The Tax Benefits of Creating a Testamentary Trust

A Testamentary Trust has a myriad of tax benefits, which can play an integral role in maximizing the net income that beneficiaries of the Trust receive.

It is important that all trustees, as well as trust creators (or grantors), are aware of these advantages in order to seek the greatest return for the beneficiaries, and to maximise after-tax net income.

What is a Testamentary Trust?

Testamentary Trusts are trusts created by a ‘testamentary’ instrument (usually a Will). This means that a Testamentary Trust comes into effect after the person who created it has died. Testamentary Trusts are usually created to benefit a person’s spouse, children or grandchildren. For more information please read: Testamentary Trusts in Estate Planning.

It is important to note that Testamentary Trusts require their own tax file numbers, separate from the tax file number of the deceased estate. Deceased estates are not subject to the Medicare Levy; Testamentary Trusts are.

Benefit #1 – Marginal Tax Rates for the Testamentary Trust

At the Commissioner’s discretion, a Testamentary Trust’s income can be assessed under s99 of the Income Tax Assessment Act 1936 (Cth) (“ITAA”). Other trusts, such as an Inter Vivos Trust (which comes into affect while the trust creator is alive), are assessed under s99A of the same Act.

What does this mean? Under s99A, an Inter Vivos Trust will be assessed at the highest marginal tax rate for undistributed income, that is, at 49% inclusive of Medicare and Budget Levies. Under a Testamentary Trust, however, the Commissioner may choose to apply s99 which taxes the trustee at what is essentially a standard adult marginal rate. This marginal rate also excludes the tax free threshold of $18,200.

Under s99:

• • Any income between $670 and $37,000 is charged at a flat rate of 19%.
  • Any income between $37,000 and $80,000 is charged at a marginal tax rate of approximately 32.5%.
  • Any income between $80,000 and $180,000 is charged at a marginal tax rate of approximately 37%.

Benefit #2 – Discount on Capital Gains Tax for Disposal of Assets

Section 99, under which a Testamentary Trust can operate, allows trustees to access a 50% discount on Capital Gains Tax for assets that are sold off. This is provided they have been held for over 12 months. Most other types of trusts are subject to s99A which does not provide access to this discount.

Benefit #3 – Personal Income Benefits

A person will either be a “beneficiary” or a “beneficiary under a legal disability”. A beneficiary under a legal disability can include minors (under 18), bankrupts who have not been discharged and persons who are deemed “mentally impaired”.  The beneficiaries will be assessed as follows:

• • An ordinary beneficiary (not under a legal disability) will have their personal income assessed under s97 of the ITAA. This means their personal income tax will be assessed at marginal tax rates which are subject to the $18,200 tax-free threshold.
  • A beneficiary under a legal disability (who is not a child) will be assessed under s98(1) of the ITAA. Here the trustee will be assessed by the ATO on the beneficiary’s behalf. The trustee will then issue a Beneficiary Tax Statement to the beneficiary. (Implications for this below).
  • Further to the above, pursuant to s102AG(2)(a) of the ITAA, a child (who is a beneficiary with a legal disability) will have their income from a Testamentary Trust classified as “excepted trust income”. This means their income will be assessed at adult marginal rates, entitling them to the $18,200 tax-free threshold they otherwise would not have been able to access.

In addition to receiving marginal tax rates, beneficiaries under a Testamentary Trust are also entitled to “franking credits”.

Overall Effect

A beneficiary to a Testamentary Trust will therefore be entitled to marginal tax rates when being assessed on income from the trust, while also receiving distributed franking credits. This maximises their overall net income.

While these are some of the nuances of taxation involved in a Testamentary Trust, if you are creating a trust, it is important to seek legal advice to help decide which trust structure is best for your personal circumstances. If you are a trustee of a Testamentary Trust legal advice can also assist in capitalising on the tax benefits available to you and the beneficiaries of the trust.

This article was written by Andrew Lind (Director).

Trust Resettlements

A trust is a relationship whereby a person (the trustee) holds property on trust for the benefit of another person (the beneficiary). A trust deed outlines the terms of the trust including the duties of the trustee in holding the trust property. Whilst these terms are binding, some trusts include a power to amend the terms of the trust. This is known as a power of amendment. There are many reasons why a person would want to make amendments to a trust deed. For example a person may wish to add a new beneficiary, appoint a new trustee, or extend the vesting date of the trust. The difficulty arises in determining what kinds of amendments can be made to a trust deed without causing a resettlement. In other words, when will amendments to a trust deed cause a new trust to be created?

What is a trust resettlement? 

A trust resettlement occurs when a trust is varied or amended to the extent that it becomes a new trust. A trust resettlement can also occur when the trust property is transferred to a new trust.

How is a resettlement triggered? 

The law relating to what constitutes a resettlement has evolved substantially over the last few years. In 2001 following the decision in FCT v Commercial Nominees of Australia Ltd,[1] the ATO released a Statement of Principles which stipulated that a resettlement would occur when:

‘there was a ‘fundamental change’ to the trust relationship and that a change in the ‘essential nature and character’ of the trust relationship can result in the creation of a new trust.’

The Statement indicated that even some relatively minor changes might trigger a resettlement in certain circumstances. However following the 2011 decision in Commission of Taxation v Clark,[2] the ATO retracted this Statement of Principles stating that the approach was no longer sustainable. In Clark, significant changes were made to the members of the trust and the trust property yet these changes were held to have not constituted a resettlement. The ATO thus amended its report and confirmed that the decision in Clark was now the correct test. It is now accepted pursuant to Clark, that a trust will be resettled where the variation to the trust disrupts the continuity of the essential features of a trust. These being:

• • the terms of the trust deed
  • the trust property
  • the members of the trust

The ATO’s amended report Taxation Determination 2012/21 further notes that provided there has been a valid exercise of the power of amendment or prior court approval, then changes to the trust deed will not result in a resettlement unless the change:

• • terminates the existing trust; or
  • leads to a particular asset being subject to a separate charter of rights and obligations such as to give rise to the conclusion that that asset has been settled on terms of a different trust.

The powers of amendment in the trust deed are very important to ascertaining what variations to the trust can be made. A trust deed cannot be amended without an express power to do so. Where a trust deed contemplates a change and the correct procedures in making the change are followed then it is unlikely that a trust will be resettled. Clark appears to confirm that there are now few amendments to a trust that will cause a resettlement.

What is the effect of resettlement? 

There are significant taxation implications which flow from a resettlement. The disposal of the trust property into a new trust triggers a number of provisions of the Income Tax Assessment Act 1997 (Cth) including a capital gains tax event which the trustee would be liable to pay. In addition, the disruption of continuity of the trust estate means that any losses or gains from the old trust cannot be transferred to the new trust.

How to avoid trust resettlements?

It is very important to obtain legal advice before amending a trust deed in any way. Even where the trust deed includes a power of amendment it is important to read the trust deed and check that the power specifically authorises the proposed amendment. Remember one cannot rely on all of the amendments listed in the different state Trusts Acts where the power of amendment in a trust deed stipulates otherwise. It is also very important that amendments made pursuant to a power are done so in accordance with any process outlined in the deed.

For more information regarding trust resettlements 

Please do not hesitate to contact our Business Development Team on (07) 3252 0011 to arrange an appointment with one of our experienced commercial lawyers.

Footnotes 

[1] [1999] FCA 1455.

[2] [2011] FCAFC 5.

Succession Plan – Discretionary Trusts

In this paper regarding succession plan discretionary trusts, I use the following terms interchangeably – “Family” / “Discretionary” Trust.

Discretionary Trust assets do not form part of your Estate

Assets owned by a trustee on trust for a discretionary trust, are held for the benefit of all the potential beneficiaries.

Discretionary Trusts are usually expressed to have a life of 80 years and so they will often survive the person who originally arranged to set them up.

Even if you are the personal trustee of your family trust, the trust will usually continue to have life after your death. The assets are not “your” personally owned assets that are part of your estate to be gifted via your Will.

Control of the trust

There are usually two levels of control:

1. 1. The trustee, who administers the trust and exercises discretion year by year as to whom income/capital is paid to; and
   2. The Appointor/Principal, who has power to hire and fire the trustee.

Ensuring that control moves to those you intend

Both levels of control must be considered and effectively passed on to your chosen person(s) otherwise the wealth in the trust may end up with those you do not intend.

Control at trustee level

If you are a personal trustee:

1. 1. We will need to consider what the Trust Deed says about:
      • Change of trustee; and
      • Death or incapacity of a trustee.
   2. It may be that the Trust Deed has contemplated these situations and no action need be taken.
   3. If not, a Variation of Trust will probably be required.

If your trust has a corporate trustee (e.g. a Pty Ltd company):

1. 1. Who are the shareholders? Who will these shares pass to under your Will? Does the corporate trustee constitution have any limitations on how shares can be transferred?
   2. Does the constitution require more than one shareholder? This is unlikely if the company has been fairly recently formed. If yes, we will take care that not all shares are left in your will to a single person or amend the constitution.
   3. What does the constitution say about appointment of directors? Generally the power to hire and fire directors rests with the shareholders.
   4. Will there be an undesired single controlling director before the estate can act? While the power to hire and fire may be with the shareholders this may not prevent a single director acting before a replacement/additional director is appointed by your estate. A solution may be to appoint an additional director(s) now.

Clearly, these issues need our advice.

Control at Appointor/Principal level

Assessing the succession of control at this level is even more critical.

Here is our usual approach:

1. 1. Check what the Trust Deed says about this.
   2. This power is often a personal power and so without express provision in the Trust Deed it will not pass to the executors of the deceased Appointor. Is there provision in the Deed for the next Appointor?
   3. Often the Appointor will need, via Deed (made now as part of their Estate Plan), to appoint their successor. After death, it is obliviously, too late.

It may be necessary to amend the Trust Deed to provide for a more robust succession mechanism.

Who does the new controller give the wealth to?

This question is often overlooked by Will makers.

When you have multiple beneficiaries and they are not all appointed as “controllers”, the potential exists for the controller to divert the wealth for their own personal benefit at the expense of other beneficiaries.

At the very least, you would want to prepare a Desired Beneficiaries Expression of Wish.

QLD Transfer duty exemption for limited recourse borrowing arrangements on transfer from bare trust SMSF

On 12 June 2013, a new exemption to the Duties Act 2001 (Qld) was introduced. This new exemption allows for the transfer of fund property from a custodian or bare trustee of a self-managed superfund (“SMSF”) to a trustee for the same SMSF to be transfer duty exempt. This exemption has been introduced retrospectively from 26 October 2011. This means that if the conditions for the exemption described below apply, the trustee or custodian may be eligible for a transfer duty refund.

Prior to the amendments introduced by Revenue Amendment and Trade and Investment Queensland Act 2013 (Qld), it was unclear as to whether transfer duty would be able exempt on the transfer from the custodian or bare trustee of a SMSF to a trustee of a SMSF. The Revenue Amendment and Trade and Investment Queensland Act 2013 (Qld) has now introduced a transfer duty exemption (by way of new section 130B in the Duties Act 2001), which clarifies this issue.

To be eligible for this exemption, the following conditions must be satisfied:

• The fund property, or interest in the fund property, must not have ceased to be fund property; and

• The members of the SMSF must have the same trust interest in the fund property after the property is transferred as they had immediately prior to the transfer..

Trustees of a SMSF who have received fund property from the custodian of the same SMSF and have paid transfer duty should consider applying for a refund of Transfer Duty.