Edited version of private ruling

Authorisation Number: 1011648103429

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Ruling

Subject: Deceased estate - testamentary trust

1. Is the trustee of the testamentary trust liable to pay tax on interest income of the trust estate where the beneficiary is not presently entitled to the income?

Yes.

2. Where the trustee of the testamentary trust is liable to pay tax on the income, is the trustee required to lodge a testamentary trust tax return?

Yes.

The scheme commences on:

1 July 2010

Relevant facts and circumstances

The deceased died several years ago.

All directions within the Will have been attended to.

The Will states that a certain amount was to be put in trust for certain beneficiaries listed until they attain the age of 25 years.

Several of those listed are over 18 years of age.

The trustee of the will believes that according to the Will, the children will not be able to access the funds until they reach 25.

Should any of the grandchildren not reach 25, the executors will make the appropriate decision in relation to the funds. The relevant funds will not go to the estate of the grandchild.

The funds are earning interest income.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 99

Income Tax Assessment Act 1936 Section 99A.

Reasons for decision

Question 1

Testamentary trust

A testamentary trust is a trust created as a result of a Will, that is, where a person specifies in a Will that estate property is to be held in trust, for the beneficiary or beneficiaries of a Will.

In this case, the Will states that the money is to be put in trust for each of the specified persons until they attain the age of 25 years.

Therefore, a testamentary trust should be established to hold their share of the estate until they reach 25.

As highlighted in Income Tax Ruling IT 2622 the deceased estate represents a legal entity or relationship quite separate from the testamentary trust.

The trustees should obtain a tax file number for the testamentary trust.

Where all matters of the deceased estate are finalised, continuing deceased estate tax returns are not required.

The liability to taxation on the net income of a trust depends on whether the beneficiaries are presently entitled to the income.

Present entitlement

Beneficiaries are presently entitled to the income of a trust if they have an indefeasible, absolutely vested interest in the income. In other words, the beneficiaries have a claim or interest in the income that cannot be defeated by another person. They must also be able to demand immediate payment of the income. This means that beneficiaries can be presently entitled even though they may not have actually received an income distribution. A beneficiary is said to be presently entitled to the trust income where a distribution is made in their favour or the income is applied for their benefit, for example, payment of school fees.

Whether an individual beneficiary has a vested and indefeasible interest depends on the wording of the will and the effect of death on their share of the trust income. Income Tax Ruling IT 319 accepted the decision of Kitto J. in the case of Taylor v. Federal Commissioner of Taxation (1969) 123 CLR 206; (1969) 69 ATC 4072; (1969) 1 ATR 97. In that case the question was whether the beneficiary, a minor, was presently entitled to income arising under a trust for accumulation, which directed the trust income to be accumulated and paid to the beneficiary when he reached 21 years of age or to pass to his personal representatives presently entitled to income arising under a trust for accumulation, which directed the trust income to be accumulated and paid to the beneficiary when he reached 21 years of age or to pass to his personal representatives as part of his estate in the event of his earlier death. It was found that if the share passes to other surviving beneficiaries the interest is not indefeasible but if the share passes to the estate of the deceased then the interest will be regarded as indefeasible.

In other words, where a beneficiary's interest in the trust income is contingent they will not be presently entitled. A contingent interest occurs where a beneficiary is not entitled to their interest in the trust income until one or more conditions are satisfied. For example, if the terms of a trust provide that the trust income of a beneficiary is to be accumulated until that beneficiary reaches 25 years of age but if the beneficiary dies before that age the trust income should go to another person, the beneficiary's right is contingent and therefore defeasible.

In this case, the terms of the will were not clear, however the trustee understands that the specified persons are not entitled to the funds until they reach 25 and if they do not reach 25, the trustee will distribute the funds appropriately. Where a specified person does not reach 25, the funds will not go to their estate.

Therefore, their interest in the trust is contingent on them reaching the age of 25 years. As such, they are not considered to be presently entitled to a share of the net income of the trust prior to them turning 25.

Liability to tax

Where the specified persons are not presently entitled to the income, the income of the trust is assessed to the trustee either under section 99A of the Income Tax Assessment Act 1936 (ITAA 1936) or section 99 of the ITAA 1936.

Initially, all net income of a trust to which no beneficiary is presently entitled falls under section 99A of the ITAA 1936 and is taxed at the maximum rate of personal tax.

However, subparagraph 99A(2)(a)(i) of the ITAA 1936 provides that the maximum rate of personal tax will not apply to a trust estate that resulted from a will if the Commissioner is of the opinion that it would be unreasonable for the special rate of tax to apply to that trust income. If the Commissioner is of the opinion that it would be unreasonable for the maximum rate of personal tax to apply to the trust income, the more concessional rate of tax will apply under section 99 of the ITAA 1936.

As the trust was created in consequence of a will, the discretion under subsection 99A(2) of the ITAA 1936 is exercised to assess the income of the trust in accordance with section 99 of the ITAA 1936.

Please note that when a specified person attains the age of 25, they are presently entitled to their share of the trust income and therefore will be assessable on that income from that date.

Rates of tax

The rates of tax for trustees assessed under section 99 of the ITAA 1936 are found in section 12(6) of the Income Tax Rates Act 1986 (ITRA 1986), which directs attention to Schedule 10 of the ITRA 1986. Part 1 of Schedule 10 to the ITRA 1986 identifies two classes of trustees for the purpose of determining the rates of tax that are to apply.

In the first class are trustees who are liable to be assessed under section 99 of the ITAA 1936 in respect of resident trust estates of a deceased person where the income is derived in the year of death of the deceased or in any one of the following two years. These trustees are liable to pay tax at the rates applicable to resident individuals.

The second class of trustees identified in Part 1 of Schedule 10 to the ITRA 1986 comprises trustees liable to be assessed under section 99 of the ITAA 1936 in respect of income of a resident trust estate, other than the estate of a person who died fewer than three years before the end of the income year.

These trustees (including the trustees of testamentary trusts) are liable to tax at the rates specified for resident individuals except that they do not benefit from the tax free threshold of $6,000.

A trustee is responsible for lodging the testamentary trust's tax return and paying the resulting tax liabilities.

Please note that as the specified persons who are under 18 are not presently entitled to any income from the testamentary trust, Division 6AA of the ITAA 1936 does not apply.

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