Testamentary trusts qualify for an income tax concession in respect of income derived and paid for the benefit of minor beneficiaries. This means that children are taxed at adult rates on income they received and that has been derived from the trust, as opposed to the standard penalty rates that apply to children.
In the 2018-19 Federal Budget, it was announced that the Income Tax Assessment Act 1936 (“ITAA”) would be amended to clarify the application of this concession. The existing law 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).
A Bill amending the ITAA has recently been introduced to clarify that income derived from assets that “top up” or are “injected” into the testamentary trust do not obtain concessional tax treatment.
If passed, the legislation will apply in relation to assets acquired by or transferred to the testamentary trust on or after 1 July 2019.
What is the Change?
The draft legislation amends s102AG of the ITAA to provide some pre-requisites to the ability to access the concessional tax treatment, namely:
- The assessable income must be derived by the trustee of the testamentary trust from property which satisfies one of the following three requirements:
- the property must be transferred from the estate of the deceased person concerned, as a result of the Will, Codicil, intestacy or order of a Court; or
- the property, in the Commissioner’s opinion, represents accumulations of income or capital from property transferred from the estate of the deceased person; or
- the property, in the Commissioner’s opinion, represents accumulations of income or capital from previously accumulated income or capital. This essentially ensures that income on subsequent accumulations of income or capital will generally be able to be concessionally taxed.
- The explanatory memorandum provides that the property can be converted from one asset type to another, without losing the concession, however the actual legislation is less clear.
The ATO is calling for submissions by the end of October, after which time, the legislation can be expected to be finalised.
Implications – General
On one view this is not a change and merely serves as a reminder as to when income distributions will not be concessionally taxed. Prior to these proposed amendments, Furse’s case suggested that the concessional tax treatment could apply to assets injected into the estate.
There is, however, some uncertainty in respect of certain aspects of the draft legislation, including:
- It is not clear as to whether superannuation death benefits paid to an estate will lose concessional income tax treatment. From a policy point of view, that doesn’t appear to make sense, as the concessional tax treatment applies to income paid to minors directly; and
- Much of the new legislation hinges on the Commissioner’s discretion, such that self-assessment may not be appropriate; and
- although the explanatory memorandum appears to suggest the concession will apply to assets reinvested from original assets, the drafting of the Bill is not clear.
Further, the proposed changes apply to assets acquired or transferred to the testamentary trust on or after 1 July 2019. That appears to mean the current law applies to deceased estates in place prior to 1 July 2019 (but still being administered at that time), which will require a complete review of the status of the assets in testamentary trusts.
Pending finalisation of the law, it is difficult to be conclusive about how strategies might change.
If however the changes outlined above do come to fruition, then:
- All existing testamentary trusts will need to be able to separate in their accounts assets from the deceased and after acquired assets. Further separation in some cases could be required if estates were part administered as at 1 July 2019;
- Testamentary trusts with no power to distribute capital may be problematic in respect of “after acquired” assets;
- Accurate inventories prepared in any probate application will take on extra significance;
- It will impact on the investment strategy of each trust, eg, possible investments made from borrowings of the testamentary trust.
- It will affect the decision about the utility of superannuation death benefits testamentary trusts. They will retain the benefit of control and protection but without access to the income tax concession. It may enliven a review of superannuation death benefits trust created by deed.