Edited version of your written advice

Authorisation Number: 1013120956420

Date of advice: 10 November 2016

Ruling

Subject: Testamentary trust - present entitlement - taxation of income

Question 1

Is the beneficiary presently entitled to all of the income of the testamentary trust in each income year?

Answer

No

Question 2

Is the beneficiary presently entitled to the income of the testamentary trust that is applied for their benefit in each income year?

Answer

Yes

This ruling applies for the following period(s)

Year ended 30 June 201X

Year ended 30 June 201X

Year ended 30 June 201X

Year ended 30 June 201X

Year ending 30 June 201X

Year ending 30 June 201X

Year ending 30 June 201X

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on

1 July 201X

Relevant facts and circumstances

The testamentary trust for the beneficiary was created according to the Will of the deceased.

The beneficiary is a minor.

Amounts from the trust have been applied for the benefit of the beneficiary for purposes such as education expenses and dental work. The remainder of the income has been accumulated in the trust.

The pertinent clauses of the Will for taxation purposes are:

4. Subject to clause 4 hereof, I give all my real and personal property (“my estate”) to my Trustee upon trust to sell, call in and convert my estate into money with power at their absolute discretion to postpone sale, calling in and conversion of the whole or any part of my estate and after payment of my debts, funeral and testamentary expenses and all duties from those moneys to hold the residue of those moneys (herein referred to as “my residuary estate”) upon trust for my child, if they survives me and attains the age of 21 years.

5. If my child -

(a) dies during my lifetime; or

(b) survives me but dies before attaining a vested interest in my residuary estate;

(in this clause referred to as the “deceased parent”) and leaves a child or children who attain the age of 21 years, such child or children as the case may be will stand in the place of the deceased parent and take equally between them the share and interest of my residuary estate to which their deceased parent would have been entitled if she had survived me and attained a vested interest in my residuary estate.

6. My Trustee may, during the period prior to any person who takes an interest under this Will attaining 21 years, apply the whole or such part as my Trustee thinks fit of the capital and income of the interest or share in my estate to which the person may be or become entitled for or towards his or her maintenance, education, advancement or benefit in life with power to pay the same to the guardian or guardians for the time being of that person without being liable to see to the application of that interest or share in my estate.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 95

Income Tax Assessment Act 1936 Section 98

Income Tax Assessment Act 1936 Section 101

Income Tax Assessment Act 1936 Subsection 102AG(2)

Anti-avoidance rules

No

Reasons for decision

Present entitlement is a critical concept in trust provisions. This is because the method of taxing trust income varies according to whether it is income to which a beneficiary is presently entitled or income to which no beneficiary is presently entitled.

Several conditions must be satisfied for a beneficiary to be presently entitled to trust income:

1. The beneficiary must have an indefeasible, absolutely vested, beneficial interest in possession in the trust income. The interest must not be contingent but must be such that the beneficiary may demand immediate payment of that income. Or, if the beneficiary is under a legal disability such as infancy or insanity, the interest must be such that the beneficiary would have been able to demand immediate payment of the income had there been no disability or incapacity.

2. A beneficiary can only be presently entitled to income that is legally (that is according to trust law) available for distribution to the beneficiary, even though it may not be in the trustee's hands for distribution at the relevant time.

3. A beneficiary in whose favour a trustee exercises a discretion to pay or apply trust income is deemed to be presently entitled to the amount so paid or applied (section 101 of the ITAA 1936)

Application to your facts

Clauses 4 and 5 of the Will clearly indicate that the beneficiary will not attain a vested interest in the residue of the estate until they reach the age of 21 years. If they do not reach the age of 21 years, any children they may have will stand in their place and share in the residuary of the estate under the same terms (they will have to attain the age of 21 years).

In the period from now until they attain the age of 21 years, the beneficiary does not have an indefeasible, absolutely vested, beneficial interest in possession of the trust income. This is contingent on them attaining the age of 21 years.

Clause 6 of the Will gives the Trustee the power to apply the whole or part of the capital or income for the benefit of the beneficiary during the period from the creation of the trust until they attain the age of 21 years.

You have indicated that amounts have been applied for the benefit of the beneficiary to pay for expenses, for example, relating to education and dental work. To the extent that these amounts have been paid (applied for their benefit) the beneficiary will be presently entitled to this amount of trust income under section 101 of the ITAA 1936. These amounts will be assessed to the trustee on their behalf as amounts to which they are presently entitled but under a legal disability. The remainder of the income will be assessed to the trustee as income to which no one is presently entitled.

When they reach the age of 18 years they will not be under a legal disability, so they will be assessable on that income that is applied for their benefit in their individual return.

Additional information

For income tax assessment purposes when you lodge the income tax returns you will use the following assessment codes:

1. For the income to which no one is presently entitled you use assessment code 37. This income will be assessed under section 99 of the ITAA 1936 at the special progressive rates as it is income that arises from a Will. The special rates are the general individual rates, except you do not get the normal tax free threshold, only the first $416 has a nil tax rate (not the first $18,200).

2. While the beneficiary is under the age of 18 years, for the income which is applied for their benefit, you use the assessment code 26. Income to which the beneficiary is presently entitled but under a legal disability. The income is excepted income. This income will be assessed under section 98 of the ITAA 1936 to the trustee on behalf of the beneficiary at general individual rates.

3. When the beneficiary reaches the age of 18 years, for the income which is applied for their benefit, you use assessment code 30. This is for a beneficiary who is presently entitled to trust income and is not under a legal disability. The income will be assessed under section 97 of the ITAA 1936 to the individual at general individual rates.