New laws regarding taxation of testamentary trusts were assented on 22 June 2020.

The Before Snapshot

Prior to the introduction of the new laws, all income of a testamentary trust was “excepted trust income”.

The strong advantage of this characterisation was that even minor children receiving a benefit from the testamentary trust could be taxed at ordinary rates rather than penalty rates. In other words, children under 18 could receive up to $18,200 each year – tax free – from a testamentary trust.

This generous concession applied whether or not the income was earned through:

  1. assets left in the testamentary trust by Will; or
  2. assets unrelated to the deceased estate that were added to the testamentary trust from time to time

The After Snapshot

The impact of the new laws is that assets unrelated to the deceased estate can no longer inappropriately obtain the tax concession.

The concession will apply only to income derived from property that:

  1. was transferred to the testamentary trustee as a result of the Will;
  2. represents accumulations of income or capital from assets covered by paragraph 1; and
  3. represents accumulations of income or capital from assets covered by paragraph 2 or otherwise has its origins traceable back to the deceased estate.

Assets will not lose their status as being connected to the original deceased estate if they are converted into another asset class. For example, the testamentary trustee is still able to sell a real property held in the testamentary trust and use the net proceeds of sale to invest in a share portfolio. This type of transaction will not impact the tax concession.

The new laws apply to assets acquired by or transferred to the testamentary trustee on or after 1 July 2019.

If unrelated assets are injected into a testamentary trust on or after that date, then the testamentary trustee will need to maintain separate (and detailed) accounts within the testamentary trust.

A Few Blind Spots

The language of the new laws is not entirely clear. There may be ambiguity in its interpretation in relation to:

  1. superannuation;
  2. life insurance proceeds; and
  3. borrowings.

The Verdict on Testamentary Trusts

Notwithstanding the new laws, testamentary trusts continue to offer immense advantages:

  1. protection for the estate assets, particularly where one or more beneficiaries have family law risks, bankruptcy risks, or are otherwise vulnerable (for example, through disability, addictions or tendency to mismanage their finances);
  2. flexibility of distributions, whereby the trustee may minimise tax by splitting income; and
  3. children under 18 can access the tax concession for income earned from assets representing the assets of the deceased estate.

However, the new laws mean that specialist legal advice should be obtained to address these issues in:

  1. the estate planning phase;
  2. the estate administration phase; and
  3. the administration of the testamentary trust.

 

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