For those that do not otherwise have
access to the Weekly
Tax Bulletin, the article from earlier this month by fellow View Legal Director
Patrick Ellwood and me is extracted below.
In the
context of deceased estates (and specifically with the use of testamentary
trusts), the excepted trust income rules under Div 6AA of the ITAA 1936 are
well known.
In
particular, the rules allow income derived by infant children via distributions
from a testamentary trust to be assessed at the normal, individual adult
rates. As a result, each infant beneficiary can receive over
$20,000 of income tax-free and the balance is taxed at the adult marginal
rates. For most families, this can mean significant tax planning
opportunities.
In the vast
majority of cases, access to the excepted trust income concessions is only
available following someone's death. One key structure that falls outside
this general position however is a "child maintenance trust" (CMT).
A CMT is
another form of trust contemplated by Div 6AA that should be at least
considered whenever there is a personal relationship (referred to as a
"family") breakdown and either party is responsible for making child
support payments. This is because a validly established CMT can also
create access to the excepted trust income provisions and the resulting tax
concessions.
Given the
significant percentage of personal relationships that breakdown irretrievably,
many of which then result in child maintenance obligations being imposed, it is
important that practitioners are aware of the planning opportunities afforded
by CMTs.
What is
a "family breakdown"?
Section
102AGA of the ITAA 1936 defines a transfer of property as a result of a
"family breakdown" to include legal obligations arising from a range
of situations such as:
- The breakdown of a formal marriage.
- The breakdown of a de facto relationship.
- Where a child has been born outside a "traditional" relationship arrangement (for example, a "one night stand").
CMTs are
potentially available in relation to children who are:
- born of the union of the relationship that has broken down;
- adopted children; and
- step-children.
ITAA
1936 and excepted trust income
CMTs are
specifically provided for in s 102AG of the ITAA 1936. As noted above,
the main advantage of a CMT from a tax perspective is the ability for income of
the trust to be treated as excepted trust income.
A CMT, like
most trusts, must be established by deed but, in contrast to many of the other
types of trusts contemplated by the excepted trust income rules, cannot be
created by a will.
There are
also other requirements that must be met before the income of the trust is
treated as excepted trust income, including:
- the children named as the "primary beneficiaries" of the trust must be younger than 18 at the time the trust is established;
- income must be derived by the investment of property transferred to the trustee of the trust for the benefit of the primary beneficiary/beneficiaries, as a result of a "family breakdown", as set out above;
- there is no set time frame in which a CMT must be established following the family breakdown, although they should ideally be set up at the time of the property settlement; and
- the children for whose benefit the trust is established must ultimately receive all of the capital from the trust in equal shares.
Both in
relation to tax planning and asset control, it is important to note that
potential income beneficiaries of a CMT may include persons other than children
of the relationship subject to the family breakdown, without jeopardising
access to the excepted trust income concessions.
Non-arm's
length arrangements
The income
of a CMT can be generated from non-arm's length arrangements. However,
any income which results from non-arm's length transactions must be of equal
value to that which would have been derived on an arm's length basis in order
to be considered excepted trust income.
The arm's
length requirement is set out in detail in s 102AG(3). In particular,
this section provides that if any 2 or more parties to:
- the derivation of excepted trust income; or
- any act or transaction directly or indirectly connected with the derivation of that excepted trust income,
were not
dealing with each other at arm's length, then the excepted trust income (if
any) is only so much of that income as would have been derived if they had been
dealing with each other at arm's length.
Due to the
strict requirements for a valid CMT, particularly on the ultimate vesting of
the assets in the children of the relationship that had a family breakdown, one
approach often used is to contribute depreciating assets such as plant,
equipment and motor vehicles to the trust. These assets can be leased, either
to a related individual or business entity for value.
Provided
the lease repayments are on an arm's length basis, then the income will be able
to be distributed to infant children as excepted trust income.
Other
issues to consider
While there
can be tax planning advantages to utilising a CMT, there are also a number of
potential pitfalls (in addition to the matters set out above).Some of the
things to specifically consider before establishing a CMT include:
- Taxation Ruling TR 98/4 which sets out in detail the Commissioner's position in relation to CMTs and should be studied carefully before implementing the structure.
- The CGT relief afforded by Div 126-A of the ITAA 1997 due to a marriage breakdown does not extend to assets transferred to a CMT.
- Similarly, in relation to non-capital assets (eg depreciating assets), there will generally be no roll-over relief available for asset transfers to the CMT.
- Generally there will also be no stamp duty relief available for dutiable assets transferred to a CMT, although anecdotally it appears some State Revenue Offices do allow an exemption.
- It is often extremely difficult to establish a CMT unless both parents work collaboratively, which obviously may not be the case where the personal relationship has otherwise broken down.
Until
next week.
Image credit: Steve Corey cc