RSM Australia

Screws tightened on the taxation of Testamentary Trusts

Tax Insights

Testamentary Trusts (trusts created under the effect of a will) have provided both control and tax advantages for many years.

Testamentary TrustsEffective Testamentary Trusts will see the assets (estate) of a deceased person held and invested for the benefit of trust beneficiaries, such as the deceased’s children or family members.

Sounds straightforward, except that the government has identified a legislative loophole and seeks to improve the integrity of the taxation of Testamentary Trusts. 

The facts

One longstanding advantage of a Testamentary Trust is that distributions made to minor beneficiaries (under the age of 18) are taxed at normal resident adult tax rates; as opposed to the top marginal tax rate of 45% which is ordinarily applied to trust distributions to minor beneficiaries under the Income Tax Assessment Act 1936. 

This means minor beneficiaries are able to take advantage of the $18,200 tax-free threshold and marginal tax rates.

Testamentary Trusts, therefore, hold great tax advantages because the trustee can distribute income to minor beneficiaries at a much lower tax rate than any other type of trust.

The purpose of this lower tax rate is to allow for Testamentary Trusts to provide for specified beneficiaries after death. However, similar to countless preceding cases of circumventing the system, taxpayers have also found a way to stretch the scope of this concession.

The case study

Take the Mayfair Testamentary Trust (MTT). The MTT was created via the will of Mr. Don Mayfair, with the purpose of holding his one Subiaco rental property for the benefit of his son Mark and Mark’s five children.
Mark is a high wage earner and therefore distributes the $18,000 trust profit (from the Subiaco property rental) to one of his children. This results in no tax being paid; Mark’s child is taxed as an adult and therefore gains access to the tax-free threshold.
However, what if Mark transfers four more rental properties from his personal name, into the MTT? Mark can then distribute each property’s $18,000 profit to his other four children and as above, no tax is paid.

The legislation  

Given the intent of the concessional tax treatment of Testamentary Trusts is not to act as a tax vehicle for investment income streaming,  the government now seeks to tighten the operation of this legislation.

To improve the integrity of the taxation of Testamentary Trusts, the government has prepared exposure draft legislation. While first announced in the 2018-2019 budget, the exposure draft was released on 3 October 2019.

The exposure draft provides clarification that minors will be taxed at adult marginal tax rates only in respect of income a Testamentary Trust generates from assets of the deceased estate (or the proceeds of the disposal or investment of these assets).asset_47.png

This aims to limit taxpayers from improperly obtaining lower tax rate benefits by injecting assets unrelated to the deceased estate into the Testamentary Trust.

The change will apply from 1 July 2019.

The good news is that Testamentary Trusts continue to remain a great entity for both asset control and maintenance of beneficiaries into the future. Taxpayers should remain cognisant of the implications of injecting unrelated funds or assets into a Testamentary Trust.

As the exposure draft reflects the intention of the original legislation, we don’t anticipate a significant opposing response to this release. This will, however, generate queries on methods of allocation if the changes proceed.

For more information

If you have any questions regarding Testamentary Trusts, contact your local RSM specialist today. 

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