One of the main benefits of testamentary trusts is the ability to have income distributed from the trust to beneficiaries under age 18 years (“minors”) treated as “excepted trust income” and taxed at ordinary “adult” rates under Division 6AA of the Income Tax Assessment Act 1936 (Cth).
This is a ‘concession’ rate because income of more than $416.00 distributed to minors from other types of trusts is usually taxed at significantly higher rates.
It is this concession which is being tightened in a recent legislative change by the Federal Parliament passed on 17 June 2020 and given royal assent on 22 June 2020.
The change (which form a part of a raft of tax measures introduced in the 2018/19 Federal Budget) takes effect as from 1 July 2020 but apply to assets acquired by testamentary trusts on or after 1 July 2019.
The New Changes
The new rules require that “excepted trust income” of the testamentary trusts must be derived from “property” transferred to the testamentary trust from the deceased estate or from the accumulation of such income and capital.
The effect is that income from property (including money) that did not form part of the deceased estate can no longer be “excepted trust income” for the purposes of Division 6AA.
The use of the term “property” in the new provisions is noteworthy because the term is defined broadly as “property, whether real or personal, and includes money”.
By requiring that “excepted trust income” must be income from property, means that income cannot be
- “streamed” through the testamentary trust; or
- recharacterised in the trust,
and taxed concessionally to minor beneficiaries under these provisions.
The Explanatory Memorandum for new provisions provides examples where:
- assets are “injected” into the testamentary trust by way of a capital distribution from a related family trust; and
- income from such assets are unpaid and reinvested in the testamentary trust.
In both examples, “excepted trust income” apportioned based on the property in which it is derived and traced through the various investments in the testamentary trust.
The changes may present a challenge to practitioners and advisors where there is insufficient record keeping in the testamentary trust to show or trace where and how unpaid income distributions are reinvested where there is an initial mingling of “injected” assets and proper assets from a deceased estate.
Potential Effects on Borrowing to Invest
The legislation change has also left it unclear whether testamentary trusts can borrow to invest. On a strict interpretation of the wording of the new provisions it appears that this may be an issue as borrowed funds will be taken to be property which are neither:
- derived from a deceased estate; nor
- accumulations of income or capital from the property derived from a deceased estate.
Accordingly, it may be the case that under the new rules, the income generated from the borrowed portion of the investment in a testamentary trust is not taken to be “excepted trust income”.
As it is early days still, the effect of these provisions are yet to be tested in a court of law and it is anticipated that further clarification may be given by the Australian Taxation Office on how the new provisions will be applied.
New Changes Applicable to Superannuation Proceeds Trusts
As superannuation proceeds trusts are a form of testamentary trusts, these new rules also apply to superannuation proceeds trusts.
In conclusion, planners, accountants, and advisors will have to be aware of these changes and how the changes may impact their tax planning and estate planning strategies for their clients if testamentary trusts or superannuation proceeds trusts are being considered.
The changes do not necessary mean that testamentary trusts and superannuation proceeds trusts are no longer viable ‘tools’ or strategies. There are many applicable positive features of these trusts such as:
- asset protection measures for beneficiaries;
- the ability to exert control ‘beyond the grave’; and
- the tax concessions the subject of this article.
Planners, accountants and advisors should discuss and consider the benefits and shortcomings of each strategy with their client before implementing them.
If you would like assistance regarding these recent changes, do not hesitate to contact us to discuss how we can assist you and your clients.