Tuesday, December 5, 2023

Why every will contains a testamentary trust (Not calling anyone a liar**)

View Legal blog - Why every will contains a testamentary trust (Not calling anyone a liar**) by Matthew Burgess

While the popularity of comprehensive testamentary trusts has continued to grow significantly in recent years, strictly every valid will does contain a form of testamentary trust.

While the popular usage of the term 'testamentary trust' refers to a comprehensive discretionary trust embedded into a will instrument, testamentary trusts can refer to any arrangement set out under a will where the intended beneficiaries are not absolutely and immediately presently entitled.

The structure lasts only for the length of administration of the estate (ie normally only a few months).

They are not testamentary trusts as normally understood and do not offer any ongoing tax, asset protection or flexibility advantages.

The phrase for the clause establishing this form of ‘trust’ in a will is often along the lines of:
‘As to 50% of my Net Estate, UPON TRUST for my child once they attain the age of 25 years absolutely’
One (perhaps anecdotal) way to determine if a will has a comprehensive testamentary discretionary trust included is to apply ‘the weight test’.

That is, a comprehensive testamentary discretionary trust will usually is around 30 pages in length.

A ‘bare’ testamentary trust will is rarely more than 10 pages, and can often be as short as 2 pages.

Some examples of where basic or 'bare' testamentary trusts exist include:
  1. where the beneficiary receives a direct gift that is subject to them attaining a certain age (for example, the clause set out above);
  2. where a gift is given to a beneficiary who does not have legal capacity (for example, because they are under the age of 18, or are over the age of 18 and lack mental capacity); and
  3. where a specific gift is given to a beneficiary, however the administration process of the estate has not been completed.
In relation to the first two categories, the Tax Office will generally allow the ultimate beneficiary to enjoy access to the excepted trust income provisions.

In relation to the last category however, the Tax Office generally only allows a maximum of 3 years whereby the excepted trust income provisions apply, and practically, we are aware of situations where they in fact only allow a maximum of 12 months.

The Taxation Ruling IT 2622 explains in more detail the Tax Office’s approach.

The case of Walker v Walker [2022] NSWSC 1104 similarly explores many of the key principles in this area - and indeed appears to support a conclusion that the administration process of an estate will be completed, at least for the purposes of present entitlement for tax, at a point in time even earlier than what the Tax Office has historically suggested in the IT.

That is a beneficiary may be held to have a vested and indefeasible interest to the income (and be specifically entitled) far earlier than might otherwise be assumed. Furthermore, executors may have a duty to ensure tax imposts are legitimately minimised by protectively making interim distributions to beneficiaries.

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** For the trainspotters, the title of today's post is riffed from the Florence and the Machine song 'I’m not calling you a liar’.

Listen here: