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Subject: Transferred property and excepted trust income

Question 1

Will the trust satisfy the excepted trust income condition set out in subparagraph 102AG(2)(c)(viii) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

Question 2

Will the trust satisfy the excepted trust income requirement of subparagraph 102AG(2)(c)(viii) of the ITAA 1936 if it continues its existence and operates as a discretionary trust after its legal obligations cease?

Answer

No

Question 3

Is the trustee assessable on any excepted trust income which is distributed to the beneficiary?

Answer

Yes

Question 4

What rates of tax will apply to the excepted trust income of the beneficiary, the trustee, or both?

Answer

The normal rates of tax which apply to an adult resident taxpayer will apply to both the trustee and the beneficiary, to the extent they are assessable on the excepted trust income.

Question 5

The trustee of the trust has a power to borrow funds on an interest free basis and use the funds for income producing purposes. Will this resulting income constitute excepted trust income under subparagraph 102AG(2)(c)(viii) of the ITAA 1936, with respect to the beneficiary and the trustee?

Answer

No

Question 6

The trustee of the trust has a power to borrow funds on an arm's length transaction or commercial basis, and invest the funds for income producing purposes. Will this resulting income constitute excepted trust income under subparagraph 102AG(2)(c)(viii) of the ITAA 1936, with respect to the beneficiary and the trustee?

Answer

No

This ruling applies for the following periods:

Financial year ended 30 June 2012

Financial year ended 30 June 2013

Financial year ended 30 June 2014

Financial year ended 30 June 2015

The scheme commences on:

1 July 2011

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 parents of a child separated.

An obligation arose between the parents in relation to their child and pursuant to section 80C of the Child Support (Assessment) Act 1989.

The rulee set up a trust, of which the rulee is the trustee.

The trust deed identifies the child as the beneficiary of the trust. The trust deed also identifies the trustee's powers, the trust property, and the rules regarding how the trust property is distributed.

It is anticipated that the trust will receive additional property, and will borrow funds in the future.

Any income derived by the trust in respect of the investment of the trust property will be the product of commercial arm's length arrangements.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 98,

Income Tax Assessment Act 1936 Division 6AA,

Income Tax Assessment Act 1936 Section 102AC,

Income Tax Assessment Act 1936 Section 102AG and

Income Tax Assessment Act 1936 Section 102AGA.

Reasons for decision

Question 1

Summary

Will the trust satisfy the excepted trust income condition set out in subparagraph 102AG(2)(c)(viii) of the ITAA 1936?

The purpose of the trust is to facilitate the satisfaction of the legal obligation between the parents. The trust deed ensures that property may be transferred to the trust. The transfers of property to the trust will be as a result of a family breakdown, provided that:

§ the transfer of property to the trustee is for the benefit of the beneficiary, and

§ the transfer gives effect to, or discharges an amount up to the amount of the parent's legal obligation.

In this case, any income that the trust derives from the investment of property, which has been transferred to the trust for the benefit of the beneficiary and as a result of a family breakdown, will satisfy the excepted trust income condition.

Detailed reasoning

Division 6AA of the ITAA 1936 sets out special rules that apply in working out the basic income tax liability on the income of minors. These rules apply to income derived by a minor directly or indirectly, such as through a trust.

The Division 6AA rules apply to any person classed as a prescribed person who receives eligible assessable income. Subsection 102AC(1) of the ITAA 1936 defines a prescribed person as a person who is under 18 years of age at the end of the financial year and is not an excepted person.

Trust income

Subsection 102AG(1) of the ITAA 1936 identifies when the special rules apply to trust income. If a beneficiary of a trust estate is a prescribed person, the special rules apply to so much of the beneficiary's share of the net income of the trust (net trust income) as the Commissioner considers is attributable to the assessable income of the trust estate that is not excepted trust income.

Subsection 102AG(2) of the ITAA 1936 identifies a number of different categories of excepted trust income that apply for the benefit of the prescribed person. Subparagraph 102AG(2)(c)(viii) of the ITAA 1936 specifies that amounts included in the assessable income of a trust estate are excepted trust income in relation to a beneficiary, to the extent they are derived by the trustee of the trust estate from the investment of any property transferred to the trustee for the benefit of the beneficiary, as a result of a family breakdown.

The previous subparagraph will not apply unless subsection 102AG(2A) of the ITAA 1936 is satisfied. The beneficiary of the trust must, under the terms of the trust, acquire the trust property when the trust ends. In addition, the beneficiary must not acquire the trust property in a capacity as a trustee. Paragraphs 29 to 46 of Taxation Ruling TR 98/4 Income Tax: child maintenance trust arrangements provide further information and examples on when a property has been transferred to the trustee for the benefit of a beneficiary (TR 98/4).

Section 102AGA of the ITAA 1936 clarifies when a transfer of property will be a result of a family breakdown. Subsection 102AGA(2) of the ITAA 1936 is relevant in this case. A transfer of property to the trustee for the benefit of a minor beneficiary will be a result of a family breakdown if:

…

(b) at least one of the persons:

(i) is the parent; or

…

(iv) has legal custody or guardianship;

of the minor or the beneficiary; and

(c) an order, determination or assessment of a court, person or body (whether or not in Australia) is made wholly or partly because the person has ceased to live as the spouse of the other person; and

(d) the effect of the order, determination or assessment is that a person (whether one of the parents, the transferor or any other person) becomes subject to a legal obligation to maintain, transfer property to, or do some other thing for the benefit of, the minor or beneficiary or one of the parents of one of the spouses; and

(e) the transferor transfers the subject property to the minor, or to the trustee for the benefit of the beneficiary, in giving effect to the legal obligation (including in discharging the legal obligation if it falls on someone else, and whether or not the legal obligation could have been given effect in some other way).

The Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 4) of 1994 explains the intention behind paragraph 102AGA(2)(c) of the ITAA 1936. It states:

2.33 The third requirement is that an order, determination or assessment of a court, person or body is made wholly or partly because the parties have ceased to live together on a genuine domestic basis [new paragraph 102AGA(2)(c)]. The requirement is not restricted to orders, determinations etc. made in Australia. The intention of this requirement is to include all obligations arising not only by way of court order but by operation of law (for example, an administrative assessment under the [Child Support (Assessment) Act 1989]). …

Application

The trust's beneficiary is under the age of 18. The beneficiary is a prescribed person in a given financial year under section 102AC of the ITAA 1936, up until the beneficiary turns 18 years of age.

One of the beneficiary's parents is subject to a legal obligation in relation to the beneficiary. The legal obligation will last until the terms of that obligation have ceased.

The trust deed ensures the beneficiary will acquire the remaining trust property when the trust ends. The beneficiary will not acquire the property in a capacity as a trustee. The trust deed makes it certain that the beneficiary cannot be excluded as a beneficiary.

Another person or entity may transfer property to the trust. The transfers of property to the trust will be taken to be as a result of a family breakdown under subsection 102AGA(2) of the ITAA 1936, provided that:

§ the property is transferred to the trustee for the benefit of the beneficiary, and

§ the transfer gives effect to, or discharges an amount up to the amount of the parent's legal obligation.

In this case, any income up to the amount of the legal obligation that the trust derives from the investment of that property, which has been transferred to the trust for the benefit of the beneficiary and as a result of a family breakdown, will satisfy the excepted trust income condition under subparagraph 102AG(2)(c)(viii) of the ITAA 1936.

Question 2

Summary

Will the trust satisfy the excepted trust income requirements of subparagraph 102AG(2)(c)(viii) of the ITAA 1936 if it continues its existence and operates as a discretionary trust after its legal obligations cease?

The trust may continue, and operate as a discretionary trust, after the parent's legal obligation for the beneficiary ceases. A major condition which must be met is that the beneficiary must acquire the relevant property of their interests in such property, when the trust ends.

When the legal obligation ends, the transferred property will not satisfy the legal obligation requirements. Any income the trust generates from the transferred property after the legal obligation ends will not be excepted trust income.

In addition, when the beneficiary turns 18, the excepted trust income requirement in subsection 102AG(2) of the ITAA 1936 will not apply, and the beneficiary will then be subject to any income from the trust as an adult beneficiary.

Detailed reasoning

Section 102AG of the ITAA 1936 requires that each beneficiary's share of the net trust income is attributable, in full or in part, to income generated from property placed into the trust for the benefit of the beneficiary, and in connection with a family breakdown.

The transfer of property will be a result of a family breakdown if, among other conditions, a person is subject to a legal obligation under paragraph 102AGA(2)(d) of the ITAA 1936.

The trust may have other beneficiaries and other property. Whether the share of the net trust income distributed to another beneficiary will be eligible or excepted income under Division 6AA of the ITAA 1936 will depend on the circumstances of that beneficiary, and the nature of the assessable trust income contributing to their share.

Neither section 102AG of the ITAA 1936 nor TR 98/4 prevents the trust from continuing after the beneficiary turns 18 years of age or the legal obligation ceases. Nor does either prescribe in general whether the trust is to be a fixed trust or otherwise. Whatever the activities and assets of the trust, it must be able to meet the requirements of section 102AG of the ITAA 1936, with respect to any property which is set aside for the benefit of the beneficiary, and as a consequence of the family breakdown.

Legal obligation under the Child Support (Assessment) Act 1989

As stated in question 1, the trust may derive excepted trust income from the investment of property transferred to the trust for the benefit of the beneficiary and as a result of a family breakdown under subparagraph 102AG(2)(c)(viii) of the ITAA 1936. This is partly because one of the beneficiary's parents is subject to a legal obligation in relation to the beneficiary.

However, this legal obligation will terminate in the future upon the satisfaction of a term in the legal obligation. When this occurs, the transferred property will not satisfy the legal obligation requirements in paragraph 102AGA(2)(d) of the ITAA 1936.

It follows that any income generated from the transferred property after the legal obligation terminates will not satisfy the excepted trust income requirement under subparagraph 102AG(2)(c)(viii) of the ITAA 1936.

Excepted trust income and adult beneficiaries

If the trust satisfies subsection 102AG(2) of the ITAA 1936, then the beneficiary's share of the net trust income will be excepted trust income, and will not be subject to the special rules in Division 6AA of the ITAA 1936.

The Division 6AA rules apply to any person classed as a prescribed person under section 102AC of the ITAA 1936 who receives eligible assessable income. As stated in question 1, the trust's beneficiary is under the age of 18. The beneficiary will continue to be a prescribed person in a given financial year under section 102AC of the ITAA 1936, up until the beneficiary turns 18 years of age.

When the beneficiary turns 18, the special rates in Division 6AA of the ITAA 1936 will no longer apply to the income of the trust and the beneficiary will then be subject to any income of the trust as an adult beneficiary.

Question 3

Is the trustee assessable on any excepted trust income which is distributed to the beneficiary?

If the beneficiary of a trust is a resident minor, then the trustee is assessed and must pay tax on the minor beneficiary's share of the net trust income under section 98 of the ITAA 1936. The trustee's liability arises irrespective of the net trust income being eligible or excepted trust income amounts under section 102AG of the ITAA 1936.

Question 4

Summary

What rates of tax will apply to the excepted trust income of the trust and/or the beneficiary?

The normal rates of tax which apply to an adult resident taxpayer will apply to both the trustee and the beneficiary (to the extent they are assessable on the income).

Detailed reasoning

If a resident beneficiary is presently entitled to a share of trust income, and is under a legal disability because they are a minor under the age of 18, then the trustee is assessed on the minor's share of the net trust income under section 98 of the ITAA 1936.

Division 6AA of the ITAA 1936 sets out special rules that apply in working out the basic income tax liability of the minor's income. These rules apply to income derived by a minor directly or indirectly, such as through a trust.

The Division 6AA rules apply to any person classed as a prescribed person who receives eligible assessable income. As stated in question one, the trust's beneficiary will continue to be a prescribed person under section 102AC of the ITAA 1936 up until the beneficiary turns 18 years of age.

The rate of tax on income subject to Division 6AA of the ITAA 1936 is governed by Schedule 12 of the Income Tax Rates Act 1986. Where a beneficiary's eligible taxable income exceeds the relevant threshold, the tax is payable on the whole of the eligible income at the rate of 45%.

If the beneficiary only received excepted trust income under section 102AG of the ITAA 1936, then Division 6AA of the ITAA 1936 rates will not apply to the excepted trust income. Instead, the excepted trust income will be assessed at the normal rates of tax which apply to a resident adult taxpayer, and will include the tax-free threshold.

Question 5

Summary

The trustee of the trust has a power to borrow funds on an interest free basis and use the funds for income producing purposes. Will this resulting income constitute excepted trust income under subparagraph 102AG(2)(c)(viii) of the ITAA 1936, with respect to the beneficiary and the trustee?

The beneficiary of the trust must, under the terms of the trust, acquire the trust property when the trust ends.

The trust is entitled to borrow funds for the purpose of investing in an asset which derives income for the trust's beneficiaries. However, the beneficiary will not obtain beneficial ownership of the borrowed amount, as the trustee will ordinarily be required to repay the borrowed amount or property to the original lender. This means the transfer of funds to the trust under an interest-free loan basis will not satisfy the beneficial transfer requirement. It follows that the income derived by the trust from the investment of borrowed funds will not produce excepted trust income.

Detailed reasoning

Subsection 102AG(2) of the ITAA 1936 identifies a number of different categories of excepted trust income. Subparagraph 102AG(2)(c)(viii) of the ITAA 1936 specifies that amounts included in the assessable income of a trust estate are excepted trust income in relation to a beneficiary, to the extent they are derived by the trustee of the trust estate from investing any property transferred to the trustee for the benefit of the beneficiary, as a result of a family breakdown.

Section 102AGA of the ITAA 1936 clarifies the meaning of when a transfer will be a result of a family breakdown. Subsection 102AGA(2) of the ITAA 1936 applies in this case. As stated in question 1, transfers of property to the trust will be taken to be as a result of a family breakdown, provided that:

§ the property is transferred to the trustee for the benefit of the beneficiary, and

§ the transfer gives effect to, or discharges an amount up to the amount of the parent's legal obligation.

However, subsection 102AG(2A) of the ITAA 1936 states the beneficiary of the trust must, under the terms of the trust, acquire the trust property when the trust ends. TR 98/4 provides further information and examples on when a property has been transferred to the trustee for the benefit of the beneficiary. Paragraph 33 of TR 98/4 reinforces the requirement of subsection 102AG(2A) of the ITAA 1936. It states that:

… the child must, under the terms of the trust, acquire the trust property other than as a trustee when the trust ends. Moreover, the property must pass into the child's estate, should the child die before the trust ends. …

Paragraphs 34 to 35 of TR 98/4 identifies an arrangement where transferred trust property ends up passing to someone other than the child beneficiary. It states:

34. Under some [Child Maintenance Trust] arrangements, substantial property is transferred to a trustee, it is invested at arm's length or to derive no more than an arm's length of return, and the child is to receive the income from the investment. However, on completion of the arrangement - for example, when the child ceases full-time education, or when maintenance obligations for the child cease - the property is to pass to someone other than the child, usually the person with an obligation to maintain the child, or to a nominee of that person. This may be expressly provided for, or may occur as a matter of discretion.

35. The arrangements described in the previous paragraph do not produce excepted trust income. For income derived on or after 7 March 1999, subsection 102AG(2A) makes it clear that such arrangements are not within subparagraph 102AG(2)(c)(viii).

Application

The trust is entitled to borrow funds and apply the funds for income producing purposes. It is irrelevant that borrowings are on an interest-free basis or on a commercial arm's length arrangement. What is relevant is that any income derived by the trust from the investment of the borrowed property will only be excepted trust income if it satisfies subparagraph 102AG(2)(c)(viii) of the ITAA 1936 and subsection 102AG(2A) of the ITAA 1936.

According to the trust deed, the beneficiary will acquire the trust property. The trust deed does not indicate that the beneficiary will be entitled to beneficial ownership of the trust's borrowed funds, borrowed property, or the obligation to repay an amount owing on the borrowed funds or property.

The loan of funds to the trust is similar to the arrangement described in paragraph 34 of TR 98/4. The trust is entitled to borrow an amount of funds for the purpose of investing in an asset which derives income for the trust's beneficiaries. However, the beneficiary will not obtain beneficial ownership of the borrowed amount. Instead, the trustee will ordinarily be required to repay the borrowed amount or property to the original lender. It follows that the transfer of an amount of funds to the trust under an interest-free loan basis will not satisfy the beneficial transfer requirement in subsection 102AG(2A) of the ITAA 1936.

As stated in paragraph 35 of TR 98/4, any arrangement where property does not pass beneficially to the beneficiary, will not satisfy the requirements of subsection 102AG(2A) of the ITAA 1936 and subparagraph 102AG(2)(c)(viii) of the ITAA 1936. This means any income derived from the investment of an amount of borrowed funds will not be excepted trust income unless it complies with the requirements of subsection 102AG(2A) and subparagraph 102AG(2)(c)(viii).

Question 6

Summary

The trustee of the trust has a power to borrow funds on an arm's length transaction or commercial basis, and invest the funds for income producing purposes. Will this resulting income constitute excepted trust income under subparagraph 102AG(2)(c)(viii) of the ITAA 1936, with respect to the beneficiary and the trustee?

The beneficiary of the trust must, under the terms of the trust, acquire the trust property when the trust ends.

The trust is entitled to borrow funds for the purpose of investing in an asset which derives income for the trust's beneficiaries. However, the beneficiary will not obtain beneficial ownership of the borrowed amount, as the trustee will ordinarily be required to repay the borrowed amount or property to the original lender. This means the transfer of funds to the trust under an arm's length transaction or commercial basis will not satisfy the beneficial transfer requirement. It follows that the income derived by the trust from the investment of borrowed funds will not produce excepted trust income.

Detailed reasoning

As stated in question 5, the trust is entitled to borrow funds and apply the funds for income producing purposes. It is irrelevant that borrowings are on an interest-free basis or on a commercial arm's length arrangement. What is relevant is that any income derived by the trust from the investment of the borrowed property will only be excepted trust income if it satisfies subparagraph 102AG(2)(c)(viii) of the ITAA 1936 and subsection 102AG(2A) of the ITAA 1936.

The loan of funds to the trust is similar to the arrangement described in paragraph 34 of TR 98/4. The trust is entitled to borrow an amount of funds for the purpose of investing in an asset which derives income for the trust's beneficiaries. However, the borrowed funds will not pass to the beneficiary. Instead, the funds would ordinarily be repaid to the original lender. This means the transfer of funds to the trust under an arm's length loan or commercial loan will not satisfy the beneficial transfer requirement in subsection 102AG(2A) of the ITAA 1936.

As stated in paragraph 35 of TR 98/4, any arrangement where property does not pass beneficially to the child, will not satisfy the requirements of subsection 102AG(2A) of the ITAA 1936 and subparagraph 102AG(2)(c)(viii) of the ITAA 1936. This means any income derived from the investment of borrowed funds will not be excepted trust income unless it complies with the requirements of subsection 102AG(2A) and subparagraph 102AG(2)(c)(viii).