Article - Equal Shares, Unequal Outcomes; Managing Tax Distortions in the Estate Plan - Greg Russo by taslawsociety

Equal Shares, Unequal Outcomes: Managing Tax Distortions in the Estate Plan

Greg Russo

Greg Russo Law

Even the fairest estate plans can produce unequal results once tax is considered. This session explores how different asset classes and beneficiary circumstances can distort equality, and how to plan for tax fairness. It covers:

 Factoring in CGT when allocating assets to beneficiaries

 Calculating and documenting tax equalisation provisions

 Managing differing tax consequences for superannuation, property and shares

 Addressing the CGT K3 event when bequeathing assets to non-residents

 Balancing fairness and efficiency in blended family situations

 Case studies illustrating tax distortions and strategies to redress them

Important note

The information given by Greg Russo and Greg Russo Law in this document and in Greg Russo's presentation (Information) is given in good faith but is of a general nature only. It is not financial advice.

It is not intended that the Information will be acted or relied upon. Each person's requirements and circumstances will be different and accordingly, each person should engage in professional assistance according to their own particular needs.

Furthermore, any Will (including one that includes any form of testamentary or protective trust) must be drafted to consider the particular circumstances of a will maker (including the residency and domicile of the will maker and the location of the will maker’s assets) and of the will maker’s intended beneficiaries. The illustrative clauses and sample trusts in this presentation have been prepared for educational and general information purposes only and should not be relied on as (or in substitution for) legal, accounting, financial or other professional advice.

Neither Greg Russo nor Greg Russo Law warrant or represent that the Information is accurate, reliable, complete or free from error or omissions.

None of the Information should be taken as legal or accounting advice.

Subject to any law which cannot be excluded Greg Russo and Greg Russo Law do not accept any responsibility for errors in or omissions contained in the information.

Introduction Scope

1. Estate planners are often described as “preventative practitioners” because they anticipate potential issues that may arise for their clients in the future. They should also be proactive in devising strategies to prevent, to the extent possible, potential adverse administration outcomes and promote certainty for their clients and their intended beneficiaries.

2. In the administration of estates certain estate assets have their own unique tax treatment and certain individuals can also have their own unique tax situations and consequently, the after-tax amount of an inheritance can vary markedly between beneficiaries.

3. This paper focuses on:

a. taxation issues that can arise during the administration of a deceased estate and how they may impact on a testator’s intentions regarding the distribution of their estate between their beneficiaries; and

b. how estate planners can “ plan for tax fairness” noting that “fairness” will be defined with reference to a client’s planning instructions.

4. The paper is not intended to be a comprehensive treatment of deceased estate tax issues but instead, highlights some of the common issues that can arise in estate administration and provides some strategies that may be used to promote bespoke tax outcomes to achieve a testator’s intentions.

5. In this paper practitioners providing estate planning advice to clients are referred to globally as “Advisors”.

Topics + structure

6. The paper (and the accompanying PowerPoint) adopt the following structure…

10. To the extent that this paper involves a focus on tax planning, the potential application of the general anti-avoidance provisions of Part IVA of the Income Tax Assessment Act 1936 (Cth) should be considered.

11. Beyond referring to the relevance of that consideration in this section, this paper does not further consider this aspect of the planning process.

Preliminary observations

12. The paper commences with a consideration of a Global Case Study and some preliminary observations .

Global Case Study

13. Consider the following factual matrix

Bob’s financial position…

 He owns his home, valued at $1M.

 He owns an investment property, valued at $1M, with a cost base of $750K.

 He has a share portfolio, valued at $1M with a cost base of $500K.

 He has a superannuation member balance of $500K, mainly taxable, in an SMSF

 He has cash and term deposits of $2M.

Bob’s domestic situation…

 He is single.

 He has two children:

o Dylan aged 21.

o Nina aged 16. Nina is severely disabled.

Bob’s Global Testamentary Intentions…

 Overall, his estate is to be divided equally three ways between his favourite charity, Dylan and Nina.

 Dylan and Nina are each to acquire a property in specie.

Matters for consideration…

With respect to future estate taxation issues:

 How should Bob’s Will be drafted?

 How should Bob’s estate be administered?

This case study will be further considered at the end of the paper.

Preliminary observations

Aphorisms1

14. It is useful, at this point, to consider two common aphorisms relevant to estate planning.

Where there’s a will there’s a relative.2

15. This observation is a reminder that self-interest is a big motivator. As applied specifically to more complex estate plans, that often result with blended families and Trusts

Where there’s a complex estate plan there are often a lot of trust beneficiaries and different family members with their own individual focuses.

16. Reflecting on that may remind estate planning Advisors that the planning documents that they are preparing may be the subject of Supreme Court scrutiny in future litigation.

It’s all about the money.3

17. This is another saying that is particularly relevant when estate planning.

18. Advisors working with estate planning clients will be readily aware that beneficiaries are generally extremely eager to secure their respective inheritances. Often, however neither testators or beneficiaries will openly express that eagerness. In fact, testators will often articulate and express quite strongly that their family are not particularly interested in money and that they won’t fight over their inheritance.

19. A final saying that often sums up the dynamic that often develops between an Advisor and a future estate beneficiary is:

When they say that it’s not about the money, it’s about the money.4

20. It is useful for estate planning Advisors to keep that future dynamic in mind at the planning stage – and to recognise that if the estate plan doesn’t achieve the testator’s financial objectives, there may be litigious consequences for the estate (and possibly the Advisor).5

21. The paper will now explore strategies that Advisors can employ when estate planning with blended families and Trusts

22. It begins by looking at the estate planning retainer.

1 Pithy (vigorously expressive) observation which contains a general truth.

2 Ricky Gervias – and others

3 Joe Jackson, American businessman 1929 - 2018

4 Abe Martin” in 1916.

5 To the extent that third party professional liability applies – see Hill v Van Erp - [1997] HCA 9 - 188 CLR 159; 71 ALJR 48y

Taking instructions + understanding what a client wants

Global Testamentary Intentions

23. Testators regularly instruct Advisors that they desire their future estate beneficiaries to share in the wealth available after their death with regard to a specific percentage division. Sometimes that percentage is to be calculated.

a. After the value of specific estate assets allocated to particular beneficiaries are factored in; and b. Sometimes after consideration is given to the allocation of non-estate assets.

(Global Testamentary Intention).

24. This paper is not concerned with the implementation of a testator’s Global Testamentary Intention in respect of the non-estate assets.6

25. Instead, it is concerned with the impact on the value of estate assets in the hands of particular beneficiaries with a focus on the tax consequences of assets passing from a testator to beneficiaries, and the impact that those values may have on the implementation of a testator’s Global Testamentary Intention,

26. Testator’s often do not fully consider:

a. what the various estate assets will be worth after their death; and b. the tax status of those assets in the hands of their beneficiaries

27. To give effect to a testator’s Global Testamentary Intention, insofar as future taxation considerations are concerned, an Advisor needs to:

a. take comprehensive instructions and source relevant information and documentation necessary to properly understand and implement a testator’s Global Testamentary Intention; and

b. ensure that a testator has considered:

A. all of the consequences that their death will have on their current and future assets, and on the assets that they control; and

B. the likely value of those assets.

Case study

28. A basic example of a testator’s Global Testamentary Intention follows:

Simon has two children, Paul and Art. He owns his home and an investment property – each of equal value and substantial cash assets.

He desires his properties to be distributed in specie - one to each of his children and for his estate overall to be distributed equally between his two children…

Simon could provide instructions (with an alert and focused Advisor) that:

6 That could be the subject of a separate session.

 Paul’s property and Art’s property are to be valued after his death having regard to their gross values only, and disregarding latent CGT in the investment property

 Paul’s property and Art’s property are to be valued after his death having regard to the value of the latent CGT in the investment property

In each case the cash equalisation of Paul and Art’s inheritance will be different. It is obviously important to ensure that Bob’s Global Testamentary Intentions are properly understood

Summary

29. It is part of an Advisor’s role to ensure that their clients provide comprehensive planning instructions, and that those instructions are reflected in the documents that are drafted.

30. For example, there is no reason why, in the above case study, a clear statement of Simon’s intentions couldn’t be included in the body of a Will – but as will be seen later in the paper that won’t guarantee a dispute-free administration.

31. This paper now analyses some of the more bespoke options available to succession practitioners to implement Global Testamentary Intentions with reference to taxation considerations at the planning stage and also at the estate administration stage.

The basics – keeping tax options open

Generally

32. Advisors can add value to the work that they undertake for their clients by ensuring that their clients understand that:

a. a focus on taxation consequences in the administration of their future estate; and b. flexibility in the allocation of assets between their beneficiaries

can create positive tax outcomes for the administration of the estate - and to then draft planning documents and create an estate plan accordingly.

33. It is recommended that the following basic options be included in an estate plan unless Advisors are provided with instructions to the contrary.

34. These options can be:

a. incorporated in clauses in template documents; and

b. provided in information in fact sheets; and

c. provided by way of advice in client letters,

thereby empowering clients to make informed decisions in respect of these matters and also assisting clients to appreciate and value the work that an Advisor is undertaking for them.

Direction as to Priorities

35. As an initial step, an Advisor can recommend to a client that they include a specific direction to their Executors in their Will alerting their Executors of the importance of focusing on tax outcomes when administering their future estate, and directing Executors that when allocating assets, they are to have regard to the tax consequences of doing so.

36. A sample clause follows.

It is my intention that my Executors administer my Estate in such a manner so as to give priority to the following:

 Firstly, to ensure that the division of my Estate between my beneficiaries as provided for in this Will is maintained; and

 Secondly, having regard to taxation, to consider the most cost-effective manner of dealing with the assets forming part of my Estate,

and subject to the above priorities, my Executors may pay a greater part of any asset, benefit or class of asset or benefits to a particular beneficiary or trust established under this Will.

Appropriation clauses

37. As a further initial strategy, having alerted an Executor to the importance of focusing on the tax consequences of asset allocation, it is sensible to provide an Executor with wide powers to choose how assets are to be allocated between beneficiaries.

38. An appropriation clause is a clause that will enable an executor to do so. An example of such a clause follows.

My Executors will have the power to appropriate any asset or share or interest in an asset of my estate not specifically given to a beneficiary in full or partial satisfaction of a legacy or share of residue without needing to obtain the consent of any beneficiary.

39. There are statutory powers in state trustee legislation7 affording trustees and Executors with asset appropriation powers, however there are restrictions in the powers provided to Executors in such legislation - for example a requirement for the consent of beneficiaries affected.

40. A bespoke appropriation clause in a Will can provide an Executor with greater authority and power to manage tax issues.

Case Study

41. A case study follows

Joni and has no children. She owns her home and a share portfolio with embedded capital gains.

She desires her assets to be distributed, after her death, equally between her adult niece and a registered charity that is also a deductible gift recipient.

Her solicitor drafts her Will to include both:

 A Direction as to Priorities clause; and

 An Appropriation clause providing broad powers to her executor to appropriate assets.

After her death, her Executor is not required to distribute half of the home and the share portfolio to each beneficiary but instead can consider the benefits and (appropriateness)8 of distributing more of the CGT assets to the charity to achieve a more favourable tax outcome.

7 For example, Section 46, Trustee Act 1925 (NSW), Section 46 Administration and Probate Act 1958 (Vic).

8 Subject to considering Part IVA ITAA 1936.

A more bespoke approach

Tax laws…

42. Beyond “keeping options open” Advisors can actively seek bespoke instructions from their clients to include mechanisms in their Wills to specifically have regard to, and address, tax issues which may arise in the administration of their future estates.

43. Australia has an idiosyncratic tax regime for deceased estates, with a combination of pitfalls and concessions for Executors9 to consider.

44. The taxation of deceased estates10 can be complex. That complexity means that as the result of the death of a taxpayer:

a. A variety of taxation issues may arise that need to be addressed; and that, b. Opportunities exist to achieve bespoke and beneficial tax outcomes for the deceased’s intended beneficiaries.

45. With forethought, planning and, where appropriate, bespoke treatment of testamentary and other documents, future taxation issues can often be addressed at the time that an estate plan is devised and implemented at the time that the estate or testamentary trust is being administered.

46. To do so adds value to the service provided by Advisors and minimises the possibility of a future negligence claim.

47. In order to effectively plan for future estate taxation issues, at the estate planning stage, and to implement them at the estate administration stage, as they arise, an Advisor must:

a. have an up to date and working knowledge of the taxation laws as applied to deceased estates and their administration, and as applied to testamentary trusts. b. be able to anticipate what taxation issues may arise in the future and be able to devise strategies to address those issues; and

c. be able to identify when additional expertise is required from specialist accountants, financial advisers, superannuation advisers, solicitors and barristers, and be thoroughly familiar with the law of Will Construction.

Will Construction

48. To understand the scope of instructions required to draft a testator’s Will to give effect to their Global Testamentary Intention, an Advisor needs to have a good understanding of Will Construction. The case of Fell v Fell, 11 is authority for the following propositions:

a. the meaning of a Will must be discovered from the writing itself, aided only by such extrinsic evidence as is necessary to enable it to be understood.

b. the plain meaning of words and sentences are to be used in determining the construction of Wills.

c. the law leans against an intestacy, however there are restrictions imposed on the avoidance on an intestacy. In particular, the doctrine that the Court leans against, and intestacy does not affect the construction of unambiguous provisions.12

49. Fell v Fell remains good law – for example, it was recently referred to in the NSW caseEstate of Guamani; Guamani v De Cruzado 13

50. With reference to the scope of this paper, the future determination as to how an estate asset should be valued may require the Court in the future to determine a testator’s Global Testamentary Intention through an assessment of the Will, rather than through the use of extrinsic evidence, because:

…at common law, the task of a court of construction is to give effect to the intentions of the testator by examination of the words used in the will, having regard to the will construed as a whole, aided as is necessary by any admissible extrinsic evidence.14

51. Depending on the precise words that are used in a Will, and the context in which they are used, a testator’s actual intention may not ultimately be given effect to, because.

…a court is not entitled to rewrite a will merely because it suspects the testator did not mean what is said in the will. 15

52. It is important therefore, that the Will itself is drafted in such a manner as to give effect to a testator’s Global Testamentary Intention, and their intentions with respect to the treatment of taxation, without recourse to external evidence.

53. It is also consequently essential that Advisors have appropriate systems in place to ensure that they obtain sufficient instructions.

54. Instruction Sheets and checklists that “remind” an estate planner to enquire as to thirdparty assets and estate planning objectives may be useful for this purpose.

Bespoke clauses

55. As set out above, this paper is concerned with one part of the estate planning process only - Will drafting and the use of appropriate Will clauses to achieve potential adjustments to the division of a testator’s estate assets that may be required to give effect to their Global Testamentary Intention, having regard to the tax treatments of those assets only.

56. Once a testator’s instructions have been ascertained, an Advisor can draft the testator’s Will16 to give effect to the testator’s Global Testamentary Intention. In doing so two bespoke Will clauses that are useful are:

a. Valuation Clauses; and b. Adjustment Clauses.

12 Jarman the on Wills, 8th edition 1951 at page 1409.

13 [2023] NSWSC 502.

14 Fell v Fell (1922) 31 CLR 268; Perrin v Morgan [1943] AC 399.

15 Craven at [75].

16and any other documents such as Superannuation Nominations, succession of Trust control documents, Powers of Attorney.

Valuation Clauses

57. Valuation Clauses set out a valuation procedure which may be required if a beneficiary is receiving a specific asset from an estate17 , and it is necessary for that asset to be valued in order to achieve a testator’s Global Testamentary Intention.

58. Some jurisdictions have legislative fallback provisions for the valuation of estate assets - but such generic provisions have significant limitations and will not apply equally to all situations.

59. It follows, that in the absence of an unequivocal valuation method and appropriate bespoke clauses in a Will, there is the risk of future estate litigation focused on identifying a testator’s intention being taken after a testator’s death.

60. As the focus in this paper is narrow, being concerned only with the impact of taxation on estate planning and administration, the type of valuation clauses relevant to the matters dealt with in this paper is similarly narrow and involves a consideration of the following:18

a. Where a beneficiary receives a CGT asset under a Will, generally the beneficiary will inherit the deceased’s cost base of the asset19 -

b. What that means is that if the beneficiary sells or otherwise deals with the asset in the future, the beneficiary may have to pay CGT as if the deceased had sold the asset themselves.

c. Calculations regarding the likely future tax payable can potentially be undertaken at the time that the asset is transferred to a beneficiary during the administration of an estate.

d. If that asset is to form part of a beneficiary’s share of an estate, is the valuation method to factor in that future liability, or ignore that future liability?

e. A simple example of such a clause is:

For the purposes of the determining the value of any asset in my estate in the hands of any of my beneficiaries, the value of any potential future tax payable on the asset as the result of a Capital Gains Tax event shall be disregarded.

A more complex example is featured in one of the cases analysed later in this paper.

61. As a resource for Advisors, more general information (and in particular, an analysis of the legislative fallback position in Victoria regarding estate valuation clauses) is provided in Appendix 1 at the end of this paper.

Adjustment Clauses

62. Adjustment Clauses can adjust the percentage distribution of estate assets to achieve a testator's Global Testamentary Intentions with reference to:

a. pre-death advancements.

b. post death distribution of non-estate assets.

c. the value of assets specifically distributed.

63. Such clauses are best used on a collaborative basis with other estate planning measures and often operate as a fallback measure only.

64. As the scope of this paper is confined to the future determination of the valuation of estate asset with reference to tax considerations, a subset of adjustment clauses only, namely Tax Equalisation Clauses, are considered later in the session.

65. As a resource for Advisors, more general information in relation to Adjustment Clauses is provided in Appendix 2 at the end of this paper.

CGT + Roll-over + the CGT K3 Event

CGT roll-over and deceased estates

The general position

66. In the majority of cases (the exceptions are set out below), the transfer of assets on death from a deceased person to the executor or beneficiary pursuant to the terms of a Will (or the relevant intestacy provisions) does not trigger a CGT event, because the unrealised gain or loss on the asset is effectively deferred until a subsequent physical disposal by either the executor or the beneficiary.20

67. Assets that had been acquired by the deceased on or subsequent to 20 September 1985 are deemed to be acquired by the executor or the beneficiary at the cost base of the deceased.21

68. Assets that had been acquired by the deceased prior to 20 September 1985 will be converted from pre-CGT to post-CGT assets by the deceased’s death and are deemed to be acquired by the executor or the estate beneficiary for the market value of the asset at the date of the deceased’s death.22

CGT roll-over and testamentary trusts

69. Although not specifically dealt with in the legislation, CGT roll-over relief is also generally available for assets passing from a deceased person to a testamentary trustee (via the executor), and ultimately to a beneficiary of the testamentary trust.23

70. Consequently, the disposal of an asset by a testamentary trust will not trigger a CGT liability until such time as it is disposed of to a third party (i.e., not the trustee or a trust beneficiary), provided that the asset was one that was owned by the deceased at the date of death.

71. If the asset was not owned by the deceased at the date of death, then the disposal by the trustee to a beneficiary will give rise to a CGT event and a capital gain or capital loss may result.

When CGT roll-over is not available

CGT Event K3

72. CGT assets are less “tax friendly”. CGT rollover relief is not available when the estate beneficiary is:

a. A tax-exempt entity, unless it is also a registered Deductible Gift Recipient (DGR);24

20 S 128-10 ITAA 1997.

21 S 128-15(4) ITAA 1997.

22 S 128-15, item 4.

23 Practice Statement PS LA 2003/12 - if the asset that is transferred to a beneficiary from a testamentary trust is an asset that was originally owned by the deceased.

b. A superannuation fund25; or

c. A non-resident taxpayer26 , except in respect of “taxable Australian property”.27

73. CGT K3 event will result from the transfer of a CGT asset to one of the above entities and in those circumstances the executor must include the capital gain in the deceased’s final tax return.28 This will generally result in less estate assets being available to divide between residuary beneficiaries – unless bespoke arrangements are made within the estate plan.

74. The K3 event is considered further below

Sale of asset to beneficiary

75. If an executor sells a CGT asset during the administration phase of the estate, CGT roll-over relief will not be available under ITAA 1997, and a CGT event will occur, because the asset will not be deemed to pass to the beneficiary for the purposes of the relevant provisions of ITAA 1997.29

76. Accordingly, the sale will be a CGT event and the estate will be liable to pay CGT on the sale – unless one of the CGT concessions are available.

General CGT planning considerations

General position

77. There are pitfalls and traps (but also opportunities) presented by the fact that many estates will comprise either or both pre-CGT and post-CGT assets, and with regard to:

a. the availability of CGT roll-over relief in some circumstances.

b. the different CGT treatment of testamentary gifts between local beneficiaries and overseas beneficiaries.

c. the different CGT treatment of testamentary gifts between non-charity, non DGR charity beneficiaries and DGR charity beneficiaries.

d. the possible sale of assets by an executor or testamentary trustee subsequent to deceased’s death.

e. the tax treatment of the deceased’s principal main residence.

To roll-over or not to roll-over – bespoke CGT provision

78. CGT roll-over relief can be avoided if that is consistent with succession planning requirements.

At the estate planning stage

24 S 104-215(1)(a) ITAA 1997. The options available to achieve positive tax outcomes when administering an estate involving DGR and non-DGR charities is complex, beyond the scope of this paper and will generally involve bespoke taxation and accounting advice.

25 S 104-215(1)(b) ITAA 1997.

26 S 104-215(1)(c).

27 S 855-15 ITAA 1997 - Taxable Australian property includes a direct interest in real property situated in Australia, a mining, quarrying or prospecting right to minerals, petroleum or quarry materials situated in Australia and a Capital Gains Tax (CGT) asset that you have used at any time in carrying on a business through a permanent establishment in Australia.

28 See the note to S 102-215 ITAA 1997.

29 S 128-15(3) and S 128-20 ITAA 1997.

79. At the Will making stage, in the case of planning for a future deceased estate, by drafting a Will that affords an estate beneficiary the option to purchase a business CGT asset from the LPR of the estate rather than receive it as an inheritance under the Will.

At the estate administration stage

80. In an existing deceased estate (after the asset owner’s death), subject to appropriate executor powers in the Will, a decision could be made by the Executor to sell a CGT asset rather than have it pass to a beneficiary in specie pursuant to the provisions in the Will.

Some reasons for a bespoke approach

Capital losses

81. It may be desirable for roll-over relief not to be invoked if capital losses are available.30

CGT Small business concessions

82. The availability of the CGT small business concessions in respect of the CGT event may also have an impact on that decision. If they are available, an outcome may be achieved whereby the CGT event occurs, and a capital gain is realised and dealt with favourably utilising the concessions, whilst still affording the CGT asset acquirer the benefit of a higher CGT cost base for the asset.

Testator intentions

83. A Testator may desire the CGT liability to be crystallised and paid as an estate expense pursuant to provisions in the Will, and thereby effectively shared by the various estate beneficiaries – rather than seeking to determine the relative entitlements of the estate beneficiaries with reference to an allowance for future potential CGT liability.

Bonus material - using Special Disability Trusts to mitigate future tax issues

84. Special disability trusts can also be used to address future estate taxation issues. Whilst a consideration of their use is beyond the scope of this paper, general material is provided in Appendix 3 to assist Advisors

Foreign residents and the K3 Event

Taking instructions and drafting accordingly

85. To address with CGT event K3 when a future estate beneficiary is likely to be a foreign resident Advisors will need to secure specific details of a testator’s instructions as to whether taxation: 30

a. is to be paid from the general property of the estate as a testamentary expense; or

b. reimbursed to the estate from the property of the gift.

Some sample clauses follow.

Sample clauses

86. If taxation is to be paid from the general property of the estate as a testamentary expense a clause such as the following can be incorporated into the Will.

My Executors will not reduce the amount of any gift made under this clause by the amount of any Capital Gains Tax payable on the gift by virtue of Chapter 3 of the Income Tax Assessment Act 1997 (Cth).

87. If taxation is to be reimbursed to the estate from the property of the gift. a clause such as the following can be incorporated into the Will.

My Executors will reduce the amount of any gift made under this clause by the amount of any Capital Gains Tax payable on the gift by virtue of Chapter 3 of the Income Tax Assessment Act 1997 (Cth).

Mitigating future tax liability

88. As with other aspects of planning practise a bespoke approach may assist in mitigating future tax liability arising from the CGT K3 Event

89. Two options that can be considered include:

a. Streaming non-CGT assets to non-resident beneficiaries31; and b. Using testamentary trusts (whose central management and control is in Australia) as beneficiaries in lieu of foreign beneficiaries.

Case

study

Leonard and Janis have two children:

 Paul, a resident in Australia; and

 Simon, resident in the United Kingdom

Leonard and Janis’ assets comprise:

 Their home valued at $1 million

 A share portfolio (with low CGT cost base) valued at $1 million

 Cash of about $4 million

The residue of the estate of the survivor is to be divided equally between Paul and Simon They draft Wills to provide that a non-resident beneficiary is liable to pay CGT arising due to non-residency.

What drafting options are available to mitigate Simon’s possible future tax liability?

31 Dealt with further below

Specific gifts and specific assets - super, property, shares

Specific gift - liability for taxation

90. Sometimes different estate assets will have different tax treatments. Some assetspecific cases are now considered.

Gift or sale

91. Testators often desire to provide a particular beneficiary with a gift of a specific asset, or the option to purchase or inherit a specific asset from an estate. The asset in question may have sentimental value to the beneficiary, or to the testator, or there may be other reasons motivating the decision.

92. Whatever the testator’s motivation, the distribution of the specific asset coupled with a Global Testamentary Intention that estate assets are to be divided “overall” on a percentage basis will require that the specific asset be valued – if its value is not nominated by the testator.

93. An asset can be specifically distributed to a beneficiary by way of a sale or as part of an estate entitlement.

94. Furthermore, a Will can include an option exercisable by a beneficiary in relation to the disposition of the asset.32

Sale to beneficiary

95. A decision may be made to sell an asset to a beneficiary. An extract of a sample Option to Purchase clause follows.

Provided my daughter Joni (Optionee) survives me by a period of thirty (30) days and I own the property at 1 Skid Row in the State of Victoria at the date of my death (Property), I give to the Optionee the personal right to purchase from my estate all of my right, title and interest in and to the Property…

Beneficiary to inherit

96. A decision may be made to gift an asset to a beneficiary. An extract of a sample Option to Inherit clause follows.

Provided my daughter Joni (Optionee) survives me by a period of thirty (30) days and I own the property at 1 Skid Row in the State of Victoria at the date of my death (Property) I give to the Optionee the personal right to have all of my right, title and interest in and to the Property appropriated to the Optionee’s share of the Remaining Balance of my Estate…

32 If an option is to be provided, various additional matters need to be considered including: a.the date by which the Option can be exercised, b.who will be responsible for the costs associated with the exercise of the option; and c. how the property is to be valued.

Generally

97. Additionally, and of particular relevance to the focus of this paper is what if any tax liability arises as a result of the exercise of the option, and who will be responsible for the payment.

Option to acquire and liability for taxation

98. If a testator’s Global Testamentary Intention requires an executor to sell a CGT asset during the administration phase of the estate, as noted above, CGT roll-over relief will not be available under the Income Tax Assessment Act 1997 (Cth) (ITAA 1997), and a CGT event will occur, because the asset will not be deemed to pass to the beneficiary for the purposes of the relevant provisions of ITAA 1997.33 The CGT liability will be a liability incurred by the estate.

99. As with the analysis of the CGT K3 event, testators should give consideration, in those circumstances, whether they are content for the estate to be liable to pay the CGT on the sale, or whether they desire the recipient beneficiary obtaining the benefit of the option to be responsible for the reimbursement of the CGT liability to the estate.

100. That consideration would generally involve the testator having regard to the relative interests of the beneficiaries and the general objectives of their estate plan The testator’s intentions in that regard should be recorded in the terms of the option clause in the Will to promote certainty

Option to inherit and liability for taxation.

101. Similar considerations would apply to a clause affording a beneficiary an option to inherit a CGT asset as part of their entitlement to share in the deceased’s estate pursuant to the Will. Although the exercise of such an option and the consequent transfer of the asset to the beneficiary by the estate may not, depending on the circumstances, result in a CGT liability for the estate, it remains prudent to anticipate that taxation may result, and for the testator’s intentions in that regard to also be recorded in the terms of the option clause in the Will to promote certainty.

Allocating taxation liability

102. An example of two alternatives for a portion of a clause allocating tax liabilityapplicable to both a sale/inherit option follow:

…. It is a condition of this option that the costs of obtaining the valuation of my Property, and any other costs (legal or accounting or otherwise) and any taxation or other liability accruing to my estate as a result of the exercise of the Option hereunder shall be borne by my estate.

alternatively,

….It is a condition of this option that the costs of obtaining the valuation of my Property, and any other costs (legal or accounting or otherwise) and any taxation or

33 S 128-15(3) and S 128-20 ITAA 1997.

other liability accruing to my estate as a result of the exercise of the Option hereunder shall be borne by (named beneficiary) personally or reimbursed by him/her to my estate on an indemnity basis, as the case may be

Choice of asset to gift

General considerations – streaming assets

103. At the time of taking instructions for the preparation of Will or drafting a testamentary trust, Advisors should advise their client of the likely tax treatment of gifts passing to:

a. a non-DGR tax-exempt entity beneficiary:

b. superannuation fund beneficiary: or

c. a non-resident taxpayer beneficiary.

because it may be possible for the client to arrange their affairs so as to make a specific bequest to that beneficiary of a non-CGT asset, or in the case of a nonresident taxpayer, of either a non-CGT asset or of taxable Australian property only.

104. As has been seen above, an Appropriation Clause will often be useful in achieving a degree of flexibility in the allocation of subject matter of a gift.

105. A number of asset specific examples are now considered

Real estate

105. Two examples of real estate assets are considered

K3 Event, foreign beneficiary, and Australian real property

106. For foreign tax residents, CGT event K3 will only occur where the asset passing to the beneficiary via the estate to the foreign tax resident is:

a. non-Taxable Australian Property; and

b. the deceased was an Australian resident prior to death.

107. Taxable Australian property includes real estate in Australia. Non-Taxable Australian Property assets include listed shares, shares in private companies, units in unit trusts.

108. As part of an overall estate plan, a sensible tax planning measure is to facilitate the streaming of Taxable Australian Property to foreign tax beneficiaries.

Deceased’s CGT Main Residence exemption

106. If a deceased’s main residence forms part of a deceased estate, there is an exemption in respect of any Capital Gains Tax that would be otherwise payable on its sale subsequent to the deceased’s death, if it is sold and the sale settles within two years of the date of the deceased’s death or in other limited circumstances.34

107. Those other limited circumstances include where it is occupied (for a period in excess of two years from the date of the deceased’s death) by, among others:

a. the deceased’s spouse; or

34 See PCG 2019/5EC in respect of safe harbour provisions in respect of an extension of that period.

b. an individual who had a right to occupy it under the deceased’s Will.35 It is not sufficient to have power in a testamentary trust enabling the trustee to grant an Occupation Right, analogous to section 11 of the Trustee Act 1958 (Vic).

108. Otherwise, a sale will result in a Capital Gains Tax event occurring at the date of the execution of the sale contract, with the cost base of the property deemed to be its market value at the date of the deceased’s death.

109. It may be possible for the client to arrange their affairs in such a way as to make a specific bequest of their main residence to a beneficiary who is in a high-income tax bracket and may benefit from the exemption more than other beneficiaries.

Superannuation death benefits

General considerations and streaming

110. Death benefits tax may be payable on death benefits depending upon various factors including:

a. the source of the funds comprising the death benefits. Funds may derive from a member’s accumulation account, a member pension account, the proceeds of a life insurance policy owned by the fund in respect of which the member is the life insured; and

b. the status of the deceased member’s ultimate estate beneficiaries. Tax legislation provides that:

A. to the extent that a Death Benefits Dependant, as defined by the tax legislation, benefits or may be expected to benefit from the death benefits, no tax will be payable on the death benefits; and

B. to the extent that a Non-Death Benefits Dependant benefits or may be expected to benefit from the death benefits, tax will be payable on the death benefits.36

A Death Benefits Dependant includes the deceased’s spouse or former spouse, a child under the age of 18 years and a dependant or a person who is in an “interdependency relationship” with the deceased.37

An extract of a sample streaming clause follows

Sample clause extract

In the event that any of my beneficiaries are Death Benefits Dependants, and Death Benefits are paid to my Estate, my Executors may determine in their discretion (in a manner consistent with my intention as outlined previously in this Will):P

 to use the Death Benefits to first satisfy gifts to Death Benefits Dependants from; and

 only after the gifts of Death Benefits Dependants have been satisfied to apply the Death Benefits to the satisfaction of non-Death Benefits Dependants’ gifts

Such a clause should ideally be paired with a valuation clause

35 S 118-195 ITAA 1997.

36 S 302-10 10 Income Tax Assessment Act 1997 (Cth) (ITAA 1997)

37 S 302-195 ITAA 1997

Tax + value consideration

111. If a tax dependent and a non-tax dependent of a testator each receive half of the testator’s death benefits, it is likely, depending upon the tax status of the death benefits paid, that the net amount payable to each beneficiary may be significantly different.

112. Ideally, the Will should specify, for the purposes of those gifts:

a. Whether that tax liability lies with the estate LPR or the beneficiary; and b. whether the gross or the net value of those gifts should be taken into account by the executor for the purposes of determining proportionality between beneficiaries.

Shares in a company.

113. Shares in companies also require bespoke consideration.

114. If a beneficiary inherits shares in a company, in addition to potential CGT liability in the future, tax on dividends paid by the company to the beneficiary shareholder could also potentially to be taken into account in valuing the shares.

Fairness and efficiency in blended families

General considerations

115. Estate planning for the modern family is complicated, and as social norms change over time the definition of “family” keeps pace with those norms. The traditional “nuclear family” where both partners are the biological parents of all children still exists, but the “blended family” where one of the partners:

a. have been previously married or in a long-term relationship; and b. where there are “step-relationships” between the partners and some or all of the children is becoming more prevalent - and open and honest communication at the planning stage can sometimes be difficult!

116. Advisors will readily appreciate that blended families provide challenges and introduce unique complexities into the estate planning process generally, because after all: … blood is thicker than water … and blended families, by definition, create two distinct beneficiary classes, often each with conflicting interests.

117. These challenges are no less prevalent when considering future estate tax consequences.

118. One common planning situation is considered in this paper, that of occupation rights

Occupation Rights

Generally

119. Often blended family estate planning clients want to make provision for their beneficiaries by providing them with the right to occupy real estate.

120. In order to obtain instructions adequate to draft appropriate planning documents an Advisor needs to have a comprehensive understanding of the operation of Occupation Rights to ensure that the documents drafted accord with the client's instructions.

121. There are numerous permutations of such rights, but they are generally categorised as either Life Interests or Rights to Reside

Occupation Rights and taxation

Scope

122. The impact of CGT on the administration of Life Interests and Rights to Reside is complex and a detailed analysis is beyond the scope of this paper. Under cover of that, a few discrete issues are addressed, ahead of an illustrative case study.

38 State taxes (stamp duty, land tax etc…) and Occupation Rights are not covered in this paper

Deceased’s main residence CGT exemption

123. As noted above, under S 118-195 of the Income Tax Assessment Act 1997 (ITAA 97) the exemption from CGT that applies to capital gains made in respect of a PPR automatically extends for period of two years beyond the main residence’s owner's death.

124. That two-year period is further extended if from the date of a deceased's owner's death until the date of a relevant CGT event the property is occupied by: an individual who had a right to occupy the dwelling under the deceased's Will39

125. An occupant pursuant to a Right to Reside will automatically satisfy that requirement.

126. Depending on the terms of a Life Interest, a life tenant may also satisfy that requirement, but it may be necessary to review the relevant planning document to ensure that in respect of the property in question the life tenant has a right to occupy, as well as the other rights of a life tenant, and not just an interest in the income of the property forming the life tenancy.

127. It is prudent when drafting a Life Interest to specifically provide a right to occupy in respect of all real estate forming part of the life tenancy from time to time.

Dealings with Life Interests and Rights to Reside

128. The CGT consequences of creating Occupation Rights and subsequently dealings with those rights are complex and often impact on:

a. the occupant under a Life Interest or Right to Reside

b. the trustee of a Life Interest

c. the Remainderman in relation to a Life Interest

d. the Residual beneficiaries in relation to a Right to reside

e. third parties dealing with the above parties

129. The ATO is views regarding the relevant CGT events that may occur are comprehensively set out in a number of tax rulings including TR 2006/14. That ruling bears careful reading. In the event that any dealings are contemplated in respect of an Occupation Right the ruling should be consulted, and if necessary, bespoke taxation advice obtained.

Occupation Rights and Centrelink

130. An assessment of financial outcomes of using Occupation Rights is beyond the scope of this paper. Under cover of that, and by way of information (not advice) as noted on the Australian Government Social Security Webpage:40

A life interest is an exempt asset unless included in one of the exceptions under SSAct section 1118(1)(c).

A remainder interest is an exempt asset unless included in one of the exceptions under SSAct section 1118(1)(h).

39 Section 118-195(1) ITAA 97

40 https://guides.dss.gov.au/social-security-guide/4/12/3/35 accessed 15 February 2026

131. When creating bespoke Trust outcomes for their blended family clients Advisors should obtain bespoke financial advice from a suitably qualified financial advisor to the extent that a consideration of Centrelink considerations for their client (or future estate beneficiaries) are relevant considerations within the estate planning retainer.

Case study

Bob and Joni are a married couple. They each have adult children from prior relationships. They own their respective assets in their respective names and have generally kept their finances separate. However, their home was acquired from funds contributed equally at the commencement of their relationship and is held in joint names.

Their Wills each provide for the entirety of their respective assets to pass to their respective children. They have obtained financial advice that the survivor will have sufficient assets to meet their financial needs without recourse to the assets of the other.

They desire for the survivor to be able to reside in the home after the death of the other but on the death of the survivor the property is to be distributed equally between their respective estates.

They consider a number of options including:

 the retention of the joint proprietorship and the execution of Mutual Wills

 the transfer of the proprietorship to tenancy in common and the creation of Occupation Rights (Life interests/Right to Reside) on agreed terms in their respective Wills:

o with the children of the first to die to be capital beneficiaries of their parent’s share in the property; and

o with clauses specifically authorising the survivor to advance funds equivalent to 50% of the value of the property to their stepchildren in full satisfaction of that capital entitlement.

Are there any tax consequences (state or federal) that they need to consider?

Calculating and documenting Tax Equalisation provisions

Tax Equalisation Clauses

132. If a testator desires that their future estate assets are to be divided between beneficiaries having regard to taxation considerations, in addition to providing a clear statement of testamentary intention, their Will needs to provide the Executor with all the tools that the Executor requires in order to give effect to that intention.

133. As has already be seen, those tools will include:

a. Clauses specifying how estate assets are to be valued; and

b. Clauses authorising the Executor to appropriate assets to specific beneficiaries.

134. In addition, once the allocation of assets has been carried out, and the respective entitlements of the beneficiaries determined, it will be necessary for the Executor to have the authority to adjust - or equalise - the entitlements of the various beneficiaries, in order to give effect to the proportional aspect of the testator’s Global Testamentary Intention.

135. A clause that provides a method of adjusting beneficial entitlements with reference to taxation considerations (in this paper referred to as a Tax Equalisation Clause) may be an effective tool to achieve that.

136. Tax Equalisation Clauses are a subset of the family of Will clauses that provide Executors with mandatory obligations, or discretionary powers to adjust beneficial entitlements between beneficiaries (in this paper, referred to as Adjustment Clauses) with regard to a variety of considerations including:

a. pre death advancements; and

b. acquisition by beneficiaries of non-estate assets41

137. An example of a Tax Equalisation Clause (which could be one part of a more comprehensive adjustment clause) ignoring latent CGT is:

My Executor is to divide the residue of my estate in such a manner as to ensure that the total value of the assets received from my estate by each of my children is of equal value; and

For the purpose of the previous subclause the value of each asset in my estate shall be determined by written agreement amongst all of my beneficiaries (within three months of the Grant of Probate of my Will) provided they are all sui juris, and otherwise.

o at the market value of the asset at the date of my death.

o without regard to any latent Capital Gans Tax that may be payable on the sale of the asset.

as determined by an appropriately qualified expert chosen by my Executor in my Executor’s absolute discretion and at the cost of my estate.

41 As the focus of this paper is narrow and concerned with adjustment with respect to taxation only, a summary of some of the more salient aspects of Adjustment Clauses is included in Appendix 2 at the end of this paper.

Illustrative Case law

Todd v Todd and Ors42

138. If a Will is silent as to whether or not latent CGT should be taken into account in the valuation of assets specifically gifted, the Court may need to make a determination in that regard with reference to the general principles of Will construction.

139. This issue was dealt with in the South Australian case of Todd v Todd and Ors

Facts

In this case, the deceased was survived by her four children:

 Wendy

 Yvonne

 Bronwyn; and

 Alexander

The deceased’s Will included a number of specific bequests:

 Her Clarence Gardens property was gifted to Wendy.

 Her Hawthorn property was gifted to Yvonne.

 Her Goolwa property was gifted to Bronwyn and Alexander as tenants in common.

Her Will then provided that her Millswood property was 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.

After her death, the executors sought advice from the Court as to whether any latent 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.

Issue before the Court

The issue before the Court was whether the latent CGT liability attaching to each of the assets specifically gifted should be taken into account in determining their respective values, the Relevant Clause being silent on that point.

Clause 8 in the Will directed that the estate was ultimately to be divided between beneficiaries in such a manner so as to ensure that:

at the finalisation of the administration of my estate all of my said children have received an equal value of bequests under this my will.

The issue was what the phrase “equal value” referred toClause 11 in the Will, which further provided as follows: 42 [2021] SASC 36

…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.

The Court’s determination

The Court held that whether CGT should be taken into account in valuing a particular asset would, in general, depend upon the precise circumstances of each case, including:

 the testator’s intentions

 the valuation method

 the likelihood of the asset being sold in the foreseeable future

 the circumstances of the asset’s acquisition; and

 the evidence of the parties as to their intentions in relation to that asset.

The Court determined in this case that:

The value of the three properties … should not depend on the tax affairs of the person to whom they are bequeathed43 and that

The meaning of value in clause 8 imports the ordinary meaning of value…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 44 and further that

…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 8.45 and also, that

the words “presently or presumptively or prospectively” in clause 11 must be construed narrowly…where there is no evidence of immediate sale, CGT liabilities on the three properties are unknowable and unascertainable.46

If the Court had determined that an asset needed to be sold, or if the Court was satisfied that a sale was likely to occur in the near future, an allowance for CGT that would be payable on such a sale may have been allowed.

Accordingly, in this case, the Court ultimately determined there was no basis to factor in potential CGT because:

43 Ibid at [54].

44 Ibid at [56].

45 Ibid at [57].

46 Ibid at [59].

 the possible liabilities in respect of the properties were unknowable and unascertainable; and

 there was nothing in the Will from which it could be inferred that such was the testator’s intention.

Takeaway points

It is unclear from this case what the deceased’s testamentary intentions in relation to latent CGT actually were. It is apparent however that if:

 a clear statement of testamentary intention had been included in the Will; and

 a mechanism for achieving that intention had been provided that it would not have been necessary for proceedings to have been issued at all, and the testator’s actual intention (whatever it was) could have been effected administratively by the executor.

140. A number of lessons can be learned from this case:

a. Failure by a testator to provide clear directions in a Will, in relation to an asset valuation process, and consequent adjustment/equalisation process may result in uncertainty and promote estate litigation.

b. It makes sense to consider possible potential tax liability resulting from a testator’s Global Testamentary Intentions on a bespoke basis at the estate planning stage:

Craven v Bradley (Craven)47

141. A Tax Equalisation Clause may have avoided the necessity of proceedings being issued in the Todd Case – however, as will be seen, from the next case the inclusion of such a clause will not always prevent litigation.

Facts

This matter involved a claim by a beneficiary of an estate against the executor in relation to the calculation of his entitlement under the Will, seeking damages and other orders.

The deceased was survived by her three children. Her estate included her home, valued in excess of $2 million, and an interest in an investment property valued at approximately $800,000 and subject to a potential future CGT liability.

The deceased’s Will distributed her entire estate between her three sons equally, subject to:

 one of her sons receiving her home as part of his inheritance; and

 one of her sons receiving her investment property as part of his inheritance.

The Will also directed the executor to effect adjustments in respect of those two in specie distributions to the extent necessary for her estate to be equalised between the three sons, taking into account the different values of the properties.

The relevant clause in the Will in relation to the valuation of the home was:

47 [2021] VSC 344.

The value of the …property should be determined by a registered valuer and on terms that would be granted to an arm’s length purchaser from my Estate.

The relevant clause in the Will in relation to the valuation of the investment property was:

The value of the … property should be determined by a registered valuer and on terms that would be granted to an arm's length purchaser from my Estate less an amount equal to the capital gains tax liability my Estate would pay if the property were sold at the date of my death.

Issue before the Court

The preliminary issues before the Court were:

 whether the notional CGT in respect to the valuation of the investment property should be calculated based on:

o what the estate would have paid if the asset was sold; or

o what the deceased would have paid if the asset was sold.

The beneficiary receiving the investment property preferred the latter interpretation because it resulted in a greater potential CGT liability and therefore a lower net amount that he had to account to the estate for

 the date at which the home was to be valued - noting that the clause in relation to the valuation of the investment property referred to a calculation being undertaken at the date of the testator’s death, but the clause in relation to the home was silent in that regard. The plaintiff argued that the home should be valued at the date of the distribution of the residue, noting that it had increased in value since the date of the deceased’s death.

The Court’s determination

The Court found against the Plaintiff in respect of both issues, determining that the reference to “capital gains tax liability” in the relevant clause was a reference by the deceased to liability that her estate would incur if it sold the property during the administration phase, and determining that the date that the home should be valued was the deceased’s date of death.

In coming to those conclusions, the Court found that the deceased intended to divide her residuary estate as equally as possible between her three sons and had obviously received and acted upon advice provided by her solicitors regarding the benefit for potential tax to be factored into that equalisation process.48

The Court also made general comments in relation to Will Construction in respect of the valuation of estate assets:

The interpretation of a will is analogous to the interpretation of a contract. This brings with it a consideration of the purpose of the will, or the purpose of its particular provisions, as well as the facts known or assumed by the maker at the time that the will was executed, applying common sense and ignoring evidence of subjective intention.

…in the context of the will read as a whole, and of the surrounding circumstances, the ordinary meaning of the words in the will do not make sense, extrinsic evidence is

48 Ibid at [76].

admissible under the ‘armchair principle’. In effect, the court is able to consider evidence of the circumstances surrounding the testator at the time of executing the will.

A court is not entitled to rewrite a will merely because it suspects the testator did not mean what is said in the will. 49

Takeaway point

When drafting clauses incorporating a valuation method, it’s important to consider all possible important methodologies and to draft the relevant clause to be as clear as possible when read not only in isolation, but also when read in the context of the Will as a whole.

Practitioners should also be mindful of the fact that no matter how carefully they draft a Tax Equalisation Clause, motivated beneficiaries may still entertain litigation after a testator’s death - and they should notify their clients accordingly.

49 Ibid at [75].

Global Case Study revisited

Bob’s financial position…

 He owns his home, valued at $1M.

 He owns an investment property, valued at $1M, with a cost base of $750K.

 He has a share portfolio, valued at $1M with a cost base of $500K.

 He has a superannuation member balance of $500K, mainly taxable, in an SMSF

 He has cash and term deposits of $2M.

Bob’s domestic situation…

 He is single.

 He has two children:

o Dylan aged 21.

o Nina aged 16. Nina is severely disabled.

Bob’s Global Testamentary Intentions…

 Overall, his estate is to be divided equally three ways between his favourite charity, Dylan and Nina.

 Dylan and Nina are each to acquire a property in specie.

Matters for consideration…

With respect to future estate taxation issues:

 How should Bob’s Will be drafted?

 How should Bob’s estate be administered?

Conclusion

142. This paper has considered some of the challenges and opportunities that Advisors face when providing advice to clients on the potential impact of future taxation issues on the administration of a deceased estate, and how:

a. asset classes; and

b. beneficiary circumstances can distort equality

143. In order to achieve a fair outcome aligned with a testator’s planning objectives it is important that Advisors:

a. have a solid knowledge of tax planning outcomes

b. have a clear understanding of the testator’s Global Testamentary Intentions; and

c. consider the use of both generic and bespoke Will clauses on a case-by-case basis.

144. In that way a client’s Will and other estate planning documents can be drafted to afford future executors the opportunity to:

a. respond to taxation challenges and opportunities

b. adopt a bespoke approach to estate administration to achieve distributive fairness

Appendix 1

Valuation Clauses - some relevant considerations

Generally

Where a testator’s Global Testamentary Intentions require assets to be valued after a testator’s death, in addition to having regard to tax and duty consequences the valuation process itself needs to be carefully considered.

This should be done, ideally, at the Will drafting stage.

Estate assets that may need to be valued include:

 shares in a company

 control of an inter vivos trust superannuation death benefits.

 life insurance proceeds

 real estate or personal assets.

Beneficiaries Consent

If a testator fails to specify a valuation process, an executor could try to obtain the informed consent of all beneficiaries to the proposed valuation methodology. Her Honour McMillian J, held in Hodge v De Pasquale51 in the context of the settlement of litigation:

…if all of the beneficiaries’ consent to the terms of settlement, then they may vary the trust without Court order, because they retain that power.52

Given, however, that different methodologies will result in different outcomes for different beneficiaries, consent may not be able to be obtained.

A default procedure in Victoria

Default position - S 49 Wills Act

Section 49 of the Wills Act 1997 (Vic) relevantly provides:

1. If:

a. there is an express or implied requirement in a will that a valuation be made or accepted for any purpose; and

b. the will does not provide a method of calculating the valuation or the method of calculating the valuation is not provided for by the law of Victoria or of another jurisdiction.

the reference to the valuation in the will is to be construed as if it were a reference to a valuation of the property as at the testator's death made by a competent valuer.

2. Subsection (1) does not apply if a contrary intention appears in the will.

51 [2014] VSC 413

52 Hodge v De Pasquale, bid at [77]

There are similar provisions in other jurisdictions.53 To the extent that section 49 applies, the valuation of property must be undertaken as at the date of the death of a testator by a competent valuer. The section does not appear to be confined to estate assets. The section offers no guidance as to how a “competent valuer” may value a particular asset.

A contrary intention

A bespoke Method

Section 49 of the Victorian Wills legislation only applies to the extent that the Court does not identify a method of calculation provided for by the law of Victoria or another jurisdiction (Method).

A common law example

For example. in the context of hotchpot clauses, the common law rule that developed in bringing advancements into account was:

Where a testator has… directed that any advances which he has …are …to be brought into hotchpot, it is a general rule of administration, whether in court or out of court, settled by practice over a long course of years, that…the distributable assets are to be valued as at the date of distribution and not at the date of the testator’s death, and that advanced beneficiaries are to be debited with interest at four per cent per annum on the amount of their advances down to the date of distribution. This rule should always be observed, unless there is an express direction in the will to the contrary generally held.54

To the extent that the Court finds a Method applicable to a particular case, Section 49 will not apply.

Testator’s intention and bespoke clauses

A Method applicable to a particular valuation process will be a fallback position only, and neither the Method nor Section 49 will apply to the extent that the Court finds a contrary intention in a Will.

It follows that in the absence of an unequivocal valuation method provided for in a Will, there is the risk of estate litigation focused on identifying a testator’s intention.

Accordingly, certainty in the valuation process and the avoidance of potential Will Construction litigation can be promoted by the inclusion of a precise valuation methodology in a Will and accompanying bespoke clauses.

53 E.g., S 45 Succession Act 2006 (NSW)

54 Re Hillas-Drake Deceased; National Financial Bank v Liddell (1944) 1 Ch 235 – headnote and applied in Coleman v Lake (1903) 3 SR (NSW) 603

Appendix 2

Adjustment clauses – some considerations

Hotchpot clauses

Historically, to achieve equality 55 between estate beneficiaries, a testator would often, include a “hotchpot clause”: in their Will. A simple example of such a clause is:

I declare that the sum of $100,000, advanced to my son BOB or so much as may be owing to me at my death shall not be charged as a debt owing to me but shall be brought into account by way of hotchpot in the division of the residue of my estate as against BOB’s share of my estate.

Hotchpot clauses can incorporate additional provisions, such as:

 specifically referencing post Will advancements

 making provision for interest

 extending the class of beneficiaries in respect of which the advancement is to be brought into account.

Hotchpot has been described as: the blending and mixing of property belonging to different persons, in order to divide it equally. 56

and its objective has been described as preventing:

… a person to whom a testator has left a share of his estate, and who has been advanced in the testator’s lifetime, from obtaining, by the combined effect of the bequest and the advance, more of the testator’s property than he intended the legatee should have57

Adjustment clauses for non-estate assets

The

increasing use of Adjustment Clauses

The introduction of mandatory superannuation contributions from 1992 and the increasing use of inter vivos Family Trusts and Testamentary Trusts over recent decades are two reasons why current estate planners often have to factor the impact of substantial nonestate assets in estate plans – beyond what a simple hotchpot clause can achieve.

The consequences of the failure to have regard to non-estate assets was illustrated in the well-known 2005 decision of the New South Wales Supreme Court of Katz v Grossman58

Katz v Grossman

Ervin and Evelin Katz had two children, Danny Katz and Linda Grossman.

55 Or a particular percentage split

56 Blackstone’s Commentaries on the Laws of England (new edition) Book II, p 190.

57 Re Cosier (1897) 1 Ch. 325 (C.A.)” :

58 2005 NSWSC 934

Prior to their deaths Ervin and Evelin were the trustees and members of their self-managed superannuation fund (SMSF).

After Evelin’s death, Ervin appointed Linda as the second trustee of the SMSF.

Ervin died on 19 September 2003. On 5 December 2003 Linda appointed her husband Peter Grossman as the second trustee of the SMSF.

Ervin had made a non-binding nomination that his death benefits were to be paid equally to his two children, and his Will distributed his entire estate equally to Danny and Linda

Linda refused to follow Ervin’s non-binding nomination and instead distributed the entirety of Ervin’s death benefits in the SMSF to herself. There was no Equalisation Clause in the Will.

Linda ultimately received the entirety of the SMSF death benefits and 50% of the estate assets.

Adjustment Clause anatomy.

If an adjustment may need to be carried out in a future estate, a number of matters may need to be considered including:

 whether the non-estate assets to be taken into account should be specifically identified, and if so, with reference to an inclusive or exclusive list – e.g. superannuation death benefits, life insurance and the control of inter vivos trusts.

 whether the adjustment to be carried out by the executor is to be mandatory or discretionary

 how the estate and non-estate assets are to be valued – for example whether pre-tax values, or values net of tax are to be taken into account.

Consideration should also be given to the fact that an adjustment may not be 100% possible, depending on the relative values of the estate and non-estate assets.

Sample Adjustment Clauses

Sample mandatory adjustment clause.

 It is my intention, and my executors are directed to ensure that any division of the Remaining Balance takes into account, in addition to the Remaining Balance, the following:

o X; and

o Z (Adjustment Amounts)

 I direct that my executors treat the Adjustments Amounts as if they formed part of my Estate and have been received by or are owed to (as the case may be) the relevant Remainder Beneficiary and adjust the distribution of the Remaining Balance accordingly.

 For the purposes of this clause, the value of all assets shall be calculated according to

 In the event that the value of the Remaining Balance is insufficient to enable my executors to effect the adjustment set out in this clause, I direct my executors to carry out an adjustment which most closely results in my intentions as set out in this clause being met.

Sample discretionary adjustment clause.

 In calculating the share that a beneficiary of the Remaining Balance is to receive:

o I express the wish that my executors take into account in achieving overall equality and proportionality, property, benefits and liabilities which are not strictly part of my estate, and

o I authorise my executors to adjust the shares, accordingly, being guided by what is possible, reasonable, fair and appropriate.

 Examples of property, benefits and liabilities which my executors may take into account include…

More complex adjustment clauses

Adjusting with reference to a partner’s death benefits

Where a couple desire all estate and non-estate assets owned by either or both of them to pass to the survivor, and Mirror Wills are being utilised to then pass the joint estate of the survivor to an agreed class of beneficiaries (usually children), it may be desirable, particularly in a blended family situation, to include, as assets to be adjusted in the survivor’s Will, superannuation death benefits paid in respect of the death of both of the partners.

Such a provision can address the possibility that the two partners may die within a short space of each other without effective binding nominations in place. In those circumstances the death benefits of the first to die may be paid directly to their children, and would need to be adjusted, but the joint estate would have been paid to the survivor and would therefore not be available to effect that adjustment.

Careful drafting is required, and the drafting is generally simpler if the thirty-day statutory survivorship period is excluded.

For example,

 It is my intention, and my Executors are directed to ensure that any division of the Remaining Balance takes into account, in addition to the Remaining Balance, all of the assets set out in the succeeding paragraphs of this subclause, any entitlements to superannuation, life insurance and other Death Benefits arising or payable as a result of:

o my death; or

o my partner X’s death

paid to or for the benefit of any of the beneficiaries nominated in the clause in this Will headed "Distribution of the Remaining Balance” external to my estate.

Adjusting if a non-estate asset is not received.

Sometimes a testator’s Global Testamentary Intention includes a desire that a non-estate asset is distributed to a beneficiary. For example, superannuation or life insurance, or the control of the family trust may be earmarked for transfer to a particular beneficiary directly, and a Will drafted on the assumption that will occur.

A testator may desire to guard against the possibility that such non-estate assets may not pass to that beneficiary – because, for example, a binding superannuation nomination lapses, the status of the intended beneficiary’s superannuation dependency changes between the date of the Will and the date of death, a life insurance nomination is not maintained, or control of a family trust passes to someone other than the intended beneficiary.

A fallback clause can be inserted in a Will to distribute the non-estate asset to the intended beneficiary, if it is ultimately paid to the estate.

If, however, there is a possibility that the non-estate asset may pass directly to an estate beneficiary not contemplated by the testator (Unintended Recipient), provision can be made in a Will that the distribution of the estate between the estate beneficiaries is to be varied.

A clause can be drafted to provide for a reduction in the Unintended Recipient’s share of the estate, to the extent that they benefit from the non-estate asset, and the payment of that amount can instead be passed to the intended beneficiary.

Such clauses increase the complexity of a Will and are best addressed on a case-by-case basis, with regard to the specific assets involved and subject to specific instructions.

For example:

 This clause applies if:

o any of the beneficiaries named in my Nomination fail to receive some or all of their entitlement because the Nomination is invalid at the date of my death, because some or all of my Death Benefits have been withdrawn other than by me personally prior to my death or for any other reason; and

o one or more beneficiaries of my estate instead would receive some or all of my Death Benefits (or the proceeds of withdrawn benefits) via my estate or have or will receive them external to it.

 My Executors are directed to adjust the distribution of the Balance of my Estate or the Remaining Balance between my beneficiaries, to achieve an outcome that, to the extent possible, would have been achieved, had the Nomination been fully effective.

Appendix 3 Some Special Disability Trust tax considerations

Using Special Disability Trusts to mitigate future tax issues

Special disability trusts can also be used to address future estate taxation issues. A consideration of their use is beyond the narrow focus of this paper; however some general material is provided below to assist advisors

Special Disability Trusts

Special Disability Trusts are a special type of Discretionary Trust and are often used as Testamentary Trusts in Wills to provide for vulnerable beneficiaries.

They are creatures of statute. Provided:

 the relevant beneficiary in respect of whom the Trust is set up (Principal Beneficiary) qualifies on a degree of disability basis; and

 the terms of the model Trust deed are utilised and complied with.

Centrelink, stamp duty and taxation outcomes of the allocation of Trust property to a vulnerable beneficiary are positive.

Value of the trust fund

A Principal Beneficiary can have up to $781,25059 held in a Special Disability Trust exempt from the assets test:

 The Centrelink assets test will not apply to reduce the Principal Beneficiary’s social security entitlements; and

 The income test does not apply at all to the income of a Special Disability Trust.

Model rules

The Model Rules include a number of restrictions and limitations:

 A limitation on purchase of real estate and business properties

 A restriction on the number of trustees (currently between 2 and 4)

 A limitation on the use that trust income may be put to. Trust Funds in a Special Disability Trust can only be used to pay for:

o accommodation, health-related costs (including medical and health insurance expenses), and other expenses related to the disability of the Principal Beneficiary; and

o discretionary expenditure of up to a limit of $14,000 a year.60

59 As of July 2023, indexed annually.

60 As of July 2023.

Special Disability Trusts and Capital Gains Tax (CGT)

Special Disability Trusts attract concessional tax treatment when established in accordance with social security legislation:

Net income and present entitlement

The net income of a Special Disability Trust is taxed to the Principal Beneficiary of the trust at the marginal tax rate, inclusive of income retained by the trust which would otherwise be taxed at the highest marginal tax rates in the hands of the trustee – this is because in a Special Disability Trust the Principal Beneficiary is treated as though they are presently entitled to all the trust’s net income.

Capital Gains Tax

An exemption applies to Capital Gains Tax where a CGT Asset is donated or transferred to a Special Disability Trust for no consideration, no Capital Gains Tax is payable.

Section 118.85 of the ITAA 1997 relevantly provides as follows:

1. A capital gain or capital loss you make is disregarded if you make it from transferring a CGT asset for no consideration to:

a. a special disability trust; or b. a trust that becomes a special disability trust as soon as practicable after the transfer.

Ordinarily:

 If a CGT Asset is disposed of during a person’s lifetime, tax is payable on any increase between the value at the time the asset is acquired and the value at the time the asset is disposed. Tax is payable on the increased value, even if the asset is gifted for no money in return, under the market value substitution rule61 ; and

 as noted above, roll-over relief generally applies to assets transferred into a testamentary trust pursuant to the terms of a Will.

However, under section 118-85 of the Income Tax Assessment Act 1997 (ITAA 97), any capital gain from a transfer of a CGT asset to a Special Disability Trust (or a trust that becomes a Special Disability Trust as soon as practicable after the transfer) is disregarded.

Furthermore, the cost base of the property in the hands of the trustee of the Special Disability Trust is deemed to be equal to the market value of the property when the Special Disability Trust acquires it.62

The cost base of the property is not “rolled over” and transferred to the trustee but is “refreshed” to the asset’s market value at the time it is transferred to the Special Disability Trust – in the case of testamentary Special Disability Trusts, at the date of the deceased’s death.

Options in Wills

61 Sections 112-20, 116-30 ITAA 1997.

62 Section 112-20 ITAA 1997.

Because the future needs, financial resources, and pension entitlements of a vulnerable beneficiary, and the provisions of the relevant legislation that will be applicable at the time of the testator’s death will be uncertain at the time that the Will is drafted, it makes sense to incorporate options in relation to the utilisation by an executor of a vulnerable beneficiary’s share of a deceased estate.

One option is to enable the executor to allocate the vulnerable beneficiary’s inheritance between a special disability trust, and an all needs (non-special disability) protective trust.

The election can be made by the executor after obtaining appropriate accounting and financial advice, and after assessing the needs of the vulnerable beneficiary.

Sample clause

An example of a Will clause incorporating Special Disability Trust options - omitting the trust provisions – follows:

Distribution of Leonard’s share

1. My Executors shall divide the residue of my estate63 between the funds as set out pursuant to the two succeeding clauses, being:

a. Leonard’s Special Disability Trust Fund

b. Leonard’s All Needs Protective Trust Fund

Creation of Leonard’s Special Disability Trust

2. If Leonard survives me by thirty (30) days my Executors shall hold Leonard’s Special Disability Trust Fund (as defined in this clause), on trust for sale pursuant to the trust provisions set out in Schedule A of this Will.

Creation of All Needs Protective Trust and All Needs Fund

3. If Leonard survives me by thirty (30) days my Executors shall hold the Leonard All Needs Protective Trust Fund, subject to all the powers in this Will, on trust for sale…. pursuant to the trust provisions set out in Schedule A of this Will.

Definitions

4. For the purpose clause:

a. “Leonard’s Special Disability Trust Fund” shall be the assets comprising the residue of my estate that my Executor’s allocate as comprising Leonard’s Special Disability Trust Fund, and as determined by my Executors in their absolute discretion.

b. “Leonard’s All Needs Protective Trust Fund” shall be the balance of the residue of my estate then remaining.

Case Study – Janis’ estate

The following case study focuses only on the CGT treatment of assets transferred into a Special Disability Trust – in isolation of other potential estate planning and estate administration considerations - and should be assessed accordingly. The intention of this case study is to provide an example of:

63 …or share (etc..) of the residue for example.

 the different global estate tax outcomes that can be achieved; and accordingly,

 the different estate division outcomes between beneficiaries that may be able to be achieved.

depending upon the allocation of assets within or external to a Special Disability Trust.

Background

Janis passes away. At the date of her death, she is single and has two adult children:

 Ziggy, who works in a bank and has no special needs,

 Marley, who suffers from significant physical and mental disabilities, is unable to work, and is likely to qualify as the Principal Beneficiary of a Special Disability Trust.

Janis’ Will

Notwithstanding Marley’s disabilities Janis’ Will divides her entire estate equally between her children. Her Will also contains the following provisions:

 A clause providing her Executor with the option of distributing some or all of Marley’s inheritance to a Special Disability Trust with Marley as Principal Beneficiary.

 A clause empowering Janis’ Executor to sell all estate assets.

 A Valuation Clause that provides for the administration of her estate and for assessing parity between her beneficiaries, the calculation of the value of CGT Assets inherited by each of her children which is to have regard to latent CGT liability. That is, the value of a CGT Asset is to be equivalent to the anticipated net proceeds of sale of the relevant estate asset, on the presumption that it was sold immediately after her death and all CGT liability paid from the proceeds of sale.

 An Appropriation Clause.

Janis’ estate

Janis’ estate is comprised of:

 Her principal place of residence valued at $700,000.

 Cash of $200,000

 A share portfolio with the cost base of $X and a current market value of $700,000 –Janis’ accountant calculates that if all of the estate shares in her share portfolio were to be sold, that her estate would incur a CGT liability of $100,000.

Options for Janis’ Executor

Option 1 - Sale of all estate assets

Janis’ Executor can sell all of the estate assets and distribute the net proceeds of sale and the estate cash equally between the two beneficiaries. The following tables set out the outcome of the estate administration (ignoring costs and expenses).

Net estate – value according to Janis’ Will Principal place of residence $700,000

Option 2 - Avoidance of Special Disability Trust

Janis’ Executor can distribute the assets in specie but avoid the use of the Special Disability Trust. The following tables set out the outcome of the estate administration (ignoring costs and expenses).

Net estate – value according to Janis’ Will

Option 3 - Use of Special Disability Trust

Janis’ Executor can distribute the assets in specie utilising the Special Disability Trust option. If Janis’ Executor were to transfer all of the shares to the Special Disability Trust, the following tables set out the outcome of the estate administration (ignoring costs and expenses).

Net estate

Principal

Provided it is consistent with Janis’ other estate planning objectives, and her Executor’s tax and other obligations, Option 3 may be the best option for Ziggy and Marley. This is because

the CGT liability of $100,000 that would have been incurred upon the sale of the shares (as is the case in Options 1 and 2 above), is not payable.