Edited version of private advice

Authorisation Number: 1052131627697

Date of advice: 21 June 2023

Ruling

Subject: Commissioner's discretion - section 99A

Question

Will the Commissioner exercise discretion under section 99A of the Income Tax Assessment Act 1936 (ITAA 1936) to tax the net income of the testamentary trust to which no beneficiary is presently entitled under section 99 of the ITAA 1936?

Answer

Yes

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The Testamentary Trust

The deceased passed away on XXX.

The Last Will and Testament of the deceased (the Will) was dated XXX.

The deceased was an Australian resident for tax purposes.

Under the terms of the Will, two testamentary trusts were established for the beneficiaries.

Each testamentary trust was due to receive one half of the residual assets of the deceased estate.

The testamentary trusts were established to benefit the deceased's wife and their two children.

The testamentary trusts were set up in 20XX. One half of the residual funds from the deceased estate were deposited into each testamentary trust in 20XX (once probate was granted and life insurance payments had been made to the estate).

The residual assets distributed from the deceased estate to each of the testamentary trusts were cash only.

The deceased's wife is the trustee of both testamentary trusts.

The testamentary trusts, and the beneficiaries of the testamentary trusts, are residents of Australia for tax purposes.

Child B is named as the primary beneficiary of the second testamentary trust (the testamentary trust).

The assets held in the testamentary trust are solely from the deceased estate, and the income accumulated on those assets.

No other entity has directly or indirectly transferred or lent any property (including money) to, or conferred any benefits on, the testamentary trust, nor have any special rights or privileges been conferred or attached to the assets of the testamentary trust.

The testamentary trust has invested its funds in publicly listed assets including managed funds, shares and fixed interest securities. The testamentary trust has not invested in any private companies or other non-arms length assets or provided any loans to related parties.

Income of the Testamentary Trust

The testamentary trust was created by, and is subject to, the terms of the Will.

The Will provides the trustee of the testamentary trust with the power to:

•                     Distribute income (Paragraph X of the Will)

•                     Accumulate income (Paragraph X of the Will)

•                     Determine what is income or capital (Paragraph X of the Will)

The Will does not contain:

•                     A requirement to make a decision as to the distribution or accumulation of income of the testamentary trust by a particular date (for example, by 30 June of each year).

•                     A default clause for the distribution of income to default beneficiaries in instances where the trustee has not determined to distribute the income of the testamentary trust by a particular date (for example, by 30 June of each year).

The tax file number for the testamentary trust was applied for in the 20XX financial year. However, no income was derived by the testamentary trust for the year ended 20XX. Accordingly, "Return Not Necessary" updates were lodged with the ATO for the testamentary trust for that year.

For the year ended 20XX, the net income of the testamentary trust, based on the financial statements provided, was $X.

For the year ended 20XX, the testamentary trust distributed 100% of the net income of the trust to Child B, who was under 18 at the time. The trustee of the testamentary trust was responsible for paying the income tax on Child B's behalf under section 98 of the ITAA 1936. On the basis that the income from the testamentary trust was 'excepted trust income', the income was subject to resident marginal tax rates (including the tax-free threshold), per paragraph 1(a) of subsection 12(6) of Schedule 10 of the Income Tax Rates Act 1986 (and not the punitive tax rates for distributions to minors that would otherwise apply under Division 6AA of the ITAA 1936).

For the year ended 20XX, the trustee of the testamentary trust, exercised the power to accumulate the income of the testamentary trust for the year. The aim was to grow and safeguard Child B's inheritance until such time as it would be needed. Accordingly, no beneficiary was presently entitled to the income of the testamentary trust for the year ended 20XX.

The net income of the testamentary trust for the year ended 20XX, based on the financial statements provided, was $X.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 99

Income Tax Assessment Act 1936 section 99A

Reasons for decision

Sections 99 and 99A of the ITAA 1936 operate to tax trustees if there is part of the net income of a trust estate that is not taxed to a beneficiary under section 97 of the ITAA 1936 or to the trustee under section 98 of the ITAA 1936.

Section 99A of the ITAA 1936, which imposes a punitive rate of tax, applies automatically unless:

1.            The trust estate is of a type specified in paragraphs (a)-(d) in subsection 99A(2) of the ITAA 1936; and

2.            The Commissioner considers that it would be unreasonable for section 99A of the ITAA 1936 to apply (having regard to the circumstances in subsection 99A(3) of the ITAA 1936).

If the Commissioner forms the opinion that it would be unreasonable that section 99A of the ITAA 1936 should apply, the trustee will instead be assessed under section 99 of the ITAA 1936.

Income that is taxed under section 99A of the ITAA 1936 is subject to the top marginal rate of tax (which was 45% for the income year ended 30 June 2022) (see subsection 9 of section 12 of the Income Tax Rates Act 1986).

Comparatively, income that is taxed under section 99 of the ITAA 1936 is taxed at resident marginal tax rates, with or without the tax-free threshold, depending on eligibility.

Under section 99 of the ITAA 1936, the tax-free threshold is only available for deceased estates, where the deceased person died less than 3 years before the end of the relevant year of income (see subsection 12(6) of Schedule 10 of the Income Tax Rates Act 1986). This excludes testamentary trusts (and accordingly the tax-free threshold would not be available here).

Our analysis of the two requirements is outlined below.

Condition 1 - Trust resulted from a will

The trust estate must be of a type specified in paragraphs (a)-(d) in subsection 99A(2) of the ITAA 1936. A trust estate that resulted from a will, or an order of a court that varied or modified the provisions of a will, is a trust estate listed in subparagraph 99A(2)(a)(i) of the ITAA 1936.

In order for a trust to result 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).

The testamentary trust was created through the Will. The testamentary trust had a right to a 50% share of the residual funds of the deceased estate by virtue of the provisions of the same Will. Accordingly, the testamentary trust is of a type to which the Commissioner's discretion under section 99A may be exercised, in accordance with subparagraph 99A(2)(a)(i) of the ITAA 1936.

Condition 2 - Commissioner considers it unreasonable to apply section 99A

The Commissioner must consider that it would be unreasonable for section 99A of the ITAA 1936 to apply, having regard to the circumstances in subsection 99A(3) of the ITAA 1936, as follows:

(a)  the Commissioner shall have regard to the circumstances in which and the conditions, if any, upon which, at any time, property (including money) was acquired by or lent to the trust estate, income was derived by the trust estate, benefits were conferred on the trust estate or special rights or privileges were conferred on or attached to property of the trust estate, whether or not the rights or privileges have been exercised;

(b)  if a person who has, at any time, directly or indirectly:

(i)            transferred or lent any property (including money) to, or conferred any benefits on, the trust estate; or

(ii)           conferred or attached any special right or privilege, or done any act or thing, either alone or together with another person or persons, that has resulted in the conferring or attaching of any special right or privilege, on or to property of the trust estate whether or not the right or privilege has been exercised;

has not, at any time, directly or indirectly:

(iii)         transferred or lent any property (including money) to, or conferred any benefits on, another trust estate; or

(iv)         conferred or attached any special right or privilege, or done any act or thing, either alone or together with another person or persons, that has resulted in the conferring or attaching of any special right or privilege, on or to property of another trustestate, whether or not the right or privilege has been exercised;

the Commissioner shall have regard to that fact; and

(c)   the Commissioner shall have regard to such other matters, if any, as he or she thinks fit.

In determining the weight to be given to the matters described in subsection 99A(3) of the ITAA 1936, Windeyer J stated in Giris Pty Ltd v FCT (1969) 119 CLR 365; 69 ATC 4015; (1969) 1 ATR 3 that:

The Commissioner is to ask himself whether it would be unreasonable that sec. 99A should apply to any particular trust estate.... That purpose I take it is to enable the Commissioner to keep sec. 99A as an instrument to prevent avoidance of taxation by the medium of trusts, but not to use it when to do so would seem to him not in accordance with that purpose.

For the year ended 20XX, the trustee of the testamentary trust, exercised the power to accumulate the income of the testamentary trust. The aim was to grow and safeguard Child B's inheritance until needed, particularly while Child B is still young.

Based on the information provided, none of the adverse indicators described in subsection 99A(3) of the ITAA 1936 appear to be present, as follows:

•                     The 50% share of the residual assets distributed from the deceased estate to the testamentary trust were in cash only.

•                     The assets held in the testamentary trust are solely from the deceased estate, and the income accumulated on those assets.

•                     No other entity has directly or indirectly transferred or lent any property (including money) to, or conferred any benefits on, the testamentary trust, nor have any special rights or privileges been conferred or attached to the assets of the testamentary trust.

•                     The testamentary trust has invested its funds in publicly listed assets including managed funds, shares and fixed interest securities.

•                     The testamentary trust has not invested in any private companies or other non-arm's length assets or provided any loans to related parties.

The decision to accumulate the income of the testamentary trust (and request the Commissioner to apply section 99 of the ITAA 1936) will mean that the assessable income of the testamentary trust will be subject to income tax without access to the tax-free thresholds.

If the trustee had instead resolved to distribute the income of the trust to the deceased's wife, Child A or Child B, the tax-free threshold would have been available (under section 97 or section 98 of the ITAA 1936). Depending upon the level of assessable income derived by the beneficiaries outside of the testamentary trust, the decision to accumulate the income of the testamentary trust does not appear to avoid income tax (and may possibly produce the same, or a less favourable, income tax result). This result is consistent with an objective purpose of safeguarding Child B's inheritance (and not a purpose of tax avoidance).

Conclusion

After consideration of the conditions of section 99A of the ITAA 1936, the Commissioner is of the opinion that it would be unreasonable that section 99A of the ITAA 1936 should apply in relation to the testamentary trust for the year ended 20XX.

The trustee of the testamentary trust will instead be assessed under section 99 of the ITAA 1936 for any trustee assessments for the year ended 20XX.

The assessable income of the testamentary trust will be subject to resident marginal tax rates (without the tax-free threshold).

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