Many people plan their charitable bequests well in advance and these are stated clearly in their wills. Bequests form a major part of the revenue of many charities. With some extra thought in estate planning, a bequest to a charity could be made in a more tax-effective way, creating the potential for larger charitable bequests or a greater amount leftover for other beneficiaries.
Consider this simple example. There are circumstances in which assets such as shares can be directly bequested to a charity. These assets may have significant capital gains attached to them. If the charity has zero tax status then these assets can be transferred without tax being incurred on the capital gains. Compare this to the situation where all the assets of the estate are sold down: capital gains will be incurred, and the amount of money that can be distributed amongst beneficiaries, including the charity, is smaller.
Check the tax rules
The Australian Tax Office (ATO) website explains the rules around estates, bequests and taxation. In summary:
- Generally, capital gains tax (CGT) applies to any change of ownership of a CGT asset (unless it was acquired pre-CGT (20 September, 1985)).
- However any capital gain or capital loss made on a post-CGT asset is disregarded if, when a person dies, an asset they owned passes directly through to a beneficiary. The beneficiary receives the asset and assumes the capital gains or loss position. Similarly, the capital gain on a testamentary gift of property is disregarded in the estate if the gift is made to a deductible gift recipient (DGR) and the gift would have been income tax deductible if it had been made before the taxpayer’s death. In this case ‘property’ is not specifically defined by the ATO and thus takes on its dictionary meaning (broadly, possessions) which we interpret as including shareholdings.
- A DGR does not have to pay taxes on income earned, thus the collective outcome (that of the DGR and the estate combined) is improved compared to converting all estate assets to cash or if a CGT event is deemed to have occurred and included in the ‘date of death (tax) return’.
- It appears that the ATO and the government are aware of this technique. A 2004 case confirms this (reference: ATO ID 2004/641) and was withdrawn because it was a straight application of the law and no interpretation was required. The 2004 Federal Budget removed the requirement that testamentary gifts of property to a DGR must be valued at greater than $5,000.
Charities need a checklist of actions
To make the most of this opportunity, charities need to:
- Ensure they are registered as a DGR.
- Consider whether they know their potential testators (people making the bequest) well enough to suggest that there may be a more effective way (for all parties involved) to design their estate planning. This may at first appear to be an awkward conversation but this may not always be the case. For instance some people may indicate to a charity beforehand that they intend to make a bequest to them out of their estate. Many charities develop deep personal connections with potential testators through the provision of assistance to people or associated family members, in some cases lifelong. It is quite common for the beneficiaries of charitable assistance to seek to allocate some of their estate to the charity. These situations may present opportunities to have such a discussion around how this bequest could be structured.
- Ensure that the contacts within charities handling bequests are also aware of these rules so that when they discuss the transfer of these assets with the solicitors tasked with winding up estates, the actual shares are transferred, as opposed to liquidating the shares and transferring the cash, as is often, by default, the action taken.
- Finally, be able to handle the assets that have been bequeathed. Can they easily take custody of these assets? Can they dispose of these assets if they do not fit the investment strategy of the charitable funds? Do they have the ability to understand how a particular asset will affect the overall risk profile and liquidity of their charitable funds. I am aware of some charities which are quite comfortable receiving bequests in the form of Australian equities as they have arrangements in place with fund managers to accept shares as in-specie application funds (indeed there are some interesting funds which target charitable groups and zero tax entities in general, seeking to maximise the benefit of franking credit refunds). This removes the need for the charity to perform their own transactions.
Note that this article is focused on assets held outside of superannuation. There will be different outcomes for assets held in superannuation which will depend on a number of issues including the type of super fund (whether it is a SMSF or not). For an individual planning a bequest strategy for their assets in super, it is recommended they seek specific advice on this issue.
Overall, funding remains a constant ongoing challenge for charities. This strategy results in more efficient estate planning amongst those intending to make a bequest, which in turn can lead to better outcomes for charities. Of course we recommend you seek professional advice if you intend to formalise such a strategy.
David Bell’s independent advisory business is St Davids Rd Advisory. Ben Kurtz is a Senior Accountant at Nortons Business Advisors.