In short, our answer is no. And in our view, that is entirely appropriate.
Let’s get some perspective on this issue. What are the potential ‘tax benefits’ of including a testamentary trust in your Will?
First, your executors and trustees gain some flexibility to determine where your assets ultimately end up. Rather than fixing in stone who will benefit from each particular asset in your estate, the trustee of a testamentary trust can have some ‘discretion’ to allocate assets among a range of potential beneficiaries after you have died. This can potentially defer an otherwise immediate CGT liability and save on stamp duty (where applicable) when it comes to administering your estate and deciding who gets what assets.
Secondly, if a residential property passes to a testamentary trust and the property is occupied by a beneficiary, then the property can benefit from land tax relief in most states, and ultimately pass to the beneficiary without triggering an immediate CGT liability.
Finally, any arm’s length income of the trust can be distributed to beneficiaries who are under 18, and those children can claim the tax-free threshold and lower marginal rates of tax. This can be contrasted with distributions from ‘ordinary’ trusts (i.e. trusts not set up under a Will), where income received by a child will be subject to the top marginal rate of tax from the get-go.
So yes, there are several potential tax benefits associated with a testamentary trust if the circumstances line up.
But why do these benefits exist at all? Because someone needs to die to bring the trust into existence – and most people don’t die to gain access to potential tax benefits for their heirs.
Further, what would happen if these ‘benefits’ were not available?
Well, the children of the deceased would end up paying a penalty rate of tax on the income earned from the deceased’s assets that have been left to support them. Land tax would be payable that would ordinarily not be payable if a residence did not need to be held in a trust for a minor. So the ‘benefits’ associated with a testamentary trust are really not ‘benefits’ – they are more of an ‘avoidance of a penalty‘. The status of a testamentary trust puts your beneficiaries back in the position that they would be in if you had not died. This is why the policy exists to relieve testamentary trusts from the penalty tax regime ordinarily applicable to child trust beneficiaries.
But, most importantly, we almost never recommend the use of a testamentary trust for its potential tax benefits. In every case where we have recommended a testamentary trust over the past 17 years, it has been because of the ability to protect the legacy from unjust claims and to restrict when a beneficiary gains control over the assets to an age when they are likely to make good decisions. The tax treatment of a testamentary trust means that we can achieve these very legitimate and sensible estate planning objectives without incurring a tax penalty.
So, coming back to the original question – does the 2018 Budget impact this in any material way?
Unfortunately the wording of the announcement is very brief. It is worth setting out here in full:
Tax Integrity — improving the taxation of testamentary trusts
2017-18 2018-19 2019-20 2020-21 2021-22
Australian Taxation Office – – – * *
From 1 July 2019, the concessional tax rates available for minors receiving income from testamentary trusts will be limited to income derived from assets that are transferred from the deceased estate or the proceeds of the disposal or investment of those assets.
Currently, income received by minors from testamentary trusts is taxed at normal adult rates rather than the higher tax rates that generally apply to minors. However, some taxpayers are able to inappropriately obtain the benefit of this lower tax rate by injecting assets unrelated to the deceased estate into the testamentary trust. This measure will clarify that minors will be taxed at adult marginal tax rates only in respect of income a testamentary trust generates from assets of the deceased estate (or the proceeds of the disposal or investment of these assets).
This measure is estimated to have a small unquantifiable gain to revenue over the forward estimates.
The first thing to note is that the Government does not expect to gain any material revenue from this measure. Which begs the question of why they think they need to introduce it.
The second observation is that we have always assumed that the rule they are proposing to introduce already existed! We have always interpreted the existing provisions as applying only to the income and gains from assets left through the Will, and from any assets purchased with the proceeds from the disposal of assets left through the Will. So it would be interesting to know what else people have been doing, and what the new measure is aimed at. The announcement talks about ‘injecting’ assets that are unrelated to the deceased estate into the trust. Maybe they are referring to people who have been ‘gearing up’ their testamentary trust with borrowings, and then purchasing additional assets into the trust. If this is the case, then the new measures are appropriate in our view.
So time will tell. But meanwhile, it is our view that nothing changes on the estate planning front with respect to our very legitimate and conservative use of testamentary trusts in your estate planning strategies.
If you would like to discuss these issues with us further, please call us on 1300 654 590.