Taxation of Testamentary Trust Distributions to Minors

Trust Taxation

Treasury Laws Amendment

The Impacts of the Treasury Laws Amendment (2019 Measures No 3) Act 2020

Taxation of Testamentary Trust Distributions to Minors: The Impacts of the Treasury Laws Amendment (2019 Measures No 3) Act 2020

Background 

For decades individuals have included testamentary trusts within their wills as a valuable means of ensuring the welfare of child beneficiaries within their wills after the individual has passed. 

Under Division 6AA of the Income Tax Assessment Act 1936 (‘ITAA’), where a child under the age of 18 receives unearned income (for example, interest from bonds or dividends from shareholdings) between $417 to $1,307, they will pay tax at the top marginal rate of 66% of excess over $416, and will pay tax at a rate of 45% on unearned income over $1,307. 

Distributions to a minor from a testamentary trust are exempt from these penalty tax rates under the ITAA, with distributions instead subject only to standard adult marginal tax rates. This exemption extended to proceeds from the sale of estate assets and was not limited to income generated from assets which originally belonged to the deceased. As a result, the testamentary trust has proven to be an effective tax minimisation tool in estate planning.

However, amendments introduced in June this year under the Treasury Laws Amendment (2019 Measures No 3) Act 2020 (‘the Act’), could render the testamentary trust a less tax-effective instrument than it once was. 

The Impact of the New Amendment

The Act amends section 102AG(2AA) of the ITAA, which now limits the unearned income subject to standard adult marginal rates from testamentary trust distributions to property which is transferred from the deceased’s estate to the testamentary trust, and/or property which represents an accumulation of income or capital from property transferred from the deceased’s estate. 

The wording of this amendment raises questions as to whether or not the proceeds from the disposal of estate assets will continue to attract tax liability at standard adult marginal rates, and potentially limits the flexibility of trustees in transferring assets into the testamentary trust in order to fully exploit the lower marginal tax rates. 

For example, it is common practice for trustees to regularly buy and sell shares on behalf of the estate using trust funds in line with market fluctuations. Under the new amendments, will distributions from new shareholdings still be taxed at marginal adult rates? Or will they be taxed at the Division 6AA penalty rates as the relevant income generating assets did not originally belong to the deceased?

Conclusion

The explanatory memorandum that accompanied the bill indicated that income from reinvesting estate assets should continue to be taxed at standard adult marginal rates. However it is difficult to say how the uncertain language introduced by the Act will impact the ATO’s tax treatment of distributions from testamentary trusts to minor beneficiaries in practice, as there have been no published decisions involving the new amendments to date. Estate planning practitioners should stay abreast of developments in this area to ensure testamentary trusts continue to serve their intended purpose for clients 

If you have any questions or are interested in including a testamentary trust within your Will, feel free to call Prompt Legal Services Pty Ltd on (03) 9379 0877 for a free 30 minute consultation

** Please note that Prompt Legal Services Pty. Ltd are not financial advisors and the information within this article is not intended to be a substitute for advice from a certified financial advisor. If making decisions in the discussed area please ensure you obtain advice from a qualified financial advisor.

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