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Ruling

Subject: Testamentary Trust

Question 1

Will the trustee of the testamentary trust be liable to pay tax on the undistributed income?

Answer:

Yes

Question 2

Will the discretion under subsection 99A (2) of the Income Tax Assessment Act 1936 (ITAA 1936) be exercised for the testamentary trust?

Answer:

Yes

This ruling applies for the following period

1 July 2010 - 30 June 2015

The scheme commenced on

1 July 2010

Relevant facts and circumstances

The deceased died in 2010 and probate was subsequently granted.

The deceased last will bequeathed a sum of money to several beneficiaries who will survive the deceased and who attain the age of 21 years.

In the 2009-10 income year, several of the named beneficiaries attained the age of 21 years and their share of the trust income devised to them were distributed to them.

The remaining beneficiaries are under the age of 21 years.

Under the Will, the trustees are required to invest the bequests contained in the Will on behalf of each of the beneficiaries named in the Will in an authorised trustee investment and wherever possible to pay that legacy together with any interest accrued thereon to each of the beneficiaries named on the occasion of his or her 21^st birthday.

The trustees have established a testamentary trust as a vehicle to manage the investments and income relating to their bequests.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 98.

Income Tax Assessment Act 1936 Section 99.

Income Tax Assessment Act 1936 Section 99A.

Income Tax Assessment Act 1936 Section 102AG.

Income Tax Assessment Act 1936 Subsection 251S(1).

Income Tax Assessment Act 1936 Paragraph 251S(1)(c).

Income Tax Rates Act 1986 Subsection 12(6).

Income Tax Rates Act 1986 Sch10-PtI.

Income Tax Rates Act 1986 Sch7-PtI.

Medicare Levy Act 1986 Section 10.

Reasons for decision

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.

The testator's Will states that a sum of $XXX is bequeathed to each of the named beneficiaries who survive the testator and attain the age of 21 years.

Therefore, a testamentary trust in this case was established to hold the beneficiaries' share of the estate until they reach 21 years of age.

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

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 for the daily maintenance or school fees etc.

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. 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 as part of his estate in the event of his earlier death.

Thus 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 i.e. as in this case the trust income of the beneficiaries who survive the testator is to be accumulated until they reached 21 years of age. 

Therefore, the beneficiaries' interest in the testamentary trust is contingent on them surviving the testator and reaching the age of 21 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 21.

As the beneficiaries are not presently entitled to the income they are not personally liable to declare the income from the testamentary trust.

In this case, the beneficiaries who survived the testator will be presently entitled when they reached the age of 21 years.

Income to Which No Beneficiary is Presently Entitled

Sections 99 and 99A of the ITAA 1936 apply to assess the trustee on income to which no beneficiary is presently entitled, which is retained or accumulated by the trustee.

As several of the named beneficiaries of the Will are not presently entitled to the 2009-2010 income of the Testamentary Trust, assessment will have to be raised to the trustee on the income that is not distributed in that income year.

Subsection 99A (2) of the ITAA 1936 outlines the circumstances when the Commissioner may apply his discretion for section 99A not to apply. Section 99A of the ITAA 1936 assesses the income of a trust where no beneficiary is presently entitled at the top marginal rate of tax. If the discretion under subsection 99A (2) of the ITAA1936 is exercised, the trust's income is taxed at a concessional rate of tax.

The relevant part of subsection 99A (2) of the ITAA1936 states that the discretion may be exercised where a trust estate resulted from a Will, a codicil or an order of a court that varied or modified the provisions of a will or a codicil. The discretion is exercised where the Commissioner is of the opinion that it would be unreasonable for section 99A to apply.

In order for a trust estate that resulted from a Will, it is necessary that the will should be the source of the funds and that the trust should be created in consequence of a provision in the will or court order itself (Case P53 82 ATC 247).

As the Testamentary Trust was created in consequence of the provision of a Will the discretion under subsection 99A(2) of the ITAA1936 will be exercised to assess the income of the trust in accordance with section 99 of the ITAA1936.

This means that the highest rate of income tax does not apply to trust estates resulting from a will, codicil, etc. These include both the estate of a deceased person and testamentary trusts established pursuant to the terms of a will and the income will be assessed under section 99 of the ITAA1936 as if the income were that of an individual.

The rates of tax for trustees assessed under section 99 are found in subsection 12(6) of the Income Tax Rates Act 1986 (ITRA 1986), which directs attention to Schedule 10 of the Rates Act. Part 1 of Schedule 10 of 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 ITAA1936 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 of 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.

In this particular case, the Testamentary Trust will fall into the second category, as the trust is a testamentary trust and not the estate of a deceased person.

Thus tax of 15% applies from $1 onwards excluding additional tax rate up until the next threshold changes in each income year as per Schedule 7 of the ITRA 186.

Trustee assessed where beneficiary under a legal disability and presently entitled to income of a trust estate

Under subsection 98(1) of the ITAA 1936, a trustee is assessed and liable to pay tax on behalf of the beneficiary's share of the income where the beneficiary is under a legal disability. The rate of tax is based on whatever rate the beneficiary would have paid as if it were the income of the individual.

An individual is considered to be under a legal disability if they are under 18 years of age as at 30 June of the income year.

Medicare levy is also payable by a trustee who is assessed and liable to pay tax under section 98 of the ITAA 1936 (paragraph 251S (1)(b) of the ITAA 1936).

Income of minors (prescribed persons)

Division 6AA of the ITAA 1936 ensures that special rates of tax and a lower tax free threshold apply in working out the basic income tax liability on taxable income, other than excepted income, derived by a prescribed person.

A 'prescribed person' is defined in subsection 102AC (1) of the ITAA 1936 to include any person, other than an excepted person (as defined in subsection 102AC (2) of the ITAA 1936), under 18 years of age at the end of the income year.

Under subsection 102AG(1) of the ITAA 1936, Division 6AA of the ITAA 1936 will apply where the beneficiary is a prescribed person to so much of the beneficiary's share of the net income of the trust that is not excepted trust income.

Subsection 102AG(2) of the ITAA 1936 lists the various types of income of a trust estate which are excepted trust income in relation to the beneficiary of the trust estate. Assessable income derived by a trust which resulted from a Will (a testamentary trust), is listed as excepted trust income under subparagraph 102AG (2)(a)(i) of the ITAA 1936.

Therefore the beneficiaries' income distributed from the Testamentary Trust is excepted trust income under subsection 102AG (2) of the ITAA 1936 and Division 6AA of the ITAA 1936 does not apply.

A beneficiary who is under a legal disability and derives income from another source must include their share of the net income of the trust estate as part of their assessable income in accordance with section 100(1) of the ITAA 1936.

However, subsection 100(2) of the ITAA 1936 prescribes that the tax assessed against the beneficiary is to be reduced by the amount of tax payable by the trustee in respect of the beneficiary's share of the net income of the trust estate.

The combined effect of section 98 and section 100 of the ITAA 1936 is intended to be that the total tax payable by the beneficiary and trustee will be equal to the amount if the beneficiary was assessed directly on the income.

If the beneficiaries are over the age of 18, the income they derived will be included as part of their taxable income if they are presently entitled.

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