Testamentary Trusts from 2020

However, recent legislative changes have been made to deny certain advantages of Testamentary Trusts.

What is the old rule?

Division 6AA of the ITAA 1936 and section 13 of the Income Tax Rates Act 1986 impose higher tax rates on minors (under 18 years) to deny most minors a tax advantage from receiving income that might flow from income-splitting arrangements.

One exception is that assessable income resulting from entitlement to income from a testamentary trust.

This income is a type of ‘excepted trust income’ that is generally taxed at ordinary (i.e. normal ) rates. This means that minor beneficiaries who earned no other income could receive a distribution from a Testamentary Trust of $18,200 – tax-free.

The existing rule does not specify that the assessable income of the testamentary trust be derived from assets of the deceased estate (or assets representing assets of the deceased estate) which allows some taxpayers to inappropriately obtain the benefit of concessional tax treatment by injecting assets unrelated to the deceased estate to generate excepted trust income that is not subject to the higher tax rates on minors.

What has been changed?

Schedule 1 to the TREASURY LAWS AMENDMENT (2019 MEASURES NO. 3) BILL 2019 clarifies that excepted trust income of the testamentary trust MUST be derived from assets transferred to the testamentary trust from:

the deceased estate (see example 1) or

from the accumulation of such income (see example 2).

This requirement ensures that the income from property that is unrelated to the deceased estate is not treated as excepted trust income for the purposes of Division 6AA.

It also ensures that only beneficiaries included in the class of beneficiaries by the deceased, rather than an entity that was later added to the class of beneficiaries, can have excepted trust income under paragraph 102AG(2)(a). [Schedule 1, item 2, subparagraph 102AG(2AA)(b)(i) of the ITAA 1936]

Comparison of key features of the new law and current law

Example 1: Injected asset

On 1 July 2019, testamentary trust ABC is established under a will of which a minor is a beneficiary. Pursuant to the will, $100,000 is transferred to the trustee from the estate of the deceased. Shortly after the testamentary trust is established, a related family trust makes a capital distribution of $1,000,000 to the testamentary trust. The resulting $1,100,000 is invested in ASX listed shares on the same day.

A dividend income of $110,000 is derived for the 2019-20 income year. The net income of the trust is $110,000 and the minor is presently entitled to 50 percent of the amount of net income.

The minor’s share of the net income of the trust is $55,000 which comprise:

$5,000 (i.e. $55,000 * $100,000/$1,100,000) is excepted trust income on the basis that (1) it is assessable income of the trust estate that (2) resulted from a testamentary trust (3) derived from the property transferred from the deceased estate.

$50,000 is attributable to assets unrelated to the deceased estate and not excepted trust income.

Example 2: Income from retained excepted trust income

Following on from the example above, the minor’s share of the net income of the trust (being $55,000, comprising $5,000 excepted trust income and $50,000 not excepted trust income) is not paid to the minor by the trustee but is invested for their benefit in ASX listed shares shortly after the commencement of the 2020-21 income year.

For the 2020-21 income year, that investment derives income of $5,500, and the minor is presently entitled to the entire amount, in which:

$500 (i.e. $5,500 *$5,000/$55,000) is excepted trust income on the basis that (1) it is assessable income of the trust estate that (2) resulted from a testamentary trust (3) derived from income that was previously excepted trust income.

$5,000 is attributable to assets unrelated to the deceased estate and not excepted trust income.

The changes apply retrospectively with effect from 1 July 2019.

The amendments made by the Bill apply in relation to assets acquired by or transferred to the trustee of the testamentary trust estate on or after 1 July 2019.

Income from assets and accumulations held in a testamentary trust prior to 1 July 2019 can continue to be excepted trust income under existing section 102AG.

Source: https://www.aph.gov.au/Parliamentary_Business/Bills_Legislation/Bills_Search_Results/Result?bId=r6466

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