Estate planning strategies frequently involve the use of testamentary trusts (ie – trusts created in a Will).
For many years it has been accepted that income that is derived by the trustee of a testamentary trust and is distributed to children is taxed at ordinary “adult” rates. Where such children have no other income, then up to the first $22,000 of income distributed from a testamentary trust to each child per annum can be tax-free. This is considered “concessional” tax treatment because income earned by minors is typically is taxed at higher rates. Further it is any minor beneficiary that enjoys this concession, not just children of the deceased.
On 17 June 2020 Parliament passed legislation to implement the Government’s 2018-19 Budget measure of “improving the taxation of testamentary trusts”, and the new law tax takes effect from 1 July 2019.
The law is aimed at tightening the requirements for the property that can generate the concessionally taxed income (referred to as “excepted income”). The language however is not altogether clear so some questions remain about how it will be interpreted.
Willmakers, estate planning lawyers, accountants and financial advisors will all need to be alive to the changes introduced, and potentially modify how the trusts are planned for and administered.
Prior to the passing of the amendments, the relevant tax law provided that income of a trust estate is excepted income to the extent that it resulted from a Will, codicil, (or a Court order varying a Will or codicil) or an intestacy, in relation to the estate of a deceased person.
The new law imposes additional tests in relation to the “property” that can generate concessionally taxed or excepted income. The tests include that the property that generates the income is “transferred from the estate of the deceased person concerned, as a result of the Will”. In addition, the excepted income can be generated from “property that represents accumulations of income of capital” from the property transferred from the estate.
The existing definition of “property” in section 102AA(1) of the ITAA still applies and includes real estate, personal property and money.
It is now clear that property unrelated to the deceased estate cannot be “injected” into the testamentary trust and generate excepted income. The wording in the legislation does not, however expressly address whether concessionally taxed income can be generated from:
- Assets acquired from the sale of the original assets transferred from the estate (“replacement assets”); and
- Superannuation death benefits paid to the estate.
To consider the question of replacement assets, the explanatory memoranda goes someway in that it refers to the intention that the concessional tax treatment continues to apply to “assets of the deceased estate or assets representing assets of the deceased estate”. This would at least suggest that replacement assets are eligible to continue to generate concessionally taxed income.
In relation to superannuation death benefits, they do not form part of the estate as at the date of death. However, under superannuation law the death benefits can only be paid to a limited range of persons including the legal personal representative of an estate (ie – executor or administrator). Superannuation death benefits cannot, in compliance with the superannuation law be paid direct to the trustee of a testamentary trust and also must be paid on the death of a member.
This means that superannuation death benefits can only form part of a testamentary trust if they have first been paid to the deceased estate (during administration of the estate). On that basis, the superannuation death benefits would be property transferred to the trustee of the testamentary trust from the estate of the deceased person concerned. It would also appear to be transferred as a result of the Will.
Separately there is a question of whether the mechanism by which superannuation death benefits are paid to the executor makes any difference. The explanatory memorandum to the amendments indicates that the intention is to disallow concessional tax treatment on income generated from property “injected” into the trust. The example relates to a discretionary family trust making a capital distribution into a testamentary trust. Superannuation death benefits can be received by the legal personal representative either by way of a binding document such as a binding nomination, or via the exercise of the discretion of the superannuation trustee. On one view, where the receipt is as a result of the exercise of discretion, this may cause an issue. However, we consider the better view to be that regardless of whether the mechanism is via binding nomination or via discretion, the payment is connected with the death of the Willmaker and the first recipient is the legal personal representative, such that after that point the property is transferred to the trustee of testamentary trust, and ought to satisfy the new requirements.
Why does it Matter?
It is clear that more scrutiny around the use of testamentary trusts is likely as a result of the change in this law. Assets which now are excluded from being able to generate concessionally taxed income include assets acquired with borrowings by a testamentary trust trustee, and assets injected from family trusts directly to the testamentary trust trustee.
There are a number of planning and administrative issues that arise from the changes including:
- In the planning phase, consideration of:
- whether or not to use a binding nomination or rely on trustee discretion for superannuation death benefits;
- the viability of a superannuation death benefits testamentary trust (as a standard testamentary trust would have other tax consequences not covered here);
- the terms of the testamentary trusts and appropriate powers; and
- the need for flexibility about the use and terms of testamentary trusts.
- In the administration of the estate:
- Whether or not to accumulate income of the estate (in the first three years) – this would increase the assets forming part of the property transferred to a testamentary trust;
- Whether to pay out debt or transfer assets subject to debt;
- Which assets ought form part of a testamentary trust;
- What liability does the executor carry for making these decisions;
- In the administration of the testamentary trust:
- What records need to be kept in relation to evidencing the property that can generate concessionally taxed income (this is already an issue in respect of capital gains tax and after acquired assets but different records are likely to be needed); and
- Accounts may need to be more detailed and considered to confirm which property qualifies under the new rules;
- Decisions about funding of assets will need to take into account the impact of borrowings;
- Distributions to beneficiaries will reduce the property that is capable of generating concessionally taxed income (even if loaned back).
This could affect me – what do I do next?
This area of the law is becoming more complex, and under more scrutiny. Off the shelf testamentary trust Wills may not address these issues. Specialist advice should be obtained at each of the stages referred to (planning, estate administration and testamentary trust administration).
In addition, limiting consideration of the issues to just the matters raised herein is dangerous. All estate planning and administration of trust issues need to also factor in asset protection issues and other elements.
How we can help
The team at Moores is one of the largest specialist estate planning teams in Australia, with several accredited specialists. For further information or guidance, please do not hesitate to contact us.