The Income Tax Assessment Act 1936 (Cth) (ITAA36) generally provides for income derived by minors to be taxed at rates higher than those which apply to adult taxpayers. There are, however, several exceptions to this general approach for a range of circumstances, including in relation to income received by minors from certain trusts – so-called “excepted trust income”.[1] The best known example of excepted trust income is income received by a minor under a testamentary trust.

Other excepted trust income arrangements arise less often, principally because the relevant trusts can only be established in quite specific circumstances. Two more common instances are trusts created out of the proceeds of a superannuation death benefit – Super Proceeds Trusts[2] – and trusts created from property transferred from the estate of a deceased person for the benefit of beneficiaries who would have received an amount under the intestacy rules – Estate Proceeds Trusts.[3]

For income of a Super or Estate Proceeds Trust to be excepted trust income, it is a requirement that the beneficiary of the trust must acquire the trust property when the trust ends.[4]

One strategy we have seen involves having a trust deed with a wide range of income and capital beneficiaries, but with the ultimate beneficiaries on vesting being those children for whom the property was originally intended. This strategy often also involves not having the trust vest when the ultimate beneficiaries reach majority, nor for control to pass to those beneficiaries at that time. This allows others – typically parents (or the surviving parent) – to remain in control and decide when (if ever) the child would take their interest, and in the meantime, for a range of other beneficiaries to take benefits from the trust. The rationale for this could be, partially, to prevent relatively young individuals accessing large amounts at 18, but often it may be more about the parent simply having control over and access to the money.

A recent decision of the AAT, The Trust for the Confidential Trust and Commissioner of Taxation [2014] AATA 878, highlights a major pitfall in adopting this approach.

WHAT HAPPENED IN THE TRUSTEE FOR THE CONFIDENTIAL TRUST AND COMMISSIONER OF TAXATION?

The case involves the reverse of a typical Estate or Super Proceeds Trust – the proceeds in question belonged to an adult, who sought to settle these on a trust with minor beneficiaries. However, the decision remains relevant to the more typical Estate or Super Proceeds Trust establishments.

The facts are succinctly put as follows:

  • the Trust received $400,000 after a workers’ compensation claim was settled by an individual who contributed the amount to the Trust. (Workers’ compensation claim proceeds are another instance of proceeds that may be covered under the excepted trust income rules). The individual became the sole director of the trustee;
  • the Trust appears to have been discretionary in nature, and included 2 minors amongst its beneficiaries
  • for the 2012 income year, the Trust distributed of $2,788 to each of the 2 minor beneficiaries, claiming that this was part of the Trust’s excepted trust income.

The issue was whether the minor beneficiaries' income was "excepted trust income" (in this case under s 102AG(2)(c)(i)(B) ITAA36).

Notably, the minor beneficiaries were not initially entitled to the workers’ compensation settlement, but were included amongst a range of beneficiaries in the Trust upon which the proceeds were settled.

RULING OF THE AAT

The AAT held that the $400,000 was not money to which the minor beneficiaries were initially entitled. Their only entitlement arose following the contribution of that money to the Trust by individuals entitled to the workers’ compensation settlement. The overall intention of the Tax Act is that where property is transferred to a minor in particular circumstances (in this case in the context of a law relating to workers’ compensation), income earned from that property is excepted income. That treatment continues to apply where property is transferred to a trust provided that, when the trust ends, the minors who would have otherwise been entitled to the original transfer will acquire the trust property in accordance with the trust deed.

In relation to the specific requirement that the beneficiary acquire the trust property when the trust ends, the AAT held this was not satisfied. The minor beneficiaries are required to have an absolute vested interest in the property from the inception of the trust. The trust deed provided a discretion with regard to the distribution of trust capital and income prior to the vesting day. As a result, no beneficiary had an absolute vested interest in the property of the trust.

It followed that the income of the trust was not excepted trust income, and the income distributed to the minor beneficiaries would be taxed at the usual rates applying to minors.

MORAL OF THE STORY

This case is one where minor beneficiaries were sought to be included in a trust in an unsuccessful effort to access the excepted trust income rules for income from proceeds to which they were not originally entitled. Nevertheless, the case has application to circumstances where minors are entitled to certain proceeds, and a trust is created for the benefit of those minors, but which introduces other beneficiaries.

Advisers should review the terms of Estate and Super Proceeds Trusts. If those minor beneficiaries for whom the trust could be created under the terms of section 102AG(2) do not have an absolute vested interest in the property from the inception of the trust, then the requirements of the section may not be met and the distributions may not qualify for excepted trust income treatment. It is possible that those who have taken an aggressive approach to include other beneficiaries both for income and capital purposes may now have a problem.