The title of this paper is ‘Testamentary Trusts and Taxes’ and one may presume that the speaker is motivated to spruik testamentary trusts because of their tax benefits. Having drafted and advised on testamentary trusts for close to two decades in my experience the key driver for the establishment of a testamentary trust is not tax at all. Rather will makers who establish testamentary trusts are primarily concerned with control and family wealth preservation – ruling from the grave is not a myth, it is a carefully devised estate plan. Situations where a testamentary trust may be useful include:
- where there is a vulnerable beneficiary that needs to be protected e.g. a beneficiary with issues such as disability, spend thrift or drug addiction;
- blended family situations where there are competing claims (e.g. a second spouse and children from the first marriage);
- where the will maker only wishes their bloodline to benefit from their assets and is concerned that the surviving spouse may take on a new partner after their death; or
- where the intended beneficiary should not practically receive the gift in their own name because they have asset protection concerns (e.g. a person in business or a professional who is at risk of being sued) or are a non-resident to whom a bequest would trigger CGT event K3.
Another common reason for using a testamentary trust relates to basic asset protection and tax planning where immense wealth should generally not be given to an individual personally. With the transfer balance rules forcing more benefits out of superannuation on the death of one spouse thetestamentary trust may be viewed as the ‘natural home’ for excess benefits.
Testamentary trusts, however, are not for everyone. There needs to an adequate level assets to bear the annual compliance costs of running a trust (e.g. costs related to accounting and tax returns, and from time to time legal advice on the operation of the trust). Additionally the benefits of incomesplitting and the exclusion from Division 6AA’s penalty tax rates may be of no benefit to a hermit withno children or relations. Australia’s aging population also raises an important issue concerningtestamentary capacity. Testamentary trust wills are typically long and complex documents. A key concern when implementing a testamentary trust solution is to ensure the will maker has mental capacity to enter into such complicated document. All the careful tax planning and will drafting may fly out the window, if the will is challenged on the basis that the will maker did not understand what they signed.
However, having decided that a testamentary trust is appropriate in a will maker’s circumstancesthere are a number of issues and traps to navigate to ensure that family wealth is not unnecessarily eroded by tax. Apart from the availability of the CGT discount and income splitting, the two main tax advantages provided by a testamentary trust are the testamentary trust exceptions from the penalty tax rates of Division 6AA of Part III of the Income Tax Assessment Act 1936 (ITAA 36) and the way the capital gains tax (CGT) death rollover operates in the testamentary trust context. This paper examines both these aspects as well as:
- the impact of the May 2018 Federal Budget proposal on the testamentary trust exceptions from Division 6AA;
- whether the death rollover allows for trust splitting in the testamentary trust context despite theATO’s position in Taxation Determination TD 2018/D3;
- tax issues with holding a main residence in a testamentary trust;
- the Australian tax issues arising where there are foreign beneficiaries;
- the tax concessions available for severely disabled persons which extend beyond the testamentary trust, and which could be used either in conjunction with a testamentary trust or to rescue a situation where a testamentary trust has not been established in the will; and
- the situation were a will maker has lost capacity, but there is still a desire to create a testamentary trust for family wealth preservation purposes.
The Labor Party proposes to amend the law to further rein in the income splitting advantages of discretionary trusts – their impact on testamentary trusts is also touched on.