Edited version of private advice

Authorisation Number: 1051923622567

Date of advice: 2 December 2021

Ruling

Subject: Excepted trust income

Question 1

Will the following income be covered by section 102AG(2AA) of the Income Tax Assessment Act 1936 (ITAA 1936) and be considered excepted trust income under subsection 102AG(2) if Individual B is made presently entitled to it, but it is retained by the Trustee as an unpaid present entitlement:

i.      income that is derived by the Trustee exclusively from property transferred from the Estate to benefit Individual B as a result of the Will; and

ii.     income that is derived by the Trustee exclusively from the income or capital from property described in paragraph (i) above?

Answer

Yes.

Question 2

Will the following income be covered by section 102AG(2AA) of the ITAA 1936 and be considered excepted trust income under subsection 102AG(2) of the ITAA 1936 if Individual B is not made presently entitled to it, and it is retained by the Trustee:

i.      income that is derived by the Trustee exclusively from property transferred from the Estate to benefit Individual B as a result of the Will; and

ii.     income that is derived by the Trustee exclusively from the income or capital from property described in paragraph (i) above?

Answer

No.

Question 3

Will further income (the further income) derived exclusively by the Trustee from income described in question 2 be covered by section 102AG(2AA) of the ITAA 1936 and be considered excepted trust income under subsection 102AG(2) of the ITAA 1936 where Individual B:

1. was not made presently entitled to the income described in question 2; but
2. is made presently entitled to the further income?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

4 August 20XX

Relevant facts and circumstances

Individual A died in the xx income year and had a will (the Will) and testament.

Individual B is related to Individual A and is a minor.

Individual B is a beneficiary of the deceased estate.

Under the terms of the Will, various assets (including shares) under the deceased estate were to be sold and distributed amongst several named beneficiaries, including Individual B. The Will also allowed for the assets that would otherwise be payable to Individual B to be put into a separate trust.

Accordingly, Individual B's share of the deceased estate will be transferred into a testamentary trust.

Individual B is the sole beneficiary of the testamentary trust during their lifetime. If and when they die, their lineal descendants and then their living siblings will replace them as primary beneficiaries of the testamentary trust.

Under the testamentary trust deed, the trustee has the discretion to make Individual B presently entitled to trust income, subject to the condition that each year, the trustee must distribute a minimum of $X to Individual B from the assets of the testamentary trust for their maintenance and well-being.

Whilst Individual B remains a minor, the income to which Individual B is made presently entitled may be paid directly to them or their parents for their benefit or retained within the testamentary trust as an unpaid present entitlement (UPE) for investment and administration purposes.

However, when Individual B turns 18 years, they can demand that the UPEs be paid to them.

Relevant legislative provisions

Income Tax Assessment Act 1936 paragraph 102AG(2)(a)

Income Tax Assessment Act 1936 subsection 102AG(2AA)

Reasons for decision

Question 1

Summary

Income that is derived by the Trustee exclusively from property transferred from the Estate to benefit Individual B as a result of the Will, and income that is derived by the Trustee exclusively from the income or capital from property transferred from the Estate to benefit Individual B as a result of the Will, will be income covered by section 102AG(2AA) and be considered excepted trust income under subsection 102AG(2) of the ITAA 1936 if Individual B is made presently entitled to the income but it is retained by the Trustee as an unpaid present entitlement.

Detailed reasoning

Paragraph 102AG(2)(a) of the ITAA 1936 states:

"..Subject to this section, an amount included in the assessable income of a trust estate is excepted trust income in relation to a beneficiary of the trust estate to the extent to which the amount:

(a) is assessable income, of a kind covered by subsection (2AA), of a trust estate that resulted from:

(i) a will, codicil or an order of a court that varied or modified the provisions of a will or codicil; or

(ii) an intestacy or an order of a court that varied or modified the application, in relation to the estate of a deceased person, of the provisions of the law relating to the distribution of the estates of persons who die intestate.."

The Will provides that Individual B is entitled to Y% of the assets of the deceased estate.

The Will also provides that Individual B's share of the deceased estate may be placed in a testamentary trust.

In this case, the testamentary trust was established as a result of the Will from the administration of the deceased estate.

In this case, under the current trust deed, Individual B is the only beneficiary of the trust during their lifetime. If in an income year the Trustee passes a resolution and makes Individual B (whilst a minor) presently entitled to income from the trust estate, such income would be considered to be:

•         Individual B's share of the trust estate's net income as the primary beneficiary of the trust estate, for the purposes of subsection 102AG(1); and

•         income 'in relation to' Individual B as beneficiary of the trust estate, for the purposes of subsection 102AG(1) and subsection 102AG(2).

The further requirement under paragraph 102AG(2)(a) is that the assessable income be of a kind covered by subsection 102AG(2AA) of the ITAA 1936.

Subsection 102AG(2AA) of the ITAA 1936 provides:

"For the purposes of paragraph (2)(a), assessable income of a trust estate is of a kind covered by this subsection if:

(a)         the assessable income is derived by the trustee of the trust estate from property; and

(b)         the property satisfies any of the following requirements:

(i) the property was transferred to the trustee of the trust estate to benefit the beneficiary from the estate of the deceased person concerned, as a result of the will, codicil, intestacy or order of a court mentioned in paragraph (2)(a);

(ii) the property represents accumulations of income or capital from property that satisfies the requirement in subparagraph (i);

(iii) the property represents accumulations of income or capital from property that satisfies the requirement in subparagraph (ii), or (because of a previous operation of this subparagraph) the requirement in this subparagraph..."

On the facts of this case, the relevant income is only the income derived from the assets transferred into the trust from the deceased estate and not other income. Hence, subsection 102AG(2AA) is satisfied for this question.

Therefore income that is derived by the Trustee exclusively from property transferred from the Estate to benefit Individual B as a result of the Will, and income that is derived by the Trustee exclusively from the income or capital from property transferred from the Estate to benefit Individual B as a result of the Will, is income covered by section 102AG(2AA) and will be considered excepted trust income under subsection 102AG(2) of the ITAA 1936 if Individual B is made presently entitled to the income. This is notwithstanding that the income is retained by the Trustee as an unpaid present entitlement.

Question 2

Summary

Income that is:

•         derived by the Trustee exclusively from property transferred from the Estate to benefit Individual B as result of the Will, and

•         derived by the Trustee exclusively from the income and capital from property transferred from the Estate to benefit Individual B as result of the Will,

to which Individual B is not made presently entitled and which is, instead, retained by the Trustee, will not be income covered by section 102AG (2AA) nor be considered excepted trust income under subsection 102AG(2) of the ITAA 1936.

Detailed reasoning

Under the trust deed, the trustee has the discretion to resolve that an amount of income be applied to Individual B or held on trust for them absolutely.

However, subject to the requirement of the trustee to pay Individual B $X each year from the income or capital of the trust, the trustee also has the discretion not to pay any further income to Individual B or to hold such further amount on trust for them absolutely, as a result of which Individual B will not be presently entitled to that income. The trustee may instead accumulate that further income in the trust fund.

If the Trustee exercises its discretion in this manner:

•         the income would not be Individual B's 'share' of the trust estate's net income as beneficiary, for the purposes of subsection 102AG(1); and

•         the income would not be income 'in relation to' Individual B as beneficiary of the trust estate, for the purposes of subsection 102AG(1) and subsection 102AG(2).

Consequently subsection 102AG(2) would not apply in these circumstances.

Question 3

Summary

Where Individual B is made presently entitled to the further income (income derived exclusively by the Trustee from income described in question 2), the further income will be covered by section 102AG (2AA) and be considered excepted trust income under subsection 102AG(2)(a)(i) of the ITAA 1936.

Detailed reasoning

Subsection 102AG(2AA) of the ITAA 1936 was inserted via the Treasury Laws Amendment (2019 Measures No.3) Bill 2019.

The Explanatory Memorandum of Treasury Laws Amendment (2019 Measures No.3) Bill 2019 explains why the subsection was inserted into the ITAA 1936 in clauses 1.13 to 1.17. These are reproduced below.

"The property must satisfy any of three requirements

1.13 Second, the property must satisfy any of three specific requirements. 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.

1.14 The first requirement is that the property was transferred to the trustee of the trust estate to benefit the beneficiary 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, can have excepted trust income under paragraph 102AG(2)(a). [Schedule 1, item 2, subparagraph 102AG(2AA)(b)(i) of the ITAA 1936]

1.15 The second requirement is that 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 be excepted trust income for the purposes of Division 6AA. [Schedule 1, item 2, subparagraph 102AG(2AA)(b)(ii) of the ITAA 1936]

1.16 The third requirement is that the property represents accumulations of income or capital from:

•         property that satisfies the second requirement; or

•         property that has already satisfied this requirement.

1.17 This requirement ensures that further income on accumulations of income or capital from property that satisfies the second requirement, and such further accumulations (and so on) in a testamentary trust can be excepted trust income for the purposes of Division 6AA. [Schedule 1, item 2, subparagraph 102AG(2AA)(b)(iii) of the ITAA 1936]"

Subsection 102AG(2AA) provides that the income must be derived from property transferred to the trustee to benefit the beneficiary from the deceased estate, as a result of the will, as well as income derived from that income.

In this scenario:

•         the income to which Individual B was not made presently entitled but which was accumulated in the trust falls within the scope of 'property' described in subparagraph 102AG(2AA)(b)(ii) being 'accumulations of income' from the original property that 'was transferred to the trustee to benefit the beneficiary from the estate of the deceased person...as a result of the will'; and

•         the income to which Individual B is to be made presently entitled (the further income) is derived exclusively from the subparagraph 102AG(2AA)(b)(ii) 'property' described above, and therefore would be considered to be 'assessable income...derived by the trustee' from that property under subparagraph 102AG(2AA)(a).

As such, the conditions in subsection 102AG(2AA) would be satisfied in this scenario in respect of the further income.

Given that:

•         the further income will be regarded as 'assessable income of a kind covered by subsection (2AA) of a trust estate that resulted from...a will...' ' for the purposes of subparagraph 102AG(2)(a)(i), and

•         Individual B is made presently entitled to the further income (which would thereby be considered to be income 'in relation to' Individual B as beneficiary),

the further income will be considered to be 'excepted trust income' for the purposes of subsection 102AG(2).

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