Section 102AG of the Income Tax Assessment Act (1936) (ITAA 1936) about ‘excepted trust income’ for minors has been amended.

The exception from higher tax rates which it confers will now only apply to income derived (directly or indirectly) from property transferred from the estate of a deceased person to the trustee of a trust created under that person’s Will etc.

This change, which was included in Treasury Laws Amendment (2019 Measures No.3) Act 2019, received Royal Assent on 22 June 2020. It applies from 1 July 2019 and will therefore need to be factored into returns for the 2020 and later income years.

Background

Taxing capital gains – interaction between specific and present entitlement rules

Division 6AA of Part III of the ITAA 1936 and section 13 of the Income Tax Rates Act 1986 impose higher tax rates on minors to discourage adults diverting income to them. However, there are exceptions for certain categories of income.

Those higher tax rates do not apply to ‘excepted trust income’. One category of ‘excepted trust income’ is that from a trust estate that resulted from a Will, intestacy or relevant Court order (for ease of expression we have referred to all of these trusts as testamentary trusts).

Prior to the recent amendment, there was technically no general restriction on the assets that could be used to generate excepted trust income for testamentary trusts (though there were specific anti-avoidance rules). This allowed some taxpayers to inject assets into these trusts and inappropriately obtain the benefit of the concessional tax treatment rather than the punitive Division 6AA rates that would otherwise apply to minors.

For those practitioners who, appropriately in our view, did not seek to inappropriately inject assets from a non-deceased-estate environment into a testamentary trust, the amendment will have less tax impact. However, it is still expected to affect current succession planning practices. For example, it will no longer be effective for section 102AG purposes  to establish a testamentary trust for a beneficiary on the death of one person (say a parent or grandparent), with assets from the estate of that person’s spouse passing to that testamentary trust on death.  That is because in the case of the second deceased person, the trust was not created by their Will. Two separate trusts will need to be established and maintained.

Care should also be taken in relation to borrowings within the trust!

Amendment to section 102AG

The amendment imposes additional conditions that must be met in order for trust income of testamentary trusts to be regarded as excepted trust income. Income now will only be regarded as excepted trust income if it is derived from property that satisfies one of these requirements:

• The property was transferred to the trustee of the trust estate to benefit the beneficiary of the testamentary trust from the estate of the deceased person concerned, as a result of the Will, codicil, intestacy or order of a court mentioned in paragraph 102AG(2)(a).

This requirement ensures that the income from property that is unrelated to the deceased estate is not treated as excepted trust income for the purposes of Division 6AA. It also ensures that only beneficiaries included in the class of beneficiaries by the deceased, rather than an entity which was later added to the class of beneficiaries after the death of the deceased, can be in receipt of excepted trust income under paragraph 102AG(2)(a);

• The property represents accumulations of income or capital from property that satisfies the first requirement. This ensures that further income from property that represents undistributed trust income or capital from such assets in a testamentary trust can also be excepted trust income for the purposes of Division 6AA; or
• The property represents accumulations of income or capital from property that satisfies the second requirement (and subsequent accumulations of income or capital). Accordingly, further income on accumulations of income or capital from property can also be excepted trust income for the purposes of Division 6AA.

Example – Income from injected asset not excepted income (taken from Example 1.1 of the Explanatory Memorandum).

 

On 1 July 2019, testamentary trust ABC is established under a Will of which a minor is a beneficiary. Pursuant to the Will, $100,000 is transferred to the trustee from the estate of the deceased.Shortly after the testamentary trust is established, a related family trust makes a capital distribution of $1,000,000 to the testamentary trust. The resulting $1,100,000 is invested in ASX listed shares on the same day. Dividend income of $110,000 is derived for the 2019-20 income year. The net income of the trust is $110,000 and the minor is presently entitled to 50% of the amount of net income. The minor’s share of the net income of the trust is $55,000.

 

• $50,000 is attributable to assets unrelated to the deceased estate and not excepted trust income.
• $5,000 is excepted trust income on the basis that it is assessable income of the trust estate that resulted from a testamentary trust, derived from property transferred from the deceased estate.

Example – Further accumulations of non-excepted income (taken from Example1.2 of the Explanatory Memorandum).
 
Following on from the above example, the minor’s share of the net income of the trust (being $55,000, comprising $5,000 excepted trust income and $50,000 not excepted trust income) is not paid to the minor by the trustee but is invested for their benefit in ASX listed shares shortly after the commencement of the 2020-21 income year. For the 2020-21 income year, that investment derives income of $5,500, and the minor is presently entitled to the entire amount.
 

• $5,000 is attributable to assets unrelated to the deceased estate and not excepted trust income.
• $500 is excepted trust income on the basis that it is assessable income of the trust estate that resulted from a testamentary trust, derived from income that was previously excepted trust income.