Edited version of private advice

Authorisation Number: 1052127286731

Date of advice: 21 June 2023

Ruling

Subject: Deceased estate and testamentary trust

Question 1

If a beneficiary of a testamentary trust under 18 years old is made presently entitled to a share of the net income in relation to a year of income, is the amount considered 'excepted trust income' for the purposes of subsection 102AG(2) of the Income Tax Assessment Act 1936 (ITAA 1936) and thereby subject to the rates of tax prescribed under section 1 of Part 1 of Schedule 10 of the Income Tax Rates Act 1986?

Answer

Yes.

Question 2

Will the Commissioner exercise his discretion under subsection 99A(2) of the ITAA 1936 to not apply section 99A in relation to the income year ended 30 June XXXX?

Answer

Yes.

Question 3

If the answer to question 2 is 'yes', will the net income of a testamentary trust in respect of the income year ended 30 June XXXX to which the trustee is assessed under section 99 be taxed at the rate prescribed under section 1 of Part 1 of Schedule 10 of the Income Tax Rates Act 1986?

Answer

Yes.

This ruling applies for the following periods:

1 July 20XX - 30 June 20XX.

The scheme commences on:

1 July 2022.

Relevant facts and circumstances

On XX/XX/XXXX the will of X was executed.

Pursuant to a codicil, Z became the sole executor and trustee.

Later, X died.

The assets of the deceased estate had a mixture of cash, real and incorporeal property and superannuation.

Pursuant to the terms of the will a testamentary trust was formed and it was known as the trustee for the XXXX Trust.

Pursuant to the trustee's powers, the trustee intends to make distributions to children who are beneficiaries of the XXXX Trust. These children are less than 18 years of age.

Relevant legislative provisions

Section 99 Income Tax Assessment Act 1936

Section 99A Income Tax Assessment Act 1936

Section 102AC Income Tax Assessment Act 1936

Section 102AG Income Tax Assessment Act 1936

Section 12 Income Tax Rates Act 1936

Schedule 7 of theIncome Tax Rates Act 1986

Schedule 10 of theIncome Tax Rates Act 1986

Reasons for decision

Question 1

If a beneficiary of a testamentary trust under 18 years old is made presently entitled to a share of the net income in relation to a year of income, is the amount considered 'excepted trust income' for the purposes of subsection 102AG(2) of the Income Tax Assessment Act 1936 (ITAA 1936) and thereby subject to the rates of tax prescribed under section 1 of Part 1 of Schedule 10 of the Income Tax Rates Act 1986?

Summary

Under section 102AG ITAA 1936, money from investments in a testamentary trust that resulted from a will and which is held upon trust for beneficiaries under 18 years old is excepted trust income and is subject to rates of tax prescribed under section 1 of Part 1 of Schedule 10 of the Income Tax Rates Act 1986.

Detailed reasoning

Section 98 of the ITAA 1936

Subsection 98(1) of the ITAA 1936 provides that:

"where a beneficiary who is under a legal disability is presently entitled to a share of trust income, the trustee is liable to pay tax on that share. The trustee is taxable on:

•         so much of the share of the net income as is attributable to a period when the beneficiary was a resident; and

•         so much of the share as is attributable to a period when the beneficiary was not a resident and is also attributable to Australian sources.

as if it were the income of the individual and were not subject to any deduction."

Division 6AA of the ITAA 1936

Division 6AA of Part III of the ITAA 1936 (Division 6AA) operates to tax certain income derived by a prescribed person at a higher rate of taxation.

Section 102AG of the ITAA 1936 specifies the circumstances in which Division 6AA applies 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'.

Subparagraph 102AG(2)(a)(i) prescribes the following as 'excepted trust income':

(a)   is assessable income, of a kind covered by subsection (2AA), of a trust estate that resulted from:

(i) a will, codicil or an order of a court that varied or modified the provisions of a will or codicil; or..."

Paragraph 102AG(2)(a) is restricted by subsection 102AG(2AA) which states that:

"For the purposes of paragraph (2)(a), assessable income of a trust estate is of a kind covered by this subsection if:

(a) the assessable income is derived by the trustee of the trust estate from property; and

(b) the property satisfies any of the following requirements:

(i) the property was transferred to the trustee of the trust estate to benefit the beneficiary from the estate of the deceased person concerned, as a result of the will, codicil, intestacy or order of a court mentioned in paragraph (2)(a);

(ii) the property represents accumulations of income or capital from property that satisfies the requirement in subparagraph (i);

(iii) the property represents accumulations of income or capital from property that satisfies the requirement in subparagraph (ii), or (because of a previous operation of this subparagraph) the requirement in this subparagraph."

Subsection 102AG(2AA) is applicable to assets acquired by or transferred to the trustee of trust estate on or after 1 July 2019.

The purpose of this amendment is stated in the explanatory memorandum states at paragraph 1.5 as follows:

"The existing law does not specify that the assessable income of the testamentary trust be derived from assets of the deceased estate (or assets representing assets of the deceased estate). As a result, assets unrelated to a deceased estate that are injected into a testamentary trust may, subject to anti-avoidance rules, generate excepted trust income that is not subject to the higher tax rates on minors. This is an unintended consequence, which allows some taxpayers to inappropriately obtain the benefit of concessional tax treatment."

Income Tax Rates Act 1986

The rates of tax that apply to a trustee where it is subject section 98 of the ITAA 1936 depend on whether the Division 6AA applies to the relevant income.

Subsection 13(3) of the Income Tax Rates Act 1986 states that if Division 6AA applies, 'the rates of tax payable by the trustee in respect of that share of the net income of the trust estate are as set out in Part 1 of Schedule 12'. Part 1 of Schedule 12 in turn provides, in section 2, that:

'In the case of a trustee of a trust estate who is liable to be assessed and to pay tax under section 98 of the Assessment Act in respect of a share of a resident beneficiary of the net income of the trust estate where Division 6AA of Part III of that Act applies to a part of that share, the rate of tax in respect of that part of that share is 45%.'

If, however, Division 6AA does not apply to the relevant income, it will be subject to ordinary tax rates. In this regard, subsection 12(6) of the Income Tax Rates Act 1986 states:

"Subject to sections 13 , 14 and 15 , the rates of tax payable by a trustee under section 98 or 99 of the Assessment Act are as set out in Schedule 10 ."

Section 1 of Part 1 to Schedule 10 of theIncome Tax Rates Act 1986 provides that:

"In the case of a trustee who is liable to be assessed and to pay tax -

(a) under section 98 of the Assessment Act in respect of a share of a resident beneficiary of the net income of a trust estate; or

(b) under section 99 of the Assessment Act in respect of the net income or part of the net income of a resident trust estate, being the net income or part of the net income of the estate of a deceased person who died less than 3 years before the end of the year of income;

the rate of tax in respect of that share of the net income or that net income or that part of that net income is the rate that would be payable under Part I of Schedule 7 if one individual were liable to be assessed and to pay tax on that income as his or her taxable income."

Section 1 of Part 1 to Schedule 7 of theIncome Tax Rates Act 1986 provides that:

"Subject to clauses 2, 3 and 4, the rates of tax on the taxable income of a resident taxpayer are as follows:

(a) 45% for the superannuation remainder (if any) of the taxable income;

(aa) 45% for the employment termination remainder (if any) of the taxable income;

(b) for each part of the ordinary taxable income specified in the table applicable to the year of income - the rate applicable under that table.

Table 1: Tax rates for resident taxpayers for the 2020-21, 2021-22, 2022-23 or 2023-24 year of income

Note:

The above table will be repealed on 1 July 2024 by the Treasury Laws Amendment (A Tax Plan for the COVID-19 Economic Recovery) Act 2020.

Table 2: Tax rates for resident taxpayers for the 2024-25 year of income or a later year of income

..."

Question 2

Will the Commissioner exercise his discretion under subsection 99A(2) of the ITAA 1936 to not apply section 99A in relation to the income year ended 30 June XXXX?

Summary

The Commissioner will exercise his discretion under subsection 99A(2) of the ITAA 1936 to not apply section 99A to RFTT in relation to the income year ended 30 June 2023.

Detailed reasoning

Section 99 and section 99A of the ITAA 1936 concern the trustee's liability to be assessed and pay tax on the net income of the trust estate to which no beneficiary is presently entitled.

Under subsection 99A(4) if no part of the net income is distributed to beneficiaries, and section 99A of the ITAA 1936 is considered not to apply, then the trustee is assessed under section 99 of the ITAA 1936 as if the income were that of an individual.

The issue is therefore whether section 99A applies in this case. Subsection 99A(2) of the ITAA 1936 outlines the circumstances in which the Commissioner exercises their discretion for section 99A of the ITAA 1936 not to apply.

Subsection 99A(2) of the ITAA 1936 allows the Commissioner of Taxation to exercise a discretion to not apply section 99A if he is of the opinion that it would be unreasonable to apply this provision in relation to a trust estate for a year of income. This discretion applies to a trust estate that resulted from a:

• will, codicil or a court order that varied such document; subparagraph 99A(2)(a)(i) or an intestacy or a court order that varied an application in relation to a deceased person; subparagraph 99A(2)(ii);
• trust that is a bankrupt estate; paragraphs 99A(2)(b) and (c) of the ITAA 1936;

•         trust that consists of property referred to in paragraph 102AG(2)(c) of Division 6AA of the ITAA 1936; for example, amounts that are attributable to damages, workers compensation or life insurance.

In forming the Commissioner's opinion about the exercise of the discretion under subsection 99A(2), the Commissioner must have regard to the matters outlined in subsection 99A(3) and subsection 99A(3A) of the ITAA 1936. With respect to matters relating to a deceased estate and any trust that arose as result of the death of a person, the Commissioner must examine the assets of the estate, the granting of any special rights or privileges to the trust and deceased person, the transfer of the property to the trust and deceased person by associates of the deceased, or the making of loans to the trust or deceased person.

Question 3

If the answer to question 2 is 'yes', will the net income of a testamentary trust in respect of the income year ended 30 June XXXX to which the trustee is assessed under section 99 be taxed at the rate prescribed under section 1 of Part 1 of Schedule 10 of the Income Tax Rates Act 1986?

Summary

In circumstances in which the Commissioner's discretion is exercised favourably under section 99A(2) ITAA 1936 the trustee of the trust is assessed under section 99 of the ITA 1936 and the rate of tax is prescribed under section 1 of Part 1 of Schedule 10 of the Income Tax Rates Act 1986.

Detailed reasoning

The rates of tax payable by a trustee under section 99 is prescribed by subsection 12(6) of the Income Tax Rates Act 1986 which states:

"Subject to sections 13 , 14 and 15 , the rates of tax payable by a trustee under section 98 or 99 of the Assessment Act are as set out in Schedule 10 ."

Section 1 of Part 1 to Schedule 10 of theIncome Tax Rates Act 1986 provides that:

"In the case of a trustee who is liable to be assessed and to pay tax -

(a) under section 98 of the Assessment Act in respect of a share of a resident beneficiary of the net income of a trust estate; or

(b) under section 99 of the Assessment Act in respect of the net income or part of the net income of a resident trust estate, being the net income or part of the net income of the estate of a deceased person who died less than 3 years before the end of the year of income;

the rate of tax in respect of that share of the net income or that net income or that part of that net income is the rate that would be payable under Part I of Schedule 7 if one individual were liable to be assessed and to pay tax on that income as his or her taxable income."

Section 1 of Part 1 to Schedule 7 of theIncome Tax Rates Act 1986 provides that:

"Subject to clauses 2, 3 and 4, the rates of tax on the taxable income of a resident taxpayer are as follows:

(a) 45% for the superannuation remainder (if any) of the taxable income;

(aa) 45% for the employment termination remainder (if any) of the taxable income;

(b) for each part of the ordinary taxable income specified in the table applicable to the year of income - the rate applicable under that table.

Table 3: Tax rates for resident taxpayers for the 2020-21, 2021-22, 2022-23 or 2023-24 year of income

Note:

The above table will be repealed on 1 July 2024 by the Treasury Laws Amendment (A Tax Plan for the COVID-19 Economic Recovery) Act 2020.

Table 4: Tax rates for resident taxpayers for the 2024-25 year of income or a later year of income

..."