Edited version of private ruling

Authorisation Number: 1011628286827

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Ruling

Subject: Child Maintenance Trust

1. Will income from the trust distributed to the children be excepted trust income under subsection 102AG(2) of the Income Tax Assessment Act 1936 (ITAA 1936 - all legislative references are to this Act, unless otherwise stated)?

No.

2. If the obligated parent declares that they hold the property on trust for the trust under an obligation to pay child support, and holds the property as trustee on the terms of the trust, will this be accepted as a transfer of property to the obligated parent as trustee of the trust as required by section 102AG?

No.

This ruling applies for the following periods

Year ended 30 June 2009

Year ended 30 June 2010

The scheme commences on:

1 July 2008

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The rulee (the obligated parent) and his former spouse were married a number of years ago.

They are the biological parents of a number of children.

The obligated parent has a maintenance obligation in respect of those children.

A decree absolute of dissolution of marriage issued some years ago.

The obligated parent now proposes the creation of a Child Maintenance Trust (CMT) for the benefit of the children.

A Binding Child Support Agreement (the agreement) pursuant to section 80C of the Child Support (Assessment) Act 1989, and a deed of trust for the Child Maintenance Trust, have been provided.

The agreement has been signed and witnessed by both parents and certifications have been provided by the solicitors for both parents as to the independent legal advice both parents have received regarding this agreement.

The agreement shall commence on 1 July 2009 and conclude in respect of each child on that child's 18th birthday, or on the happening of a child support terminating event, as defined in section 12 of the Child Support (Assessment) Act, whichever is the sooner.

The obligated parent's maintenance obligations consist of:

· Payment of a set monthly amount of child support to the ex-spouse.

· Payment of further expenses as agreed between the parties.

The amounts above shall account for and represent 100 percent of any liability of the obligated parent pursuant to an administrative assessment of child support and be credited against such.

Under the agreement, the obligated parent proposes to transfer units in a unit trust (the property) to the CMT. The units are currently owned by the trustee of the obligated parent's family trust, which is controlled by the obligated parent.

No provision in the agreement mentions a direction, agreement, commitment, or proposal to establish a CMT.

It is proposed that the transfer of property to the CMT will occur as follows:

· The obligated parent will assign a loan owed to them by the corporate trustee for the family trust to the CMT and the corporate trustee will transfer some units to the CMT in satisfaction of that loan.

· The obligated parent will transfer cash into the CMT to purchase the balance of the units.

The trustee of the family trust owns approximately 20 percent of the units in another unit trust. The unit trust earns income from the trustee by supplying assets and services to another company (service company). The service company carries on a consulting business.

The directors of the service company include the obligated parent, who is also the managing director.

The shareholders of the service company are an individual (not the obligated parent) and other companies. One of those companies is the corporate trustee for the family trust.

The units owned by the corporate trustee for the family trust have the same rights as all other units in the unit trust, and therefore carry a proportionate right to income and capital of that trust.

The obligated parent, as trustee of the CMT, will hold the property on the terms of the CMT.

The trust deed has been supplied and forms part of this ruling.

Relevant legislative provisions

Income Tax Assessment Act 1936, paragraph 99A(2)(d).

Income Tax Assessment Act 1936, paragraph 102AG(2)(c)(viii).

Income Tax Assessment Act 1936, subsection 102AG(2A).

Income Tax Assessment Act 1936, section 102AGA.

Reasons for decision

Question 1

Summary

The trust as currently conceived contains a number of matters that do not conform to ATO policy as set out in Taxation Ruling TR 98/4 Income tax: child maintenance trust arrangements. Therefore, the trust would not be considered to be a child maintenance trust (CMT) and, consequently, it will not meet the criteria for favourable exercise of the Commissioner's discretion in subsection 99A(2). Income generated by the trust will not be considered to be 'excepted trust income' in terms of subparagraph 102AG(2)(c)(viii).

The income of the trust would not presently be considered to be 'excepted trust income' under subsection 102AG(2) principally because it has not been demonstrated that the income will derive from the investment of property transferred to the trustee for the benefit of the children. Under a CMT the children must, when the trust ends, acquire the property other than as a trustee. Further, in the event a child dies, their share of the property must pass to their estate, as required in TR 98/4. The deed as presently constructed does not provide for this.

Detailed reasoning

The income of certain children is covered by Division 6AA. Division 6AA covers the treatment of trust income across three broad areas - the tax status of the income in the hands of the child, the tax status of the income in the hands of the trustee, and the overall tax status of the trust that is the source of that income.

A CMT is expected to generate 'excepted trust income' in terms of subparagraph 102AG(2)(c)(viii). Such trust income is excluded from the high rates of tax under Division 6AA if it is derived from the investment of property transferred to the trustee for the benefit of the beneficiary as a result of a family breakdown (as considered in section 102AGA).

We accept that the arrangement will come about as a result of a family breakdown. However, subparagraph 102AG(2)(c)(viii) does not apply unless the beneficiary of the trust will, under the terms of the trust, acquire the trust property (other than as trustee) when the trust ends (subsection 102AG(2A)).

ATO policy concerning CMTs is set out in Taxation Ruling TR 98/4 Income tax: child maintenance trust arrangements. The ruling considers the matter of property transferred to the trustee at paragraphs 29 to 46. The child must, under the terms of the trust, acquire the trust property other than as trustee when the trust ends. Moreover, the property must, if the child dies before the trust ends, pass to the child's estate (TR 98/4, paragraph 33).

There is no provision in the trust deed for the property of the children to pass to the children's estates should the children die before attaining their majority. Consequently, the trust does not meet the criteria set out in TR 98/4.

Also, the income of a CMT is derived from the investment of property transferred beneficially to the child. Given that, at the end of the maintenance obligation period for each child, the child is meant to receive the trust property other than as a trustee when the obligation period ends, the assumption is that the property can be clearly identified and apportioned to a share attributable to the child. There is no indication that this would happen.

It is noted there are two stages of property acquisition by the CMT:

· the acquisition of the loan repayable to the obligated parent by the corporate trustee of his family trust, and the subsequent transfer of units to the CMT in satisfaction of the loan, and

· an inflow of capital (money) to the CMT which will be used to purchase units in the unit trust.

Transaction 1.

We consider that the assignment of the loan to the CMT, although it represents property (a chose in action), does not represent property transferred to the children in identifiable shares. Further, the property is not being invested to generate income, but instead to acquire different capital assets (the units in unit trust). This is not considered to be investment of the property for the production of excepted trust income, but an arrangement to benefit the obligated parent by the paying out of a debt owed to him by the corporate trustee of his family trust (of which he is the sole director) that could at any time be paid out by a similar process that does not involve the children. TR 98/4, paragraphs 84-86, covers this type of situation.

Also, the process of transferring the loan, and the injection of cash into the trust, may be considered to be a non arms-length arrangement, in that the trustee (the obligated parent, in his role as trustee) is being bound to use the cash in a pre-determined way (determined by the particular interests of the obligated parent, in his role as the obligated parent, and as a creditor of his own family trust). This may not represent the most effective utilisation of that money to acquire an income producing asset.

In addition, there are the questions of how the units are valued in relation to the loan outstanding, and how the loan is apportioned to the children, who essentially are meant to receive the property beneficially at the outset of the trust (TR 98/4, paragraph 37).

We consider that, since the obligated parent is the sole trustee of the CMT, and the controlling director of the corporate trustee of the family trust, the arrangement being contemplated is not a dealing at arm's length. There is nothing to stop the obligated parent from simply arranging for the transfer of the units in the family trust directly to the CMT, without the intermediate step of assigning the loan.

Transaction 2.

We consider that a similar flaw affects this proposal. The property being transferred at the outset to the trust is cash intended not to generate investment income itself (and hence generate excepted trust income, attributable to each child in their proportions), but to acquire other units from the corporate trustee of the family trust. Since the obligated parent is the controlling mind of both the family trust (through its corporate trustee) and the proposed CMT, we consider that there is no need for the transfer of the cash to purchase the balance of the units. The units could be beneficially transferred to the children at the outset, in apportioned shares to each child.

Question 2

Summary

The action of the obligated parent in simply declaring that he holds the property on trust for the trust, under his obligation to pay child support, and holds the property as trustee on the terms of the trust, does not equate to a transfer of property beneficially to the children as required by section 102AG.

Detailed reasoning

The child support obligation on the obligated parent is evidenced by the binding child support agreement that both parents have signed. This agreement was made pursuant to section 80C of the Child Support (Assessment) Act 1989.

However, it appears that the transfer of property has not yet taken place; consequently the trust has not yet been fully created. The obligated parent proposes to transfer units in the unit trust, owned by the corporate trustee, to the CMT.

Further, the binding child support agreement contains no proposal or requirement that the maintenance obligation be met through the establishment of a CMT.

However, the principal concern is that the transactions described in question 1 do not constitute the transfer of property beneficially to the children at the outset of the trust, as set out in TR 98/4, paragraphs 33 and 37. In both instances, an intermediate step may mean that the children are not the beneficial owners of the property from which investment income is to be derived.

As explained above, the children must, under the terms of the trust, acquire their property at the end of the trust. In addition, should the children die before reaching their majority, the property must pass to their estate.

Although the trust deed specifies a perpetuity date of either the 79th anniversary of the date of the deed, or any earlier date the trustee determines, the Commissioner considers that the life of a CMT should be limited to the life of the maintenance obligations, terminating at the majority of the youngest child.

This is because a CMT is a vehicle specifically established to meet a particular trust obligation, of a limited duration, and which should not be used for purposes beyond that for which it was established. The property of the trust is intended to generate tax-advantaged trust income for the children under the obligation. Once the obligation ceases, the property must pass to the children, effectively removing a key feature of a trust (the property subject to the trust). Subsection 102AG(2A) specifically requires that paragraph 102AG(2)(c), which incorporates subparagraph 102AG(2)(c)(viii), would not apply to make the income generated 'excepted trust income' unless the beneficiary will, under the terms of the trust, acquire the property (other than as a trustee) when the trust ends.

The difficulty in sustaining the trust for longer than the obligation period is that income generated by other property which was not transferred beneficially to the children at the inception of the trust (TR 98/4, paragraph 37) would not attract concessional tax treatment. Paragraph 37 of TR 98/4 also explains that the child must have an absolute vested interest in the property from the inception of the trust.

There is also the issue of avoiding the operation of subsection 102AG(4), which rules out excepted income status under subsection 102AG(2) for income from an arrangement that was entered into simply to achieve tax-favoured treatment of that income. The trust must be established principally as a bona-fide arrangement for the benefit only of the children subject to the obligation.

The number of potential beneficiaries is also considered to be too wide. This is particularly so since the secondary beneficiaries include the children of any of the beneficiaries (which could include children of the obligated parent from a subsequent marriage, and children of a subsequent spouse). There is the risk of improperly ascribing as 'excepted trust income' any trust net income distributed to a child who is not one of the primary beneficiaries. The 'excepted trust income' status of that net income does not flow through to a child who is not under the maintenance obligation.

Further, the range of tertiary beneficiaries is considered unnecessary. As with children not under the obligation, the concessionally-taxed 'excepted trust income' status of CMT income will not flow through to a child beneficiary of another trust. The secondary beneficiaries include the obligated paret, and potentially include a second spouse of the obligated parent, who could be beneficiaries of the other trust, as could any children of either individual, not just the children under the obligation. If CMT income is not distributed to the children under the maintenance obligation, but is retained in the trust, it would be concessionally taxed as undistributed income; added to the corpus of the trust; and effectively bypass section 99A.

The Deed essentially allows the trustee to hold the property transferred to the children as trustee of another trust. This clause is not acceptable since it weakens the protection of the children's property. Income from the child's property, if so transferred, will not be considered exempt trust income.

The clause covering title to trust property is not sufficient in that the trust property must be transferred beneficially to the children at the outset of the trust (TR 98/4, paragraph 37). Legal title to the children's property should reflect the beneficial ownership of that property by the children, or as trustee for the child. Title should also reflect the division of property owned by each child.

Finally, the trust powers detailed in the first schedule are considered to be too wide for the more narrow intent of a CMT, which is holding property to generate tax-favoured income for specific beneficiaries, in a specific context. Examples of these powers include items that allow the CMT to:

· establish and support any associations, institutions or other funds or trusts to benefit any beneficiary, employee or ex-employee of the Trustee

· dispose of property by way of exchange for other property

· pay all outgoings in respect of property

· dedicate land for parks, public purposes, roads and footpaths

· take out or acquire policies of life, disablement or trauma insurance upon the lives of any persons

· accept gifts of money or property to form part of the Fund

· make gifts and advances to anyone the Trustee may think fit

· when making a distribution to a beneficiary, transfer any assets of the Fund in specie to that beneficiary, and

· to mix the trust fund including income and any other money and property held by the trustee pursuant to this deed with other money or property held by the trustee pursuant to or under any other trust (mixed funds).