rulings on the matter (as in the case of double death).

In the circumstances, the private ruling discussed above is significant because the Commissioner found that the second deceased had owned the relevant CGT asset just before their death notwithstanding that the asset had not been transferred them before their death. While this may have been driven by the desire to achieve a practical outcome in the revenue’s favour,¹⁵  by making the finding, the Commissioner has opened up the possibility that, in a double death scenario, section 128-15 also applies on the passing of an asset to a beneficiary of the second deceased estate (as this also only applies where the asset was owned by the deceased just before their death).

This gives rise to an intriguing possibility: that the Commissioner may now provide an administrative 'patch' to the gap in the legislation in the context of double death through the private ruling process, by ruling that the second deceased owned the CGT asset just before their death.

Certainly, such a patch would solve many complex issues if the second deceased would otherwise be regarded as not having owned the CGT asset just before their death, for example:

• Does Division 128 apply on the passing of the asset from the LPR of the first deceased estate to the LPR of the second deceased estate? While the Commissioner ruled that it does in the private ruling, there is a strong argument to the contrary.¹⁶
• If the answer is ‘no’:
  o Does the market value substitution rule apply?
  o Who bears any CGT liability arising from the transaction? Who bears the economic burden?
  o If the asset is transferred shortly afterwards to the beneficiary of the second deceased estate (and the market value substitution rule applies on the transfer between the two estates), does it matter whether Division 128 applies on the transfer to the beneficiary?
  o If the asset was a pre-CGT asset in the hands of the first deceased and they died on a pre-CGT date:
  (a) Was the asset a pre-CGT asset in the hands of the LPR of the first deceased estate? While this was found this to be the case in the private ruling, it would appear that the answer would turn on the probate and administration act in the relevant jurisdiction.
  (b) If the answer is ‘yes’, would there be an incentive to delay the administration of both estates and retain the asset in the first deceased estate until such time as the asset is to be sold? Is this against the public interest, both in terms of tax base erosion and in terms of finalising the affairs of a deceased in as prompt a fashion as possible?  
  o Does this undermine the operation of CGT event K3 (which applies where a CGT passes to a beneficiary that is an exempt entity, foreign resident or trustee of a superannuation fund)?

The private ruling reveals that the Commissioner may now be inclined towards overcoming the inadvertent tax consequences arising from a double death scenario through the private ruling process. In the vast majority of cases, overcoming these consequences will be in the taxpayer’s favour; however, in some cases, it may not be. Given this, and in the absence of binding authority on the matter, the appropriate strategy will turn on the particular facts and circumstances and the risk profile of the parties involved.

In view of the private ruling and the Commissioner’s objective of promoting consistency of treatment for all taxpayers, it is the authors’ view that taxpayers in a double death situation should consider applying for a private ruling to obtain clarity on the operation of Division 128 to their circumstances. Where appropriate to the taxpayer’s circumstances, it may be that, through the process, the double death conundrum may be successfully navigated.

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This article was originally published in the February 2023 edition of The Tax Institute's journal, Taxation in Australia (citation T Donlan and A Manapakkam, ‘Tax on dying of a broken heart’ (2023) 57(7) Taxation in Australia 419.) The article was written by Archana Manapakkam, Special Counsel at Velocity Legal.

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[1] Section 128-10 the ITAA97. There are exceptions to this rule e.g. where the asset passes to a beneficiary thatis an exempt entity, a foreign resident or the trustee of a superannuation fund.

[2] Section 128-15(1) of the ITAA97.

[3] Section 128-15(3) of the ITAA97.

[4] Section 128-15 of the ITAA97.

[5] Law Administration Practice Statement PS LA 2003/12 ‘Capital gains tax treatment of the trustee of a testamentary trust’.

[6] Sections 128-10 and 128-15(1) of the ITAA97.

[7] T Donlan and K Peiros, ‘Tax on dying of a broken heart’ (2021) 55(9) Taxation in Australia 488

[8] Under section 108-7 of theITAA97, individuals who own a CGT asset as joint tenants are treated as if they each owned a separate CGT asset constituted by an equal interest in the asset and as if each of them held that interest as a tenant in common.

[9] Treasury proposals paper ‘Minor amendments to the capital gains tax law’ (issued in May 2011)’. The proposal was subsequently rejected by the then Government upon completion of its review of announced but unenacted tax and superannuation measures – refer to the then Assistant Treasurer’s media release ‘Integrity Restored to Australia’s TaxationSystem’ dated 14 December 2013.

[10] ATO advice and guidance regarding when the Commissioner’s remedial power has been considered but not applied for individuals, available at www.ato.gov.au/General/ATO-advice-and-guidance/Commissioner-s-remedial-power/When-the-Commissioner-s-remedial-power-hasn-t-been-used/Commissioner-s-remedial-power-not-applied---individuals/.

[11] Private ruling authorisation no. 1051943938848(issued 28 January 2022).

[12] This is based on the subject matter of the private ruling (which includes the phrase ‘double death’) and analysis(which includes consideration of whether ‘the entitlement in the property will be considered an asset owned by the…[second deceased] just before they died’).

[13] This was by operation of section44(1) of the probate and administration legislation in the relevant jurisdiction,which provided that, upon the grant of probate or letters of administration,title vests in the LPR as at the date of death. The Commissioner presumably could not rely on the deeming provision regarding the acquisition date in section 128-15(2) of the ITAA97 because the first deceased died before the CGT regime was introduced.

[14] The Commissioner does not provide any analysis in support of this finding.

[15] Presumably, the Commissioner’s finding that the second deceased had owned the asset just before their death was not just made to effect symmetry with the acquisition date for the LPR of thefirst deceased estate, but also to counter the potential argument that the asset had retained its pre-CGT status when it was eventually sold (on the basis that the LPR of the first deceased estate remained the owner of the asset).

[16] In terms of a contrary interpretation, while the LPR of the second deceased estate can receive the second deceased’s entitlement as a beneficiary on their behalf, the scheme of the legislation (which draws a distinction between a beneficiary and an LPR) would appear to not support the interpretation that Division 128 applies.

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‍This article in no way constitutes legal advice. It is general in nature and is the opinion of the author only. You should seek legal advice tailored to your individual circumstances before acting on anything related to this article.