Recent change to the tax treatment of income from super in a testamentary trust

Recent change to ITAA 1936

New subsection 102AG(2AA) was introduced by the Treasury Laws Amendment (2019 Measures No. 3) Act 2019 (Cth) from 23 June 2020.

This measure was first announced in the 2018-19 Federal Budget and was designed to address:

… 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). 

The Explanatory Memorandum (‘EM’) includes useful information on considering the potential application of ss 102AG(2AA) and understanding the ‘schemes’ it was designed to catch. The following paragraph and example are the key extracts from the EM:

1.13   … These requirements are directed at ensuring that assets unrelated to the deceased estate cannot be injected into the testamentary trust and derive income that is excepted trust income for the purposes of Division 6AA. That is, the requirements ensure that there is a connection between the property from which excepted trust income is derived and the deceased estate that gave rise to the testamentary trust.

Recent change to ITAA 1936

New subsection 102AG(2AA) was introduced by the Treasury Laws Amendment (2019 Measures No. 3) Act 2019 (Cth) from 23 June 2020.

This measure was first announced in the 2018-19 Federal Budget and was designed to address:

… 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). 

The Explanatory Memorandum (‘EM’) includes useful information on considering the potential application of ss 102AG(2AA) and understanding the ‘schemes’ it was designed to catch. The following paragraph and example are the key extracts from the EM:

1.13   … These requirements are directed at ensuring that assets unrelated to the deceased estate cannot be injected into the testamentary trust and derive income that is excepted trust income for the purposes of Division 6AA. That is, the requirements ensure that there is a connection between the property from which excepted trust income is derived and the deceased estate that gave rise to the testamentary trust.

Treatment of superannuation death benefits and insurance

In contrast, a superannuation death benefit relates to the deceased member’s interest in a superannuation fund. While this is an interest under a trust, the deceased member was entitled to that payment prior to their death and the payment can either be paid to their executors (or legal personal representative) or to a dependant. In short, this is very different to the type of schemes contemplated by the new subsection.

Similarly, insurance proceeds paid to a person’s executors that form part of their deceased estate, from a life insurance policy on their life following their death has a relevant connection to the contractual entitlement to insurance cover.

Both superannuation death benefit payments and insurance proceeds paid to their executors following a person’s death that forms part of their deceased estate have a relevant connection to that person’s membership interest or contractual entitlement. These amounts can be contrasted to the situation outlined above in Example 1 of the EM where a $1 million payment by a related family trust to a testamentary trust.

These financial entitlements are typically amounts that the deceased estate may be entitled to (eg, if the deceased had insurance cover which is paid to their estate or an interest in an SMSF or industry super fund that pays a death benefit to that member’s deceased estate (via a BDBN or a discretion exercised by the super fund trustee). Moreover, these financial entitlements can be contrasted to ‘schemes’ that seek to artificially inflate an estate from property that has no ‘close or real’ connection to the deceased person such as a $1 million family trust distribution to a deceased estate.

Since many do not have an appropriate will or otherwise have a will that is considerably out of date, they should be reviewed. Further, wills moving forward should be more carefully drafted as many wills do not provide sufficient guidance on how superannuation and insurance payments should be dealt with. Some, for instance, seek to transfer these amounts directly to a testamentary trust rather than the relevant entitlement forming part of the deceased estate which then converts to a testamentary trust following the finalisation of the administration of a deceased estate. Note that a deceased estate generally progresses into a testamentary trust once the ‘date of assent’ is arrived at. The date of assent is, broadly, where the assets and liabilities of the estate can be established and the estate can be ascertained with certainty. Prior to this stage, a potential beneficiary generally has no interest in an unadministered estate (refer ATO ruling IT 2622).

Finally, there is also the opportunity for the Commissioner of Taxation to exercise some discretion where he considers the income from superannuation death benefit payments and insurance amounts do not relate to the property in question. This aspect can give rise to some degree of uncertainty if there is not a sufficient connection between the proceeds and the deceased person, or where appropriate documentation, such as a suitably drafted will, is not in place.

Conclusions

We therefore recommend that individuals review their estate plans and wills to make sure they are appropriate in view of this new law. Invariably, on review, many wills are considerably out of date or not up to date with recent changes.

Daniel Butler, director, DBA Lawyers