Stamp duty and capital gains tax issues when dealing with wills delegating a testator’s power.
Taxation traps for the unwary
By CHRISTOPHER BEVAN
Stamp duty and capital gains tax issues when dealing with wills delegating a testator’s power.
One of the greatest reforms of the Succession Act 2006 (the Act) was the repeal of the common law rule against delegation of testamentary power. That is, the rule that prevents a testator from delegating to their executor the power to determine who receives what parts of their estate.
The reforms were made in a taxation vacuum by the legislators in NSW and they have, in the result, created an unwitting stamp duty and capital gains tax (CGT) trap for testators, executors and their legal advisers, particularly succession lawyers in NSW.
Critically, this newfound freedom to delegate to an executor the discretion to determine who receives what assets in the estate under a testamentary trust or testamentary power of appointment created by the will comes at a very high price:
- where the estate consists of valuable assets which are “dutiable property” for the purposes of s.11 of the Duties Act 1997 (NSW), duty at ad valorem rates is payable on the dutiable property comprised in the estate which is transferred under a power of appointment or a discretion exercised under the delegation clause in the will; and in the case of CGT assets acquired by the testator at a cost base far below their market value at the date of death, which thereby have a large latent (unrealised) CGT liability attached to them, the rollover of the testator’s CGT liabilities on the assets comprised in the estate (for all intents and purposes the entire estate where it is situated entirely in Australia) applicable on their death will not apply. This means that the executor will be left to pay the testator’s CGT liabilities on the transfer of estate assets, to the ultimate detriment of the beneficiaries of the estate (invariably residuary beneficiaries).
Delegation of Testamentary power in NSW
It has been a long-standing rule in Australian common law that a testator cannot delegate his or her power of testamentary disposition to an executor, whether by a general power of appointment or an intermediate power of appointment.1
But on 1 March 2008, on the commencement of the Act, this rule was repealed altogether in NSW by the enactment of s.44 of the Act, which provides that: “A power or a trust to dispose of property, created by will, is not void on the ground that it is a delegation of the testator’s power to make a will, if the same power or trust would be valid if made by the testator by instrument during his or her lifetime.”
Since then, many wills have been prepared in which solicitors have taken advantage of the repeal of the rule to permit executors to determine who will take the estate property under a power of appointment. A number of delegation clauses have taken the form of testamentary trusts and others are outright testamentary powers of appointment exercisable by the executor at their absolute discretion, either at large or among a defined class of discretionary objects.
Identification of the specific stamp duty issues which arise
The practical impact of the reforms under the Act throws up specific stamp duty implications by virtue of s.63 of the Duties Act 1997 NSW and how the courts have interpreted the executor’s power to appoint.
Section 63(1) of the Duties Act provides an exemption from ad valorem stamp duty and imposes a liability for nominal duty of $50 on a transfer of dutiable property by the legal representative of a deceased person to a beneficiary, being:
- a transfer made in conformity with the trusts contained in the will;
- a transfer of property the subject of a trust for sale contained in the will; or
-an appropriation of property in or towards satisfaction of the beneficiary’s entitlement under the trusts contained in the will.
On the issue of what an appointment by the executor constitutes, the courts have considered that it is a resettlement of the estate property. In Davidson v Chirnside (1908) 7 CLR 324, Griffith CJ said that in the context of a power to appoint the property of a deceased person granted to the executor under a will, it transferred the estate property to a new trust created by the executor and thereby divested the property from the executor under the trusts created by the will. 2
In so holding, the Chief Justice said that the test of a resettlement of a trust fund (made by will or otherwise) is determined by the following test: “In my opinion any instrument, which on its face purports to be the future charter of rights and obligations with respect to the property comprised in it, and which contains such limitations as are ordinarily contained in settlements, is a settlement or agreement to settle within the meaning of [the Stamps Act (Vic)], whether those rights could have been established aliunde or not.”3
The stamp duty issue is a sleeper
The effect of the statement of law in Davidson v Chirnside is that, on exercise of a power of appointment by an executor under a will, the transfer of the estate property to the beneficiary ceases to be a transfer made “under and in conformity with the trusts contained in the will”, as required by s.63(1)(a) of the Duties Act, insofar as it is “dutiable property” within the meaning of s.11.
The transfer of title to the estate property, being dutiable property, is a transfer made by the executor’s resolution under the power or discretion granted to them by the delegation clause in the will.
This result follows because the executor’s resolution to exercise the power of appointment is “the new charter of rights” referred to by Griffiths CJ in Davidson v Chirnside to which the beneficiary receiving the transfer of the property must look to enforce their right to receive the transfer if the power is exercised but not consummated with a transfer of title. The beneficiary cannot rely on the terms of the will because it contains no such right of transfer, despite it being the only legitimate method of transferring estate property which is “dutiable property” so as not to attract liability for ad valorem duty.
The interpretation of the effect of the exercise of a power of appointment under a testamentary trust on the operation of the deceased estate exemption contained in s.63(1) of the Duties Act addressed above is the current view of the NSW Office of State Revenue as stated by the Commissioner of State Revenue, Anthony Johnson.4
It is accepted as an unforeseen consequence of the repeal of the rule against the delegation of testamentary power made in a stamp duty vacuum, but it represents the law in NSW. Until it is amended by the extension of s.63(1) to encompass transfers of dutiable property made under the powers of appointment by executors of deceased estates, testators, executors and their lawyers alike need to be aware of state taxation obligations before they make wills that include such powers or, having been appointed executor of a will containing such a power, proceed to exercise it.
In short, if there is a delegation clause in a will of the kind permitted by s.44 of the Act, any transfers of estate property that constitute dutiable property for stamp duty purposes made under the section will be subject to ad valorem duty on the unencumbered value of the property (that is, on the market value of the property determined by an independent valuer) in the hands of the beneficiaries receiving the property as transferees. This applies whether the transfer was made in exercise of a testamentary power of appointment or under a discretion provided for in a discretionary testamentary trust.
CGT issues – yet another sleeper
When a person dies, any capital gain they make on disposal of their CGT assets to beneficiaries is disregarded, subject to compliance with the requirements of Division 128 of the Income Tax Assessment Act 1997 (ITAA 97).5 The capital gain is deferred until the beneficiary later sells the estate asset or gives it away. Hence, it is a rollover of the testator’s CGT liabilities on their CGT assets rather than a regime which exempts the beneficiaries from the testator’s liability for CGT.
The rollover provided for in Division 128 only applies if the CGT asset either “devolves” to the executor or “passes” to a beneficiary of the estate, as provided under s.128-15(1) of the ITAA 97. Any capital gain the executor makes if the asset “passes” to a beneficiary is disregarded.6 But a CGT asset only passes to a beneficiary for the purposes of s.128 if one of four conditions are met, namely, only if the CGT asset:
- passes under the will;
-passes by operation of an intestacy law;
- is appropriated by the executor in satisfaction of a pecuniary legacy; or
-passes under a deed of family arrangement made in settlement of a claim on the estate, such as a family provision claim or challenge to the testator’s testamentary capacity in order to probate an earlier will.7
Where the CGT asset passes to a beneficiary under the exercise of a power of appointment or discretion under a discretionary testamentary trust created by the will, it is not considered as having passed to the beneficiary by virtue of s.128-20(1)(a), which requires the death of the testator. Therefore, because the CGT asset passes under a separate and independent power of appointment or testamentary trust (albeit one created by the will), it does not qualify for a deferral of the testator’s liability for CGT on the CGT assets comprised in their estate.
The consequence of this disqualification from the deferral of the testator’s liability for CGT on their death (when the CGT assets in their estate “devolve” to their executor) under Division 128 of the ITAA 97 is that CGT is payable by the executor on transfer of the CGT assets in question to the beneficiaries, as if the testator were still alive and had effected a transfer of the assets. That is, the CGT assets will assume the same CGT characteristics which they had in the hands of the testator, and the executor will be treated as disposing of the assets at their market value8 with a cost base equivalent to the testator’s cost base on their original acquisition of each CGT asset.
Any doubt about this draconian interpretation of the conditions for a rollover of the testator’s CGT liabilities is dispelled by s.128-20(2), which provides that a CGT asset does not ‘pass’ to a beneficiary for the purposes of s.128 if transferred under a power of sale in the will. A power of appointment or discretion to transfer estate property under a discretionary testamentary trust created by the will is relevantly indistinguishable from a power of sale for the purposes of qualifying for a deferral of the testator’s CGT liabilities provided for in Division 128 of the ITAA 97.
As can be seen, the freedom to delegate testamentary power granted in 2008 in NSW has come at a very high price in a fiscal sense. Until stamp duty and CGT legislation catches up with the repeal of the rule against delegation of testamentary power, testators, executors and succession lawyers must weigh up the costs in terms of federal and state taxes in exercising this newfound testamentary freedom.
Tatham v Huxtable (1950) 81 CLR 639 at 649-655.
Davidson v Chirnside (1908) 7 CLR 324 at 340.
Ibid at 341. Barton and O’Connor JJ agreed with Griffith CJ at 342, and Isaacs J stated to similar effect at 344-345.
Commissioner Anthony Johnson at the Taxation Institute’s State Revenue Liaison Committee meeting in Sydney, 6 March 2012. See the minutes of the committee meeting of that date on the Tax Institute’s website, www.taxinstitute.com.au.
Income Tax Assessment Act 1997 (ITAA 97), s.128-10.
ITAA 97, s.128-15(3).
ITAA 97, s.128-20(1).
As it is a non-arm’s length transfer: see ITAA 97 s.116-30(2)(b)(i).
Christopher Bevan is a barrister at Wentworth Chambers, Sydney.