Aug 20, 2020 / News

Superannuation

Changes to Testamentary Trusts may Affect Super Arrangements

A recent change to the taxation of trust income distributed to minors (people under 18) means that some clients may need to review their estate planning arrangements in relation to superannuation and life insurance benefits.

The current position

Special rules were enacted in 1980 to prevent family trusts from using the tax free thresholds of minor beneficiaries to reduce the total tax payable on the trust income by distributing trust income to children up to the limit of their tax free thresholds. The rules operate by imposing a penalty rate of tax on the trust income of minors unless the income falls into a number of categories of “excepted trust income”. These include employment income and trust income arising from the investment of property transferred to the trustee for the benefit of the minor beneficiary arising from events such as personal injury claims or family breakdown.

One significant class of excepted trust income is the income of a trust where the trust resulted from a person’s will or a court order relating to intestacy. Such trusts are often referred to as “testamentary trusts”, and it is common for parents to provide in their wills for a testamentary trust in favour of their minor children. Usually a reliable family friend or advisor is nominated to be the trustee. The intention is that, should both parents die while their children are still minors, the nominated trustee will have the duty of providing for them from the assets left by their parents until the children are old enough to take charge themselves.

Under the current law it is the origin of the trust, not the source of the trust assets, which determines if the trust income is excepted trust income. This has led to a tax planning strategy of transferring other assets to a testamentary trust after its creation, with the aim of reducing tax by generating excepted trust income from the additional assets. The recent amendments are aimed at removing this tax benefit.

Under the changes, the income from assets of a testamentary trust will only be excepted trust income if the assets were transferred to the trust from the deceased estate, or represent the accumulation of such income. These amendments were originally announced in the 2018-19 Federal Budget, and apply to assets transferred to a testamentary trust on or after 1 July 2019. Income from assets transferred before that date continues to be treated as excepted trust income.

Here is an example of how the new rules will work from the Explanatory Memorandum:

“On 1 July 2019, testamentary trust ABC is established under a will of which a minor is a beneficiary. Pursuant to the will, $100,000 is transferred to the trustee from the estate of the deceased. Shortly after the testamentary trust is established, a related family trust makes a capital distribution of $1,000,000 to the testamentary trust. The resulting $1,100,000 is invested in ASX-listed shares on the same day. Dividend income of $110,000 is derived for the 2019–20 income year. The net income of the trust is $110,000 and the minor is presently entitled to 50 per cent of the amount of net income.

The minor’s share of the net income of the trust is $55,000. $50,000 is attributable to assets unrelated to the deceased estate and not excepted trust income. $5,000 is excepted trust income on the basis that it is assessable income of the trust estate that resulted from a testamentary trust, derived from property transferred from the deceased estate.”

The changes may create unintended consequences for superannuation death benefits and life insurance benefits. It appears that where such benefits are intended to be part of a testamentary trust in favour of minor children, they should first be directed to the deceased’s estate and then flow to a testamentary trust through the provisions of the will. Otherwise there is a danger that income on the assets from such benefits will not be regarded as excepted trust income, and taxed at penalty rates in the hands of the minor children.

These changes are yet another reason why it is important to periodically review estate planning arrangements, to ensure they are appropriate to current law and conditions.

Please contact your Nexia Edwards Marshall advisor if you wish to obtain any further advice in this area.

The material contained in this publication is for general information purposes only and does not constitute professional advice or recommendation from Nexia Edwards Marshall. Regarding any situation or circumstance, specific professional advice should be sought on any particular matter by contacting your Nexia Edwards Marshall Adviser.