Kym Bailey, Technical Services Manager at JBWere, discusses Division 6AA of the Income Tax Assessment Act 1936 and why practitioners must be alert to a potential shake-up to the interpretation of the operation of section 102AG, which deals with excepted trust income.
The minor matter of tax
Division 6AA ITAA 1936 applies to tax minors (a prescribed person), at penalty tax rates for eligible assessable income (unearned income)above $416.
|66% for income between $416 – $1,308
The top marginal tax rate thereafter
The provision however does not apply to excepted persons and excepted income.
An excepted person is a minor who is in full-time employment as at 30 June; a minor with a disability(i); a minor who cares for someone as evidenced by the receipt of Carer’s Allowance
(i) In receipt of a disability support pension; principal beneficiary of a disability trust; medical evidence to testify the disability
If a minor is not an excepted person, they will not be subject to Div 6AA tax if they are in receipt of excepted Income
The list of excepted income is long so only a few highlights are included here: employment or business income; payments for personal injury, workers comp, super, life insurance, etc; and testamentary trusts.
Excepted trust income is excepted income that is received by a trust – the same criteria applies.
[A prescribed person can receive both excepted income and eligible assessable income – different tax rates apply to the different income classes.]
Excepted Trust Income (ETY)
In respect of testamentary trusts (TT), ETY is income of a trust from which the capital has derived from an estate process that is transferred within 3 years from the date of death of the testator.
|The result is that around $20,000 that is distributed by a TT to a child is tax free and, thereafter, taxed at the marginal tax rates.|
Precedent established by case law
The Trustee for the Estate of the late AW Furse No 5 Will Trust v FCT (1990) 21 ATR 1123 (Furse) is a Federal Court decision that interpreted the application of Div 6AA, as it applies to deceased estates. In essence, the Court found that provided a trust estate was created by a will, than any income of it is ETY, provided the parties are dealing ‘at arm’s length’ when deriving the income – that is, the income NOT the parties are at arm’s length.
2019 Federal Budget announcement
The 2019 federal Budget included an ‘integrity measure’ that, if enacted to law, will result in a potentially significant change to the interpretation of the operation of section 102AG ITAA 1936 that deals with excepted trust income (ETY).
Limited details are in the public arena at present but in broad terms, the proposal will seek to deny classification of ETY to income derived by an estate that is from capital introduced. This could be from borrowings undertaken by the TT or; gifts to the TT, for example.
Whilst taking pro-active action outside the change to legislation being tabled is fraught, in the case of estate planning, consideration of this potential issue is warranted.
The flexibility to inject capital into a testamentary environment is an option that should be incorporated into wills. For example, if the estate wishes to borrow to invest, the terms of the trust must provide for the trustee to be able to borrow (privately and publically). Likewise, an estate should have the power to receive gifts.
If the Budget measure results in a change to the law along the lines of the announcement, both the loan and the gift are likely to be considered a ‘capital injection’.
|Incorporating flexibility, without intersecting with the potential change to the identification of ETY, should be in sharp focus. After all, incorporating features in an estate doesn’t necessarily compel the trustee to utilise them however, if they aren’t present, it may reduce flexibility.|
Many are familiar with the concept of carving out pots in a will. Super Proceeds Trusts (SPTs), for example, are in sharp focus given the Super17 reforms that result in more of super ending up in the estate. In order to ensure tax efficiency of SPT capital, the super has to be carved out within the will. Perhaps the changes to ETY in respect of injected capital will need to be treated as a separate pot or, prohibited from benefiting minor children, for example.
The devil is always in the detail of new legislation however, given the EP process, a little “pre-emption” may be warranted.
As the JBWere Technical Services Manager, Kym Bailey, provides support to JBWere Strategic Advisers across Australia. Her role includes analysing and developing technical solutions for client-facing Advisors, as well as providing technical capability training and development to the Adviser Teams, along with the curation of the client document library that is used by Advisors. Often acting as a coach and a sounding-board to Advisors, Kym enjoys distilling the complex into practical, sensible and appropriate solution for clients. Contact Kym at [email protected]
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