The Tax Future of Testamentary Trusts
Strictly speaking, a testamentary trust comprises of any trust created under the terms of a Will. However, in recent times, the term ‘testamentary trust’ is most often used to describe what is commonly known as a ‘discretionary trust’ contained within a will. These trusts are almost identical to regular family trusts with the exception that they are only created upon the death of the testator and the terms of the trust are set out in the deceased’s Will.
Testamentary trusts ordinarily appoint a trustee to manage the trust and beneficiaries who are intended to benefit from the trust. The most common form of testamentary trust is one which is created by a parent in their Will for the benefit of their children and grandchildren.
Some of the key advantages to using testamentary trusts include greater asset protection and tax benefits for beneficiaries. Unlike regular family or discretionary trusts which tax children under the age of 18 years on income they receive at the top marginal tax rate, testamentary trusts enable income distributed to minor children to be treated as “excepted trust income” and taxed at ordinary “adult” rates under Division 6AA of the Income Tax Assessment Act 1936 (Cth). This means that each minor beneficiary is entitled to receive $18,200 per annum without having to pay any tax (assuming they do not have any other income, earned or unearned, in that income year.).
On 22 June 2020, legislation was enacted to prevent minors from accessing concessional tax rates (that is, the ordinary tax rates) on income derived by a testamentary trust from assets unrelated to the deceased estate.
The new rules require that “excepted trust income” of the testamentary trusts must be derived from “property” transferred to the testamentary trust from the deceased estate or from the accumulation of such income and capital. The effect is that income from property (including money) that did not form part of the deceased estate can no longer be “excepted trust income” for the purposes of Division 6AA.
The effect of these changes means that the following arrangements no longer qualify for tax concessions:
- Assets distributed into a testamentary trust by way of a capital distribution from a related family trust; and
- Assets contributed to the testamentary trust after its creation.
The changes have also resulted in a lack of clarity in respect of the following arrangements:
- Whether income derived from borrowings in the trust will continue to qualify for concessions, and
- Whether superannuation proceeds would qualify for concessions, given that they are held in a form of trust prior to death.
The changes described above apply to assets acquired by, or transferred to, the trustee of a testamentary trust on or after 1 July 2019.
If you are the trustee of a current testamentary trust you will need to take advice from your accountant and advisor to ensure that your tax planning objectives remain viable.
Despite the recent changes, testamentary trusts remain an excellent vehicle for clients looking to leave inheritances to their intended beneficiaries in a tax effective and better protected environment.
If you would like to discuss incorporating testamentary trusts into your Will, please contact our Head of Estates, Karolina Rymkowska:
Telephone 08 9375 3411
About the author:
Karolina Rzymkowska is a Perth Lawyer and Head of Estates at Lynn & Brown Lawyers. Karolina is an experienced lawyer in the areas of probate & Wills and commercial law.