Update on Taxation of Testamentary Trusts

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A testamentary trust is a trust created by a Will and arises upon the death of a testator. The use of a testamentary trust as part of general estate planning is not uncommon and can provide many benefits, including asset protection and a greater flexibility over the distribution of income and assets to beneficiaries.

In addition, distribution of income from a testamentary trust to a minor is taxed at ordinary adult rates under the current tax law. This means, a minor that would otherwise be subject to higher income tax rates from income distributions, could receive a tax-free trust income distribution of up to $18,200 from a testamentary trust.

Given the generous tax concessions testamentary trusts attract, it is unsurprising that some taxpayers and their advisers seek to utilise these trusts to the maximum extent possible. For example, the existing law does not require that the concession is limited to income derived from the original assets of the relevant deceased estate. As a result, assets unrelated to the deceased estate that are injected into the testamentary trust, may generate excepted trust income that is not subject to the higher tax rates on minors.

To close the ‘loophole’, legislation was recently introduced into the Parliament to amend the existing law.

The Proposed Change

The legislation proposes to make amendments and impose additional conditions that must be satisfied in order for income of the testamentary trust to be treated as excepted trust income. In particular, the amendments require that in order for testamentary trust income to be treated as excepted trust income, the following additional conditions must now be satisfied:

the assessable income must be derived by the testamentary trust from property (real or personal); and the property must be the original property that was transferred to the testamentary trust to benefit beneficiaries from the relevant deceased estate as a result of a will, codicil, intestacy or order of a court or it represents accumulations of income or capital from the original property or such further accumulations from subsequent property.

The proposed change is directed at ensuring there is a connection between the property and the deceased estate. Where new assets are acquired by the trustee of the testamentary trust estate out of the proceeds of the disposal of the original property, the connection will not be severed under the proposed change. Further, it also ensures that only beneficiaries included in the class of beneficiaries by the deceased estate, rather than entities which are later added to the class of beneficiaries, can derive excepted trust income.

MKT Note

The amendments will apply to assets acquired by or transferred to the testamentary trust on or after 1 July 2019. Importantly, any income derived from assets acquired or transferred before 1 July 2019 and distributed to minors will not be subject to the new rules.

If you would like MKT to assist you in this area, please contact Peter Hong.

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