Accessing excepted trust income – avoid being a paranoid android**

Estate planning best practice dictates to ’begin with the end in mind’ and ensure a person's documentation achieves their objectives, for example, by including a testamentary trust.

This said, as previous posts have highlighted, it is possible to establish a trust following a person's death such as an estate proceeds trusts, superannuation proceeds trust or a special disability trust.

When considering the use of ‘post death testamentary trusts’ it is important to ensure income derived from gifted property to the structure does in fact create excepted trust income.

The Tax Office has provided useful guidance in this regard in Private Ruling 50621.

In the situation of this Ruling, minor children had each received gifts of money from 2 sources which were then invested on their behalf by a relative.

The 2 sources of the gifts were:

1. money left to them in a will; and
2. other gifts made to them by persons who were alive at the time the gifts were made.

The Tax Office confirmed its view that:

1. The investment earnings derived from monies that were sourced from a deceased estate (whether due to an absolute gift under a will or due to the intestacy rules) held in trust for minor beneficiaries were excepted income.
2. In contrast, the investment earnings from monies gifted to children by their living relatives were not excepted income.

As usual, please make contact if you would like access to any of the content mentioned in this post.

** For the trainspotters, the title of today's post is riffed from the Radiohead song ‘Paranoid android’.

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#exceptedtrustincome #estateplanning #Radiohead #bethechange #viewlegal #matthewburgess

Excepted trust income and ‘bare’** trusts

A previous post has considered various aspects of the statement that ‘every will contains a testamentary trust’.

One example of where basic or 'bare' testamentary trusts exists includes where a gift is given to a beneficiary who does not have legal capacity (for example, because they are under the age of 18).

This was the factual matrix in the Tax Office private ruling mentioned in last week’s post, namely 1011602878465.

In particular –

1. The beneficiary had received gifts of money which were invested on their behalf by their parent.
2. The money had been sourced from several places, including money left to the beneficiary from a deceased estate.
3. The money was held in trust by the parent in a bank savings account named '[Parent's name] in trust for [child's name]'.
4. Under the terms of the relevant will, the child received a certain amount, which was to be paid to their parent or guardian to be held for the benefit of the child if the child was under 18.

It was held that the proportion of the interest income earned that would be 'excepted trust income' would be determined with reference to how much of the original amount invested into the bank account was sourced from the deceased estate, as compared to the amount gift from non-estate sources.

As usual, please contact me if you would like access to any of the content mentioned in this post.

** For the trainspotters, the title of today's post is riffed from the Cure song 'Bare’.

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Sometimes** - in days gone by - you may have been able to use an inter vivos trust to access excepted trust income

One of the advantages of testamentary trusts is the ability to access the 'excepted' trust income rules and therefore ensure infant recipients are taxed as adults.

The Tax Act only allows excepted trust income in relation the amount which is assessable income of a trust estate that resulted from a will, codicil or court order varying a will or codicil.

Importantly, historically the legislation did not appear to expressly exclude an indirect interest as being a beneficiary for the purpose of the provisions.

This meant that as one example, any income received by an infant beneficiary derived from assets of a testamentary trust created under a deceased estate that may have been transferred to an interposed inter vivos trust may be able to be treated as excepted trust income.

It should be noted however that there are rules that provide that an amount will not be treated as excepted trust income if it was derived by a trustee ‘as a result of an agreement entered into for the purpose of securing that the income would be excepted trust income’.

However arguably, historically this prohibition was thought not apply to income derived via an interposed inter vivos trust as the income would have in fact been excepted trust income in the testamentary trust the assets were sourced from.

The Private Rulings mentioned in recent posts provide some support for the above interpretation.

Since the 2018 budget changes however (featured in many previous posts), the rules are now clear that access to excepted trust income is only possible while the assets of the deceased are owned via the testamentary trust under that person’s will. Once the assets are removed from the testamentary trust, for example, to an inter vivos trust, the ability to benefit from the excepted trust income regime ends.

As usual, please contact me if you would like access to any of the content mentioned in this post.

** For the trainspotters, the title of today's post is riffed from the John Butler Trio song 'Sometimes'.

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Don't know what you got 'til it's gone** - testamentary trusts and ETY

Thank you to all those who were part of our Estate Planning 2021 webinar this week.

A key question discussed related to the way in which the new restrictions on excepted trust income (ETY) via testamentary trusts operate.

In particular, in the context of a husband and wife preparing wills incorporating Testamentary Trusts, are there any tax consequences that flow from preparing the husband and wife’s wills to reflect that in the event the husband predeceases the wife (for example) the wife’s will provides that her assets will be gifted into the Testamentary Trust previously set up under the husband’s will.

Focusing solely on the ETY position, the new rules unfortunately make it clear that in this situation the income earned on the wife’s assets gifted to the husband’s Testamentary Trust will not give rise to ETY.

The reason for this is that the legislation mandates that the ‘property (must be) transferred to the trustee of the trust estate to benefit the beneficiary FROM THE ESTATE OF THE DECEASED PERSON concerned’ (emphasis added).

View made submissions on the draft legislation on this point (which were ignored ...) as follows:

‘The draft legislation is focused on “the deceased person concerned”, and it is unclear why this restriction is relevant.

For example, for most couples who both implement testamentary trusts, it will be the case that they will die at different times and there will often be a desire to transfer assets between testamentary trusts.

It is clearly the case that the excepted trust income rules should continue to apply in situations where a couple both implement testamentary trusts.

To argue otherwise would again see the proposed amendments extend significantly beyond the stated intent of the announced measure and impact taxpayers in a range of circumstances where there is no inappropriate tax benefit received by a beneficiary.’

** For the trainspotters, the title of today's post is riffed from the Joni Mitchell song ‘Big Yellow Taxi'.

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Not dead yet ** but watch this space following Budget attack on excepted trust income

The announcement in the 2018-19 Federal Budget that “the concessional tax rates available for minors receiving income from testamentary trusts will be limited to income derived from assets that are transferred from deceased estates or the proceeds of the disposal or investment of those assets” was for many a surprise.

As is usually the case with Budget announcements attacking perceived arbitrage revenue opportunities, the exact impact of the changes will revolve almost entirely around how the legislation is crafted - the 2017 Budget changes to the small business CGT concessions being a recent a high-profile example of what appeared at announcement to be a narrowly focused change that in fact has proven to be significantly wider.

Thus, advisers in the estate planning industry should likely be concerned as to what the Government means by suggesting that the mischief to be addressed is “that some taxpayers are able to inappropriately obtain the benefit of (a) lower tax rate by injecting assets unrelated to the deceased estate into testamentary trusts.’’

In turn, the Budget statement that the “measure will clarify that minors will be taxed at adult marginal tax rates only in relation to income of a testamentary trust that is generated from assets of a deceased estate (or the proceeds of the disposal or investment of these assets)” also has the distinct prospect of having much wider consequences than might otherwise be expected.

Excepted trust income rules currently 

Previous posts have explained that pursuant to Div 6AA of the ITAA 1936 and, in particular, subs 102AG(2)(a)(i), excepted trust income is the amount which is assessable income of a trust estate that resulted from a will, codicil or court order varying a will or codicil.

Where income is excepted trust income and it is distributed to minors, those minors are taxed as adults, instead of the normal penal rates that otherwise apply to unearned income.

Currently, subss 102AG(2)(a)(i) and 102AG(2)(d)(i) of Div 6AA make it clear that the provisions are not limited to income derived from estate assets.

Importantly, the subsections only prescribe how the trust estate is deemed to have arisen and do not place any limitations on the management of the trust estate, or on the assets which the trust may hold.

The fact that estate assets forming part of the trust estate may be realised and others may be acquired has no implications on the validity of a testamentary trust, nor the ability of the trustee of a testamentary trust to treat the income as excepted.

Similarly, if the trustee decides on behalf of the testamentary trust to borrow money and acquire assets which earn income, then it has generally been accepted that Div 6AA applies to that income.

Current limitations 

Section 102AG(3) currently contains an exception for non-arm’s length arrangements. In particular, it provides that if any 2 or more parties to:

1. the derivation of the excepted trust income mentioned in subsection (2); or 
2. 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 in relation to the derivation of income, or in relation to the act or transaction, the excepted trust income is only so much (if any) of that income as would have been derived if they had been dealing with each other at arm’s length in relation to the derivation, or in relation to the act or transaction. 

Furthermore, s 102AG(4) provides that an amount will not be treated as excepted trust income if it was derived by a trustee as a result of an agreement entered into for the purpose of securing that the income would be excepted trust income.

Furse’s case 

The Trustee for the Estate of the late AW Furse No 5 Will Trust v FCT (1990) 21 ATR 1123 (“Furse”) is one of the few reported decisions dealing with Div 6AA.

In this case, a will made in July 1974 established multiple testamentary trusts, each with capital of $1 after the testator passed away shortly after making the will.

A trustee was then appointed over one of the testamentary trusts and proceeded to borrow small amounts of money and acquire a unit in a unit trust.

The ATO did not consider the income from the unit as excepted income and argued that the income derived by the trustee was not assessable income of a trust estate that “resulted from a will.”

Justice Hill rejected the ATO’s argument and held that it was only necessary that the parties be dealing on an arm’s length basis, and that it was not necessary that they also be arm’s length parties.

The Court noted that provided the trust estate was created by a will and the arm’s length test was satisfied, then any income of a testamentary trust would be considered as excepted trust income.

What might new rules attack? 

Taken at face value, the new rules will simply create an obligation on trustees to track the source of assets in a testamentary trust and ensure the income to be treated as excepted trust income is sourced from assets passing directly to the trust from the willmaker.

In theory, this type of probation would be similar to what is currently the case with post death testamentary trusts (often referred to as estate proceeds trusts) set up to comply with s 102AG. Indeed, this style of tracking mechanism is analogous to that which trustees are meant to undertake in relation to ensuring trust assets vest within the perpetuity period.

Thus, any further assets gifted or settled on a testamentary trust, other than by the willmaker, would be segregated from excepted trust income purposes.

Depending on the drafting approach adopted, however, some areas that may be impacted (potentially unintentionally) by the new rules include:

• Assets that form part of a testamentary trust that are not owned outright by the willmaker (that is, are subject to existing borrowings) – what happens as the level of debt changes? 
• Even if assets that initially form part of the testamentary trust are debt free - what are the consequences if further assets are acquired using the initially contributed assets as security? 
• If an asset class at the date of death of the willmaker is cash at bank – does the tracing of the assets acquired continue indefinitely? 
• If assets acquired using borrowings no longer generate access to excepted trust income – is it appropriate that tax laws essentially directly impact the investment decisions of trustees? 
• If an asset acquired is itself tax advantaged (one obvious example in that regard being insurance bonds) - how will the proceeds from the investment be treated? 
• In relation to shares - how will dividend reinvestment arrangements be treated? 
• How will assets that are acquired by the testamentary trust as a consequence of the willmaker’s death, however, are not directly from the willmaker, be treated – for example will superannuation death benefit payments and insurance policy payouts to an estate be considered to be legitimate capital from which to source excepted trust income? 
• Particularly for those in life spouse relationships, it is common for testamentary trusts to be established under each person’s will and for there to be a subsequent merger of the trusts some years later – what will be the approach in relation to wealth that passes to a testamentary trust sourced from another testamentary trust? 

In conclusion: some further questions 

Testamentary trusts (and, in turn, access to excepted trust income) only arise because someone has died.

Traditionally, in Australia, death has not been seen as a tax planning strategy.

The 2018 Budget announcement arguably changes the position in this regard.

If there is, in fact, widespread abuse of the existing rules in this area, it must be asked why there is essentially only one reported case in the area that is now over 25 years old and remains unchallenged, and in turn what aspects of the offensive arrangements are not already addressed by s 102AG itself or, in the alternative, Part IVA.

The above post is based on an article originally published in the Weekly Tax Bulletin.

** For the trainspotters, ‘Not dead yet’ is a quote from the ‘Bring Out Your Dead’ scene in Monty Python’s ‘The Holy Grail’.