Income passing to children under 18 years of age will have penalty rates of tax applied, unless the income is “excepted trust income” (and therefore taxed at normal (adult) tax rates).
For this purpose, ‘children under 18 years of age’ means if they are less than 18 years of age on the last day of the year of income.
The excepted trust income provisions applicable to a testamentary trust Will are found in section 102AG(2)(a)(i) of the 1936 Tax Act, which states that the income must be income from a trust estate that resulted from a Will.
In 2019, subsection 2AA was inserted into section 102AG. The effect of this is that additional prerequisites must be met in order for the exemption under section 102AG to apply. These requirements apply to assets transferred to the trustee on or after July 2019.
In relation to the income of a testamentary trust, the first requirement is that it must be income from property transferred:
If this first requirement is met, the exemption can also apply to:
For these purposes, “property” would include real estate, personal property and money.
What does all this mean as to how a testamentary trust can operate? These examples will give you an idea, but remember each case depends on the particular facts.
Borrowing and lending powers should be included in the Will to allow the flexibility in the operation of the testamentary trust. However, the ATO’s position appears to be that assets acquired by the trustee of a testamentary trust through borrowings that are undertaken post death will not qualify for the exemptions under s.102AG.
This was considered in a private ruling in January 2023. A testamentary trust lent money to the primary beneficiary, payable on demand. The borrower then repaid the loan. Any distributions made by the trust to any minor beneficiaries of the trust, including income generated from the investment of the repayment of the loan, would be excepted trust income for the purposes of section 102AG.
This was considered in a private ruling in December 2021. A minor was the sole beneficiary of a testamentary trust. The assets of the trust were transferred from the Estate as a result of the Will. The trust powers allowed the income to be paid to the minor or be retained within the trust as an unpaid present entitlement (UPE). The income retained by the trustee as an UPE would be excepted trust income for the purposes of section 102AG.
A private ruling from November 2021 says yes. A testamentary trust, using funds sourced from assets transferred from a deceased Estate, acquired shares in a company. The dividends of the company are excepted trust income for the purposes of section 102AG.
If subsequent to the date of death the terms of the testamentary trust are amended to add another beneficiary to the trust, and then there were income distributions made to that newly added minor beneficiary – that would not qualify for the exemptions under s.102AG. (ie. not a beneficiary as a result of the terms of the Will).
Assuming the power is there then you can consolidate testamentary 2 trusts. However, the consolidation runs the risk of being outside as a result of the terms of the Will.
If superannuation death benefits are paid to the Estate and then form part of a testamentary trust, it is most likely the income would be excepted trust income for the purposes of section 102AG. The superannuation death benefits would satisfy the requirements of being property transferred to the trustee of the trust from the Estate of the deceased and as a result of the terms of the Will.
The information contained in this article is for general information only and is not a substitute for specific advice. You should obtain specific and appropriate legal advice before any action or decision is taken on the basis of any of the information contained in this article.
Please contact us if you or your clients require any advice on the complexities and benefits of testamentary trusts.
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