What the new testamentary trust laws mean for estate planning
A recent change to the tax treatment of income from super in a testamentary trust may require some SMSF clients to update their estate plans.
There has been a recent change to the tax treatment of superannuation proceeds that are paid to testamentary trusts and the interaction of Div 6AA of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936) which covers excepted trust income (ETI).
Recent change to ITAA 1936
New subsection 102AG(2AA) was introduced by the Treasury Laws Amendment (2019 Measures No. 3) Act 2019 (Cth) from 23 June 2020.
This measure was first announced in the 2018–19 federal budget and was designed to address:
… some taxpayers are able to inappropriately obtain the benefit of this lower tax rate by injecting assets unrelated to the deceased estate into the testamentary trust. This measure will clarify 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).
The Explanatory Memorandum (EM) includes useful information on considering the potential application of ss 102AG(2AA) and understanding the “schemes” it was designed to catch. The following paragraph and example are the key extracts from the EM:
1.13 … These requirements are directed at ensuring that assets unrelated to the deceased estate cannot be injected into the testamentary trust and derive income that is excepted trust income for the purposes of Division 6AA. That is, the requirements ensure that there is a connection between the property from which excepted trust income is derived and the deceased estate that gave rise to the testamentary trust.
Example 1.1 – injected asset
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 per cent 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.
- the 2018–19 Budget Papers No 2 refers to:
… assets unrelated to the deceased estate cannot be injected into the testamentary trust …
- the EM refers to:
… Shortly after the testamentary trust is established, a related family trust makes a capital distribution of $1,000,000 to the testamentary trust …
Treatment of superannuation death benefits and insurance
In contrast, a superannuation death benefit relates to the deceased member’s interest in a superannuation fund. While this is an interest under a trust, the deceased member was entitled to that payment prior to their death and the payment can either be paid to their executors (or legal personal representative) or to a dependant. In short, this is very different to the type of schemes contemplated by the new subsection.
Similarly, insurance proceeds paid to a person’s executors that form part of their deceased estate, from a life insurance policy on their life following their death, has a relevant connection to the contractual entitlement to insurance cover.
Both superannuation death benefit payments and insurance proceeds paid to their executors following a person’s death that forms part of their deceased estate have a relevant connection to that person’s membership interest or contractual entitlement. These amounts can be contrasted to the situation outlined above in Example 1 of the EM where a $1 million payment was made by a related family trust to a testamentary trust.
These financial entitlements are typically [what] the deceased estate is entitled to — e.g. if the deceased had insurance cover which is paid to their estate or an interest in an SMSF or industry super fund that pays a death benefit to that member’s deceased estate (via a BDBN or a discretion exercised by the super fund trustee). Moreover, these financial entitlements can be contrasted to “schemes” that seek to artificially inflate an estate from property that has no “close or real” connection to the deceased person such as a $1 million family trust distribution to a deceased estate.
Since many do not have an appropriate will and that many are considerably out of date, they should be reviewed. Further, wills moving forward should be more carefully drafted as many wills do not provide sufficient guidance on how superannuation and insurance payments should be dealt with. Some, for instance, seek to transfer these amounts directly to a testamentary trust rather than being paid a deceased estate which then converts to a testamentary trust following the finalisation of the administration of a deceased estate.
Note that a deceased estate generally progresses into a testamentary trust once the “date of assent” is arrived at. The date of assent is, broadly, where the assets and liabilities of the estate can be established and the estate can now be dealt with certainty. Prior to this stage, a potential beneficiary generally has no interest in an unadministered estate (refer ATO ruling IT 2622).
Finally, there is also the opportunity for the Commissioner of Taxation to exercise some discretion where he considers the income from superannuation death benefit payments and insurance amounts do not relate to the property in question. This aspect can give rise to some degree of uncertainty if there is not a sufficient connection between the proceeds and the deceased person or the appropriate documentation such as a suitably drafted will is not in place.
We therefore recommend that people review their estate plans and wills to make sure they are appropriate in view of this new law. Invariably, on review, many wills are considerably out of date or not up to date with recent changes.