Superannuation proceeds trust: excepted income changes

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The recent Tax Act amendment on excepted income of testamentary trust distributions may potentially affect superannuation proceeds trusts (“SPT”) that are structured as testamentary trusts.  The amendment is an integrity measure to prevent assets unrelated to the estate being injected into the testamentary trust for the purpose of generating concessionally taxed excepted income.  Importantly, the SPT will not be affected if it is appropriately structured and implemented.

SPTs have been gaining momentum in super planning as SPTs have distinct advantages over child death benefit pensions which are limited by the modified transfer balance cap and the pension vesting requirement at age 25, except for disability pensions.

Most SPTs are structured as testamentary trusts under sub-section 102AG(2)(a)(i) of the ITAA 1936.  This type of SPT provides certainty of succession and proper documentation is essential to ensure super death benefits will be paid to the deceased member’s estate, with the dependants as the ultimate SPT beneficiaries.

In addition, there are also SPTs formed after the death of the fund member by deed under subsection 102AG(2)(c)(v).  These benefits devolve outside the Will and are subject to certain restrictions.  The latter option is often used as a “catch-up” measure where on death of the member, no testamentary trust provision is in place and the beneficiaries of the benefits are minors.

In both scenarios, the beneficiaries of the SPT will be Tax Act dependants (“TA dependants) of the deceased fund member.  Super death benefits distributed to the estate with TA dependants as beneficiaries are tax free. This preserves the tax-free status of the distributions as if they were made directly to TA dependants. In addition, SPT income distribution to minors, subject to applicable rules, will qualify as excepted income taxable at the adult’s marginal tax rates and not the penalty rates of children.

The Amendment

The recent “excepted income” amendments apply to distributions under sub-section 102AG(a)(i) i.e. testamentary trusts.  A new subsection (2AA) has been inserted.  To qualify as excepted income, the assessable income of the testamentary trust has to be derived by the trustee for the benefit of the beneficiary out of “property transferred to the trust from the estate of the deceased person” as a result of the Will, codicil, intestacy or a court order.  Accumulations of income or capital from such property and conversion of such property from one type to another will also meet this requirement.

This means only assets unrelated to the property of the deceased estate injected to the trust will be caught by the new provision, as stated below by the ATO.

“Your income from a testamentary trust is not excepted income if it is generated from assets:

  • acquired by or transferred to the trustee of the trust on or after 1 July 2019 and
  • that were unrelated to property of the deceased estate.”

Where a super fund pays death benefits to the deceased member’s LPR (the Executor or Administrator of the estate), the super death benefits will devolve in accordance with the Will of the deceased member. In the case of the SPT, the property (which includes money) transferred to the testamentary trust under the Will will be made directly from the estate.  The transfer is not of unrelated estate property and the requirements of subsection 102AG(2AA) will be met.

Example

The following example is from the ATO publication “Work out if you receive excepted income”.

Lavender Trust is a testamentary trust established under a Will of which Alex is a beneficiary.  Alex is 14 years old.  As a result of the Will, $100,000 is transferred on 17 July 2019 to the trustee of Lavender Trust from the deceased estate.  Shortly after, the trustee of a family trust makes a capital distribution of $1M to the trustee of Lavender Trust.  The trustee of Lavender Trust invested the entire amount of $1.1M in listed shares.

In the 2019-20 income year, the trustee of Lavender Trust derives $110,000 of dividend income from the investment in the listed shares.  The net income of Lavender Trust for that year is $110,000.  Alex is made presently entitled to 50% of that amount, which is $55,000.

Alex’s excepted income is $5,000.  This amount is the extent to which the $55,000 income resulted from the $100,000 transferred from the deceased estate.  The remaining income $50,000 is unrelated to the estate and is not excepted income.

How about SPT outside the Will?

Subsection 102AG(2)(c)(v) makes provision for excepted income of SPTs that are not testamentary trusts.  It contains a requirement that the assessable income of the trust must be derived from investment of property transferred “directly as a result of the death of a person” and in addition, out of a provident, benefit, superannuation or retirement fund.

This precludes injection of any asset unrelated to the death of a deceased person.

SPT outside the Will has the following additional restrictions.

  • Under this arrangement, the minor beneficiaries must under the terms of the trust benefit from the trust capital at the end (subsection 102AG(2A)).
  • The death benefits must be paid directly from the super fund to the trustee of the SPT and such payment must be permitted by the governing rules of the super fund.
  • The trustee of the super fund can potentially refuse to pay the death benefits directly to the SPT as being not in the best interest of the beneficiary, subject to the circumstances.

For all SPTs, the income distributed is only excepted income if the trust investments are made on arm’s length terms (sub-section 102AG(3)).

Documentation

Where STPs are involved, the testamentary trust arrangement is the better option.  It is also necessary to consider this option together with other super death benefit options available to minor beneficiaries.

Implementing testamentary objectives and outcomes require expert planning and documentations.

Our views expressed in this article are our opinions based on sound legal reasoning rather than a statement of established ATO policy or practice.

By Maria Siu, Special Counsel – Superannuation

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