Edited version of your written advice

Authorisation Number: 1013038270642

Date of advice: 24 June 2016

Ruling

Subject: Income from a testamentary trust

Question 1

Are investment earnings from monies from a deceased estate held in trust for minor beneficiaries excepted trust income?

Answer

Yes

Question 2

Are investment earnings from monies willed from a spouse's deceased estate to a pre-existing testamentary trust excepted trust income?

Answer

Yes

This ruling applies for the following periods:

From the taxpayer's death until the Trust end vesting date

The scheme commences on:

The taxpayer's death

Relevant facts and circumstances

Taxpayer 1 and Taxpayer 2 are both currently alive and are preparing their Wills.

Taxpayer 1's Will, will create a testamentary trust leaving a majority of his assets to their children's testamentary trusts (80%). The remaining 20% of the estate will be gifted to Taxpayer 2.

Taxpayer 1's Will and testamentary trust creating by the Will, have a specific provision allowing the acceptance of additional corpus from Taxpayer 2's estate. The testamentary trust will not and is not allowed to accept any other corpus additions except upon Taxpayer 2's death.

Allocation of funds to the existing testamentary trust is designed to reduce the administrative cost and burden of concurrently running two testamentary trust funds.

Relevant legislative provisions

Section 102AG Income Tax Assessment Act 1936 ('ITAA 1936')

Reasons for decision

Question 1

Are investment earnings from monies from a deceased estate held in trust for minor beneficiaries excepted trust income?

Summary

Under section 102AG ITAA 1936, the investment earnings from monies from a deceased estate held in trust for minor beneficiaries is excepted trust income.

Detailed reasoning

Division 6AA of Part III of the ITAA 1936 ('Division 6AA') operates to tax certain income derived by minors at penalty rates.

A minor will be a prescribed person for the purposes of Division 6AA if, in relation to a year of income they are:

• less than 18 years of age on the last day of the income year, and

• not an excepted person in relation to the year of income (subsection 102AC(1) of the ITAA 1936)

Excepted persons are defined in subsection 102AC(2) of the ITAA 1936. It is assumed that none of the beneficiaries of the testamentary trust will be excepted persons for the purposes of Division 6AA.

Section 102AG of the ITAA 1936 specifies the circumstances in which Division 6AA will apply to trust income. Specifically, where a beneficiary of a trust estate is a prescribed person, Division 6AA will apply to so much of the beneficiary's share of the net income of the trust estate as, in the opinion of the Commissioner, is attributable to the assessable income of the trust estate that is not, in relation to the beneficiary, excepted trust income (subsection 102AG(1)).

Subsection 102AG(2) sets out what amounts are included in assessable income. Under subparagraph 102AG(2)(a)(i), an amount included in the assessable income of a trust estate is excepted trust income in relation to the beneficiary of the trust estate to the extent to which the amount:

• is assessable income of a trust that resulted from a will, codicil or an order of a court that varied or modified the provisions of a will or a codicil

Application

The testamentary trust created under Taxpayer 1's Will, will be a trust that satisfies paragraph 102AG(2)(a)(i) ITAA 1936.

The beneficiaries are prescribed persons under subsection 102AC(1) ITAA 1936, as they will be under 18 years of age and are not excepted persons as defined in subsection 102AC(2) ITAA 1936.

Investment money earned under the testamentary trust set up under Taxpayer 1's Will, provided all the assumptions are correct, will be excepted trust income in relation to beneficiaries of that trust.

Question 2

Are investment earnings from monies willed from a spouse's deceased estate to a pre-existing testamentary trust excepted trust income?

Summary

Investment earnings from monies willed from a spouse's deceased estate to a pre-existing testamentary trust will be excepted trust income under section 102AG ITAA 1936.

Detailed reasoning

In Re Trustee of the Estate of the Late AW Fuse; A/C Jessica N Delaney and A/C Skye Nea Delaney) v the Commissioner of Taxation [1990] FCA 470 ('Furse'):

• a discretionary trust was established under a will. The initial trustee retired shortly after the establishment of the trust and a new trustee was appointed

• the new trustee of the trust borrowed money to acquire units in a related unit trust

• income from the units in the unit trust was included in the net income of the discretionary trust

• the trustee of the discretionary trust distributed some of the income to three minor beneficiaries

• the Commissioner assessed the trustee in respect of the three distributions under the provisions of Div 6AA at the rate of 46%

The question for the Court was whether the distributions were 'excepted income' of the children under paragraph 102AG(2)(a)(i) of the ITAA 1936 or whether they were taxable at the top marginal rates under Division 6AA.

It was held that all that was necessary for assessable income of a trust estate to fall within paragraph 102AG(2)(a)(i) of the ITAA 1936 was that the assessable income be income of the trust estate, and that the trust estate be one of the forms of trust estate referred to in subsection 102AG(2)(a) - which includes a trust estate resulting from a will.

Subsections 102AG(3) and 102AG(4) of the ITAA 1936 are anti-avoidance provisions that may operate to exclude income from being excepted trust income in certain circumstances.

Subsection 102AG(3) of the ITAA 1936 states:

(3) Subject to subsection (4), if any 2 or more parties to:

(a) the derivation of the excepted trust income mentioned in subsection (2); or

(b) any act or transaction directly or indirectly connected with the derivation of that excepted trust income;

were not dealing with each other at arm's length in relation to the derivation, or in relation to the act or transaction, the excepted trust income is only so much (if any) of that income as would have been derived if they had been dealing with each other at arm's length in relation to the derivation, or in relation to the act or transaction.

Subsection 102AG(4) of the ITAA 1936 states:

(4) Subsection (2) does not apply in relation to assessable income derived by a trustee directly or indirectly under or as a result of an agreement that was entered into or carried out by any person (whether before or after the commencement of this subsection) for the purpose, or for purposes that included the purpose, of securing that that assessable income would be excepted trust income.

Subsection 102AG(5) of the ITAA 1936 states:

(5) In determining whether subsection (4) applies in relation to an agreement, no regard shall be had to a purpose that is a merely incidental purpose.

Application

According to Furse, provided a pre-existing trust meets the requirements of subsection 102AG(2) ITAA 1936, income from that trust will be excepted trust income. In the present case, there is an addition of monies from Taxpayer 2's estate to the testamentary trust, which will be duly invested and provide income to the beneficiaries. This income will be excepted personal income as it comes from a trust created under Taxpayer 1's Will.

Non-arm's length dealings - 102AG(3) of the ITAA 1936

Subsection 102AG(3) of the ITAA 1936 excludes income from being excepted trust income in circumstances where that income is derived from transactions between parties who are not dealing with each other at arm's length in relation to the derivation of that income.

Although there are related parties involved i.e. Taxpayer 1 and Taxpayer 2, the addition to the testamentary trust from Taxpayer 2's estate would not be considered to be income. Rather, it would be an amount of corpus settled on the testamentary trust.

The amount distributed to the testamentary trust from Taxpayer 2's estate would not be considered to be income for the purposes of subsection 102AG of the ITAA 1936.

Further, the monies contributed from Taxpayer 2's estate forms part of the testamentary trust, any income earned will be from arms-length investments.

There are no non-arm's length dealings in relation to the derivation of trust income and subsection 102AG(3) would not apply.

Agreement to secure income as excepted trust income - 102AG(4) of the ITAA 1936

Subsection 102AG(4) operates to exclude assessable income derived by a trustee under or result of an agreement that was entered into or carried out by a person for the purpose of securing that assessable income would be excepted trust income.

However, under subsection 102AG(5), in determining whether subsection (4) applies in relation to an agreement, no regard is made of a purpose that is merely an incidental purpose.

Agreement is defined in subsection 102AA(1) of the ITAA 1936 and means any agreement, arrangement, understanding or scheme, whether formal or informal, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings.

The purpose for the allocation of funds from Taxpayer 2's estate to the testamentary trust to reduce the administration and yearly compliance costs of maintaining two testamentary trusts.

Although the income received from the testamentary trust would be excepted trust income, it does not appear that an agreement was entered into for the purpose of securing that assessable income as excepted trust income. The purpose was to reduce administration and yearly compliance costs. If the taxpayer did not enter into this arrangement, the trust income from a testamentary trust formed under Taxpayer 2's Will would likely also be excepted trust income. There is no additional benefit, other than the saving of administration and compliance costs and there is no additional tax benefit.

As the taxpayer has not entered into an agreement for the purposes of securing the assessable income would be excepted trust income, subsection 102AG(4) does not apply.