a matter of trusts

Testamentary trust will structuring by Will Monotti, Edward Skilton and Rob Jeremiah, CTA, Sladen Legal

An approach to will drafting in which a master trust and sub-trusts are “layered” may suit the needs of a in certain circumstances.

Introduction upon that attaining a certain Testamentary trusts do have important As our population ages, wage growth age, uses what is effectively a “fixed” trust characteristics distinguishing them from stalls and younger people continue to arrangement in that the will’s appointed inter vivos trusts. An oft-cited advantage struggle to enter into the property market, executor will hold the beneficiary’s share of testamentary trusts is the concessional it is becoming more and more common of the on trust for that beneficiary tax treatment of income classified as for members of the community to put in until the specified age is attained. Other “excepted trust income” under s 102AG place a succession planning structure that categories of trust such as charitable trusts of the Income Tax Assessment Act 1936 affords estate assets a certain degree and special disability trusts should also (Cth) (ITAA36). This provision states of protection and allows for several be considered if appropriate to meet the that any assessable income of a trust generations of a family to benefit. needs of particular beneficiaries, though estate resulting from a will or (ie a ) that is distributed Testamentary trusts are frequently these forms of trust will not be addressed to a child under the age of 18 is taxed being used to assist in this regard. A in this article. to that child at adult marginal rates, testamentary trust is any trust established Commonly, trusts established by will are meaning the tax-free threshold (presently, by the will of a deceased person. This discretionary in form and may have a approximately $18,200) would apply to article gives a brief overview of some of broad range of beneficiaries that usually any income distributed to that child. By the benefits of using testamentary trusts include family members of the testator contrast, pursuant to s 102AG(1), any and examines in particular a structure and potentially also companies of which similar distribution to a minor child by the where testamentary trusts are “layered” those family members are directors or of an existing to best strike a balance between factors shareholders or other trusts of which would result in the trustee paying tax on clients tend to consider critical: asset they are beneficiaries. From that class behalf of that minor beneficiary at the top protection, tax flexibility, and avoiding of beneficiaries, the trustee may use its marginal rate. disharmony between beneficiaries forced discretion to distribute trust income or 1 to work together. Further, PS LA 2003/12 provides the capital to benefit whomever they choose following:2 (subject to any restrictions such as a Forms of testamentary trust “… the Commissioner will not depart from the requirement to obtain consent in writing and their advantages ATO’s long-standing administrative practice of A testamentary trust commences after the (for example, from an appointor or treating the trustee of a testamentary trust in the death of the testator. For a trust to exist, guardian) before making capital same way that a legal is there must be trust property, a trustee distributions). In this way, a discretionary treated for the purposes of Division 128 of the to hold such property, and beneficiaries testamentary trust is very similar to an ITAA 1997, in particular subsection 128-15(3).” inter vivos family trust. Both may subsist for whom the property is held. If a valid, Pursuant to this practice statement, for up to eighty years (potentially in proved will exists, the executors of the capital gains or losses which arise from perpetuity in South Australia), allowing estate will distribute its assets to the the transfer of an asset from a deceased beneficiaries listed in the will (subject to multiple generations of a family to benefit person to the beneficiary of a trust any litigation which leads to a change from the trust assets. Both forms of trust established by that deceased person’s in the distribution). If this will provides allow for the protection of assets by will are disregarded. This is subject for a testamentary trust, the transferee virtue of the existence of multiple persons to CGT event K3 which happens if the of the gift under the will is the trustee of who may ultimately derive benefit from testator dies and a CGT asset owned by that testamentary trust which may have them. In addition, given that the trustee is the testator just before dying passes to a as beneficiaries persons who may have afforded discretionary powers in respect of beneficiary of their estate who (when the otherwise been beneficiaries under the will. distribution, income may be paid or applied asset passes) is either an exempt entity Testamentary trusts may take various to beneficiaries in a manner that best (for example, a charity), the trustee of forms. A will, in which a portion of the suits their circumstances and those of the a complying superannuation entity or is left to a beneficiary trustee from the perspective of tax. a foreign resident.3 If the asset passes to a

TAXATION IN AUSTRALIA | VOL 53(1) 33 a matter of trusts

beneficiary who is a foreign resident, CGT announcements from the ATO in respect of beneficiary. Subject to the testator’s event K3 happens only if the testator was its approach to such splits. objectives, it may be appropriate to include an Australian resident just before dying and There may be situations in which the in the terms whether a particular sub-trust the asset (in the hands of the beneficiary) is testator wishes to separate control of the should continue to be an eligible 3 not taxable Australian property. capital (particularly where there are lumpy beneficiary of the master trust if the child assets such as business premises) from who is the named primary beneficiary Structuring testamentary of the sub-trust dies leaving no lineal trust wills control over distributions of income. By way of example, a testator with four children descendants. That is to say, the testator Once a prospective testator has may prefer a structure where capital is may prefer that income be directed to the determined they wish for their will to invested by independent persons but that other sub-trusts. establish trusts, the question arises as to each child of the testator is empowered considering adopting this structure how best to structure the trust to suit their to distribute 25% of the excepted trust should be mindful of PS LA 2003/12, circumstances. In the case of a married or income between their own family group in which does not explicitly address the tax de facto couple with children, particularly whatever proportions the child considers treatment of capital gains or losses which where there are no specific asset appropriate. In such instances, a structure pass from one testamentary trust (ie the protection concerns, this may be as simple that makes use of multiple trusts, but retains “master” trust) to another (ie one of the as deciding whether to provide for the some of the benefits of the single-trust “sub-” trusts) before distribution to an establishment of one trust for all surviving model, may be suitable. A will using this individual beneficiary. Note, however, that relatives of each member of the couple, or structure directs that the testator’s residuary private binding rulings issued by the ATO multiple trusts of which each child of the estate passes to of a “master” do point to the conclusive factors when couple would respectively be named as a investment testamentary trust. The capital making any assessment pursuant to primary beneficiary. is invested by the independent controllers Div 128 of the Income Tax Assessment Act Each approach has its own advantages of the master trust. The income and capital 1997 (Cth) as being that the relevant trust and the model ultimately adopted will beneficiaries of that master trust would be is a testamentary trust created under the be a personal decision of the testator. the trustees of multiple “sub-” testamentary deceased’s will and that the CGT asset Multiple testamentary trusts allow for trusts and general beneficiaries limited to passes to a beneficiary under the will.4 each child (for example) to separately the testator’s spouse (if relevant), children, In the structure described above, both of manage assets, a flexible model which further lineal descendants and perhaps these factors are present. may minimise the effect of a family specific charities which the testator and dispute (between the testator’s children). An additional issue currently without family support. Generally, one of the sub- Conversely, if all children of a relationship resolution has arisen from the trusts would be established for each of are named as primary beneficiaries of a government’s recent announcements the testator’s children and that child’s single discretionary testamentary trust, it in relation to testamentary trusts in the descendants as well as the usual class would be difficult to verify any definable 2018-19 federal Budget. The government of general beneficiaries. The structure is contingency in the assets of that trust has broadcast its intention to limit the designed to allow the trustees of the master of any particular beneficiary, should concessional tax rates available to minors trust to distribute income and capital to the that beneficiary be subject to relevant in receipt of income distributions from testator’s spouse and lineal descendants proceedings. In this way, the single-trust testamentary trusts pursuant to s 102AG direct or via trustees of each sub-trust, model is often recommended as an ITAA36 to income derived from assets while preserving capital assets longer appropriate one for those with strong transferred to a testamentary trust term for future generations. These income concerns relating to asset protection. either “from the deceased estate or the distributions could either be discretionary A (temporary) potential solution to problems proceeds of the disposal or investment or fixed, depending on circumstances. 5 caused by beneficiaries wishing to of those assets”. In its Budget papers, If the distributions are flexible, the sub- separately control inherited wealth is for a the government referred to the ability of trusts could still be default beneficiaries single trust to lend capital to beneficiaries. taxpayers to “inappropriately obtain the and restrictions on the discretion of the This solution is often used where the benefit of this lower tax rate by injecting trustees of the master trust (for example, beneficiaries express a preference to pay assets unrelated to the deceased estate a requirement that consent be obtained 5 down personal non-deductible debt rather into the testamentary trust”. One before certain distributions are made) could than receive distributions of excepted trust interpretation of this wording is that in provide a level of comfort to the children income. A capital distribution or loan to a situation where both members of a an existing family trust could also assist of the testator. The sub-trusts receiving couple make a “mirror” will establishing in retaining a degree of asset protection income (or capital) then operate in the same testamentary trusts on identical terms upon and some tax flexibility, but it should be manner as would a standard discretionary the first of them to die, the concessions noted that the income generated by the trust, with a broader range of beneficiaries. provided by s 102AG will not be accessible existing trust would not qualify as excepted Using this structure provides advantage in respect of the estate assets of the trust income. A more permanent solution, in that it allows for the protection of an survivor should those assets pass to the subject to capital gains tax and stamp duty estate’s capital assets with the use of a already existing testamentary trusts. Clarity considerations, may be to split the trust, single “master” trust, but also allows for in respect of this matter will, hopefully, that is to say, to appoint different controllers children to separately manage and invest soon be provided by the government as it over different assets but maintain the same any income or capital distributed (or lent) may affect the wills that have been made class of beneficiaries. We await further to trustees of which they are a primary by many members of the community and

34 TAXATION IN AUSTRALIA | July 2018 a matter of trusts

would, on its face, contradict the decision that in such circumstances the drafter take of Furse,6 in which it was held that income particular care to document the testator’s from a pre-existing trust which meets the instructions as to why they are making a requirements of s 102AG(2) will be treated will, their assets, the potential beneficiaries as excepted trust income. and the reasons for making the will in the manner they are. The authors suggest that Knowledge and approval the testator should be able to explain to the of a will’s contents and the drafter the main clauses of the (often long) question of capacity will. If the testator does retain the requisite Trust concepts will be second nature to capacity, the drafter should be careful to most readers of this journal. However, ensure that the testator actually did know even clients with complex family structures and approve of all of the contents of the and/or significant wealth may have limited will (that is to say, not only did the testator understanding of the operation of trusts. have the ability to understand the will, but Care should be taken when explaining to also the testator did understand the actual clients the effect of establishing a trust will in question). Providing the testator by will. We expect that many readers with time to read the will and consider the have agreed to be independent executors contents, ensuring adequate explanations and controllers of testamentary trusts. It are provided and recording the testator’s is conceivable that the child (or another comments in a file note would, it is potential beneficiary) of a testator may suggested, be minimum requirements. not want independent controllers of a An impatient client may resist this master trust to decide if or when the exercise, but if it acts to mitigate a dispute child or sub-trust controlled by the child over the will and estate administration in should receive an income or capital the following years, it is one well worth distribution. The authors therefore take their time. this opportunity to remind the reader that the executors seeking to propound Will Monotti the will may find themselves as plaintiffs Associate in will validity proceedings in relation to Sladen Legal K&L an estate in which they have no financial Grant interest and in circumstances where they Edward Skilton Stamp Duty out now may not be entitled to receive all of their Special Counsel costs from the estate. Where there is any Sladen Legal doubt as to a testator’s capacity to make such a complex will, the drafter should Rob Jeremiah, CTA Principal (in addition to, where relevant, seeking a Sladen Legal medical report and requesting that the medical practitioner be a second witness References to the will) carefully record steps taken to 1 Note that this practice statement is not law but assess the testator’s capacity. The test merely a practice. for provided by 2 Para 2 of PS LA 2003/12. Cockburn J in Banks v Goodfellow7 is still 3 S 104-215 of the Income Tax Assessment Act 1997 the most accepted authority in respect of (Cth). this question. Cockburn J held that: 4 See, for instance, PBR 1012846046513. 5 Australian Government, Budget measures 2018-19: “It is essential to the exercise of such a power that Part 3: Capital measures, p 44. a testator shall understand the nature of the act 6 Re Trustee of the Estate of the Late AW Furse; A/C and its effects; shall understand the extent of the Jessica N Delaney and A/C Skye Nea Delaney v FCT [1990] FCA 470. property of which he is disposing; shall be able to 7 Banks v Goodfellow (1870) LR 5 QB 549. comprehend and appreciate the claims to which he ought to give effect; and, with a view to the latter object, that no disorder of the mind shall poison his affections, pervert his sense of right, or prevent the exercise of his natural faculties — that no shall influence his will in disposing of his property and bring about a disposal of it which, if the mind had been sound, would not have been made.” Complex wills may arise in the context of complex asset ownership and complex family relationships. The authors suggest

TAXATION IN AUSTRALIA | VOL 53(1) 35