Creating a Testamentary Trust - Sladen Legal · PDF filefi˚˛ LADE EGA fi˚ CTBER fi˙ Wills...

18 OCTOBER 2013© 2013 SLADEN LEGAL

Wills and Tax Technical Paper Creating a Testamentary Trust

This paper was presented by Rob Jeremiah to the Tax Institute at the 1st Annual Tax Forum held on 10-11 October 2013

1 IntroductionThis paper explores issues affecting what are commonly referred to as “testamentary trusts”.

That is, the presentation focuses on discretionary trusts which are created under a will as distinct from a discretionary trust (commonly known as a “family trust”) which is created during the lifetime of the settlor (inter-vivos trust). The trustee of a discretionary trust will usually have absolute discretion as to the appropriation and distribution of income and capital as between specified primary beneficiaries and a class of general beneficiaries which will usually include extended family (relatives of the primary beneficiaries who are connected by marriage or blood) and related entities (companies and trusts). Consequently, in this paper all references to a “testamentary trust” are to be construed as referring to a discretionary testamentary trust unless the context suggests otherwise.

There are three main reasons why persons with substantial assets or potential vulnerabilities are often advised to provide for the establishment of testamentary trusts in their wills.

The first is that by establishing a testamentary trust, to some extent the testator can dictate the manner in which their assets are managed after their death. This is in contrast to a testamentary gift to a natural person absolutely, in which case the person inherits the assets for their own benefit and can therefore deal with them in any way permitted by law. The will may set up a very broad discretionary trust with maximum flexibility for the trustee to make decisions in its discretion and in accordance with the circumstances. However, it may, for instance, direct that as a beneficiary a particular person may only have access to certain parts of the trust capital when the beneficiary reaches a certain age, it may impose restrictions on borrowing assets from the trust such as the requirement for a registered mortgage over property, or it may impose a requirement for the consent of the appointor or guardian to certain transactions. In this way, testamentary trusts can enable the testator to exercise some control over their assets after their death.

The second reason why people establish testamentary trusts is that they bring favourable tax treatment when compared to absolute testamentary gifts to natural persons or inter-vivos trusts. Inter-vivos trusts bring the same asset protection and control benefits as testamentary trusts. The tax advantages are unique.1 The main tax advantage relates to the way in which any income distributed to minor beneficiaries (beneficiaries who are aged under the age of 18 at the end of the tax year in question)2 is taxed. There are also some benefits related to capital gains tax (CGT) and State duty.3

The third reason why people set up testamentary trusts in their wills is for asset protection. In the case of a gift to a person absolutely, the inherited assets are subject to any risks associated with the beneficiary. Perhaps the most commonly occurring risk is the risk of family break-down and the resultant division of property. Beneficiaries who are professionals or who run businesses are also at risk of claims arising from their profession or business. In any of these cases, the assets of the

1 Although to some extent the same tax treatment can be obtained by the payment of estate proceeds into a special purpose inter-vivos trust. See C Leslie, ‘Death and no

testamentary trust - establishing a trust for minor beneficiaries’ to be published in Taxation in Australia (April 2013) 584 - 586

2 With some exceptions: s102AC Income Tax Assessment Act 1936 (Cth) (ITAA 36). In this paper legislative references are to the ITAA 1936 unless otherwise specified or

the context does not permit.

3 For example, the CGT Rollover under s128 Income Tax Assessment Act 1997 (Cth) (ITAA 97). See further M Steward and M Flynn, ‘Distribution or Disposal of Assets by a

Deceased Estate or Testamentary Trust’ in Death & Taxes: Tax Effective Estate Planning (5th Edition Thomson Reuters: 2012) 257 - 306

For more information on estate planning, please contact:

Amanda Morton Senior Associate

Sladen Legal

[email protected] T +61 3 9611 0113

Creating a Testamentary Trust

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© 2013 SLADEN LEGAL 18 OCTOBER 2013

deceased can be somewhat (but not wholly) protected through a testamentary trust. This is because of the way in which testamentary trusts separate the legal and equitable estates in property and keep the title to the trust property out of the hands of the beneficiaries.4

In the case of any discretionary trust (where there are separate legal and equitable estates) the legal estate vested in the trustee will be impressed with the equitable estate. The equitable estate will not be vested in a particular beneficiary until the discretion of the trustee in relation to that estate is exercised in the beneficiary’s favour.5

In this paper, we examine:

• the fundamentals of wills, probate and testamentary trusts; • the taxation of testamentary trusts (including whether income must be distributed each year); • excepted trust income and distributions to minors; • when can property be added to the corpus of a testamentary trust? and • the asset protection benefits of testamentary trust(s) including:

– beneficiaries, appointors, powers and limitations of testamentary discretionary trusts; – the use of capital protected trusts and their taxation and duty consequences; and – how to grant a lifetime occupation right without creating a life interest.

2 Fundamentals of wills, probate and testamentary trusts 2.1 Will fundamentals

A will is a written document signed by the will maker in the presence of 2 adult witnesses (who must also sign it) which appoints a person(s) to act as executor of their estate and states to whom the will maker wishes to give their estate or personal property. The will should be dated.

There are strict requirements for a valid will (or legal will) principally related to the signing of the will6 and the initialling of any amendments.7 However, in certain circumstances, the Supreme Court is empowered to admit to probate a document which does not comply with the Wills Act that is, an informal will.8

The case of Peter Brock9 highlights the importance of making a will or writing a will which is valid. In that case 3 “wills” were submitted to the court as being representative of Brock’s intentions and the court was asked to decide whether an informal will made later in time revoked an earlier valid will.10

In Brock’s case, the Supreme Court decided that although the 2003 informal will omitted details as to how property distribution was to occur because Brock had arranged for the will to be written and signed this showed sufficient intention on his part to revoke the 1984 formal will such that the 2003 informal will was upheld as valid (but the 2006 informal will was not).

By reason that Brock was somewhat “cavalier” in his approach to the beneficiaries of his property upon his death, the pool of potential beneficiaries became embroiled in a very public bitter and

4 Unless one of the beneficiaries is also the trustee, in which case that person holds the legal title to the trust assets in the capacity as trustee and the assets may

be protected. Further detail about the inroads the courts have made into trust estates in which insufficient independent persons are involved and ways to protect

against this are discussed in the paper written by A Morton, ‘Fireproofing the Family Trust from Third Party Attack’ and delivered by Rob Jeremiah at the TEN 5th

Annual Estates and Asset Protection Conference on 31 March 2011.

5 Oswal v Commissioner of Taxation [2013] FCA 745

6 Wills Act1997 (Vic) s 7

7 Ibid s 15

8 Ibid s 9

9 Estate of Peter Brock [2007] VSC 415

10 Only the 1984 will was properly executed under s 7 of the Wills Act, the 2003 and 2006 wills did not comply with s 7 and were therefore found to be informal wills.


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that the beneficiaries of the will upheld by the court received little.

As the costs of challenging a will are almost invariably borne by the deceased estate it is important that the will be valid and reflective of the current intentions of the will maker.

In Re Matsis11, the court found that a will maker who lacked testamentary capacity (but had previously made a will which, against the recommendations of his lawyers, did not include a testamentary trust) “may have made” changes to his will to include testamentary trusts “had he had testamentary capacity”. Consequently, the court (on the application of a named beneficiary of the will) ordered that a codicil be made for Mr Matsis which established testamentary trusts for his grandsons. The grandsons wished to receive their future inheritances via testamentary trusts rather than absolutely because they were involved or likely to be involved in their own businesses potentially exposing their respective inheritances to future claims.

2.2 Probate fundamentals

Probate is the act of proving that the will of the deceased is valid and the last will they made. Consequently, an application for probate must annex the original will and be accompanied by an affidavit of search of the Office of the Registrar of Probates to confirm that an application for probate or administration has not previously been made to the Supreme Court and that a caveat objecting to the will has not been lodged.

The will “is proved” by the executors. A person named in the will as executor may renounce that office but may not do so where he or she has undertaken administration or where a grant of probate has been taken out. Where there is no will (intestacy), an application must be made to the court for the grant of letters of administration.

An executor derives his title through the will. Therefore, it may not be necessary to obtain probate. However an administrator only gains his title through the grant of letters of administration. The executor may (even prior to a grant of probate) commence to get in the assets of the estate and even commence proceedings in the name of the estate. An administrator cannot commence proceedings prior to a grant of letters, such proceedings are incompetent.

The grant of probate is a document issued by the court (“probate parchment”) which certifies (proves):

• the date of death of the deceased; • their last will by annexing a copy of the will to the parchment; and • identifies the person(s) appointed ( executor) to administer the estate. • In order to prove title, a grant must be obtained: • to transfer certain assets such as land (except where there is a surviving registered joint tenant

who may make a survivorship application direct to land titles office); • if required by the asset holder (for example, some listed companies in which the deceased held

shares and banks in respect of deposits in excess of a threshold amount such as $20,000); and • if any claims against the estate are likely, principally claims for provision of testator family

maintenance, as any claims must be made within 6 months of the date of grant of probate unless the court permits otherwise.

2.3 Fundamentals of testamentary trusts

All that is necessary to create a trust relationship is the use of the words, UPON TRUST. That is, a trust is a form of obligation rather than an entity. 12

11 [2012] QSC 349

12 Ford & Lee, ‘Definition of a Trust’ in The Law of Trusts (online) 1.010


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A testamentary trust is a trust obligation which arises under a valid will, generally once the administration of the estate is complete13 and extends beyond the period of administration of the estate. For example after all assets have been collected and debts paid (including lodgement of deceased’s final tax return and if appropriate, a tax return for the estate) and all gifts distributed to the beneficiaries, the role of the executor ceases and the administration of the estate is completed. But if a gift is to be held by the executor in their capacity as trustee for a person for any period of time after completion of the administration of the estate then that relationship between the trustee and the beneficiary in respect of the property held on trust constitutes a testamentary trust. For example, the following words create a testamentary trust:

I give my residuary estate to my trustee to hold upon trust for such of my children who attain 18 years and if more than one then as tenants in common.

What is commonly thought of as a testamentary trust is in fact a discretionary testamentary trust. That is a trust which gives the trustee discretion to determine who amongst a defined class of beneficiaries is to receive the income and capital of the trust.14 It is the ability of the trustee to stream income and capital to different beneficiaries which makes a trust truly a discretionary trust. Consequently, in this paper “testamentary trust” refers to a discretionary testamentary trust.

A testamentary trust operates in much the same way as an inter-vivos trust except that the terms and conditions upon which the trustee holds property upon trust for the benefit of the objects (or beneficiaries) are set out in a will (will trust provisions) rather than in a trust deed. In most respects, therefore, the law relating to testamentary trusts is the same as the law relating to inter-vivos trusts.

3 The Taxation of Testamentary Trusts in Australia Trusts are taxed under Division 6 of Part III (Div 6) of the Income Tax Assessment Act 1936 (Cth) (ITAA 36). For the most part, testamentary trusts are subject to the same rules as apply to trusts generally under Div 6.15 The CGT provisions of the Income Tax Assessment Act 1997 (Cth) (ITAA 97) also apply to trusts.

In broad terms, each Australian resident beneficiary who is not under a legal disability is taxed on the proportion of trust income to which that beneficiary is ‘presently entitled’ as a matter of trust law, at that beneficiary’s marginal tax rate.16 Thus, a beneficiary who is beneficially entitled to 15 per cent of the trust’s income as a matter of trust law will be taxed upon 15 per cent of the net income of the trust estate under tax law.17

There is an exception for beneficiaries who are under a legal disability, in which case the trustee is taxed on the beneficiary’s share of the net income at the beneficiary’s marginal rate.18 The term ‘legal disability’ relates to the legal status of the beneficiary rather than any physical or mental disability, although it would include persons who lack mental capacity. The disability is a legal impediment which prevents the beneficiary from obtaining payment of an amount to which the beneficiary is otherwise presently entitled.19

But it cannot be assumed that a testamentary trust may be administered in the same way as an inter-vivos trust because the will trust provisions may be considerably less flexible and probably less exhaustive than those contained in an inter-vivos trust deed. It is not uncommon to see will 13 Commissioner of Stamp Duties (Qld) v Livingston [1965] AC 694; Re Leigh’s Will Trusts [1970] Ch 277

14 Cf a “fixed trust” where there is no capacity to stream.

15 See generally, R Somers & R Jorgenson, ‘Practical Taxation of Testamentary Trusts’ Taxation in Australia v44 (September 2009) 170 - 174

16 s97

17 see generally Harwood Andrews Lawyers, Trust Structures Guide 2012 (Tax Institute) Ch 6

18 s98

19 See Taylor v FCT (1970) 70 ATC 4026 at 4029 as discussed in R Somers & R Jorgenson above


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trust provisions which contain limited powers of trust administration (for example, no definition of income or provisions regarding the making or manner of income or capital distributions) and of the trustee (short form provisions).

3.1 CGT and deceased estates and testamentary trusts

Upon the death of a person their assets pass to beneficiaries determined in accordance with their last made valid will or absent a valid will, the intestacy laws subject to an order of the court to the contrary or a deed of arrangement which complies with Division 128 of ITAA 97 (Div 128).

CGT event A1 arises upon the disposal of a CGT asset. However, by reason of section 128-10 a capital gain or loss which crystallises upon a person’s death and upon the transfer of the asset from the deceased’s legal personal representative to a beneficiary of the deceased’s estate is disregarded unless the CGT asset passes to a beneficiary who is:

• an exempt entity; • the trustee of a complying superannuation fund; or • a foreign resident.

However, there is no specific provision in Div 128 for CGT relief where an asset passes to a beneficiary from the trustee of a testamentary trust.

In the context of trusts the most relevant CGT events to the transfer of a CGT asset to a beneficiary from the trustee of a testamentary trust are CGT events E5 to E8 (in sections 104-75 to 104-100 of the ITAA 1997). CGT events E5 to E8 are as follows:

• beneficiary becoming entitled to a trust asset: CGT event E5; • disposal to beneficiary to end income right: CGT event E6; • disposal to beneficiary to end capital interest: CGT event E7; and • disposal by beneficiary of capital interest: CGT event E8.

CGT events E5 to E8 contain an exception for trusts “to which Division 128 applies”. If the exception applies, the Commissioner of Taxation (Commissioner) takes the view that it is not necessary to consider whether any other CGT event has happened.

Consequently, where the trustee of a testamentary trust distributes assets to a beneficiary of the testamentary trust there is the possibility that a CGT event may occur. That is, under current income tax legislation no clear exemption exists to prevent a CGT event occurring in this instance. Although this has caused uncertainty in the law, the Australian Taxation Office (ATO) has provided guidance as to the circumstances when the Commissioner will treat the trustee of a testamentary trust in the same way as he treats a legal personal representative.20

A further issue arises for deceased estates and testamentary trusts because the Commissioner considers that the words “trust to which Division 128 applies” should be interpreted as a deceased estate to the extent that it is a trust over an asset originally owned by a deceased individual and which may pass to the beneficiary in accordance with s 128-20 (for example, under a will).21

In the context of CGT events E5, E6 and E7, the exception will apply if, as part of the administration of a deceased estate, an asset the deceased owned when they died passes to a beneficiary in accordance with section 128-20. Specifically, in the context of CGT event E5, this means that the exception applies if s 128-15(3) applies to relieve any capital gain or capital loss that arises (or would apply in that way if there were a capital gain or capital loss) when an asset passes from the deceased’s legal personal representative to a beneficiary in their estate.

20 In certain circumstances where an asset passes to a beneficiary the Commissioner treats the trustee of a testamentary trust in the same way as he treats a legal

personal representative: Law Administration Practice Statement PS LA 2003/12.

21 Taxation Ruling TR 2006/14


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In the 2011/12 Federal Budget the Federal government announced it would legislate the current ATO practice of allowing a testamentary trust to distribute an asset of a deceased person without a CGT taxing point occurring, rewrite the deceased estate provisions using a principle-based format and fix minor technical issues for deceased estates.

In the 2012/13 Federal Budget the government confirmed legislation would be introduced and announced it would make a series of minor amendments to the measure. These changes include:

• reducing compliance costs by ensuring the deceased person’s tax return does not need to be amended as the taxing point will be recognised by the entity transferring the asset;

• modifying application dates for minor changes announced in the 2011/12 Federal Budget; • broadening the scope of the integrity provisions to also apply to assets passing via survivorship.

These changes are proposed to apply to CGT events happening on or after the day the legislation receives Royal Assent, except for the roll-over that will apply where an intended beneficiary dies before administration is completed. This change will be backdated to apply to CGT events that happen in the 2006-07 and later income years.22

On 16 August 2013 the ATO issued its intentions regarding the administrative treatment of the 2011/12 and 2012/13 Budget announcements:

The Tax Office will accept tax returns as lodged during the period up until the proposed law change is passed by parliament. Past year assessments will not be reviewed until the outcome of the proposed amendment is known.

….

After the new law is enacted, impacted taxpayers will need to review their positions in previous income years. Taxpayers who chose roll-over relief which accords with the changes do not need to do anything more. Taxpayers who did not choose roll-over relief can seek amendments. Taxpayers who chose to anticipate the roll-over relief but find that this does not accord with the changes will need to seek amendments.23

3.2 Annual Income Distributions

The tax rate applicable to the net income of a trust to which no beneficiary is presently entitled depends on whether the income is assessed under s 99 or 99A of Div 6. All such income falls initially within the ambit of s 99A.

Under section 99A (certain trust income to be taxed at special rate) the trustee is taxed at penalty rates equal to the highest marginal tax rate.24 For this reason, the terms of some trusts require that all income be distributed or appointed at the end of the tax year. In default of which some trusts require the undistributed income to be accumulated and taxed to the trustee under section 99A whilst others appoint the undistributed income to default or capital beneficiaries. However, if there is nothing in the trust deed which requires income to be distributed or appointed each tax year, then there is no legal requirement to do so.

The trustee of a family trust was assessable on undistributed trust income under s 99A in circumstances where the trustee had no power to appoint a particular entity as beneficiary and a default provision had not been triggered so as to entitle other beneficiaries to income on default.25

However, the ability to accumulate income is a specific power which must be given to the trustee in the trust provisions. Although most will trust provisions will provide for streaming

22 http://ato.gov.au/General/New-legislation/In-detail/Direct-taxes/Income-tax-on-capital-gains/Refinements-to-the-income-tax-law-in-relation-to-deceased-

estates/ 23 Tax, Australian Tax Week, 2013 Tax Week, ISSUE 32, 16 August 2013, PRACTICE ALERT [¶812] Administrative treatment: CGT and deceased estates

24 s99A(4) and Income Tax Rates Act 1986 (Cth) s12.

25 BRK (Bris) Pty Ltd v FC of T 2001 ATC 4111


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of income and capital only some will address the manner in which distributions of income and capital may be made or provide for streaming of franked dividends or excepted proceeds or enable income to be accumulated.

In respect of deceased estates, during the initial stage of administration the beneficiaries (including a testamentary trust) are not presently entitled to the income of the deceased estate but they may become presently entitled to income before completion of the administration.26

3.2.1 Commissioner’s discretion to apply marginal rates

However, the executor is generally not assessed under section 99A because there is an exception which applies to its application when the trust resulted from a will, codicil or intestacy or to variations or modifications of these by a court.27 The application of the exception is not automatic – it is necessary for the Commissioner to determine that it would be unreasonable to apply section 99A in the year in question.28 Matters to which the Commissioner shall have regard include:29

… the circumstances in which and the conditions, if any, upon which, at any time, property (including money) was acquired by or lent to the trust estate, income was derived by the trust estate, benefits were conferred on the trust estate or special rights or privileges were conferred on or attached to the property of the trust estate, whether or not the rights or privileges have been exercised;

The Commissioner is also required to have regard to any special treatment of the trust estate in so far as property or other rights have been transferred to or lent to it but not to any other trust estate and such other matters as the Commissioner sees fit.30

If an exception is made so that section 99A does not apply, the trustee is taxed under section 99 on any income to which no beneficiary is presently entitled as if the trustee were an individual who was not entitled to any deductions.31 In addition, the tax-free threshold does not apply.32

In the case of testamentary trusts, provided property is not later conferred upon the trust estate,33 it is usually the case that a determination will be made under section 99A(2) and the trustee will be taxed as an individual under section 99 rather than under the penalty rates of section 99A.

In the case of a testamentary trust which is a “special disability trust” (that is a trust established for the primary benefit of a person with a severe disability), with effect from the 2008/09 income year, unexpended income of a special disability trust is taxed to the trustee at the relevant beneficiary’s personal income tax rates34, rather than at the rate of tax under s 99A.

In the case of an executor, they are taxed on the income of the deceased estate as a natural person until such time as the residue of the estate has been ascertained; that is until the estate has been administered and its accounts settled. Further, subject to the 3 year rule, the tax-free threshold does apply to an executor. The discretion of the Commissioner under section 99A(2) to tax deceased estates at marginal rates rather than the top marginal tax rate is normally exercised by the Commissioner where the administration of the estate has not been completed. However if tax avoidance is involved or the administration of the estate is unduly delayed the Commissioner

26 Taxation Ruling IT 2622 in respect of Income Tax: Present entitlement during the stages of administration of deceased estates

27 s99A(2)(a)(i) and (ii)

28 s99A(2)

29 s99A(3)(a)

30 s99A(3)(b) and (c)

31 s99(2)

32 Sch 13, Income Tax Rates Act 1986 (subject to the 3 year rule for deceased estates).

33 See section 5 of this paper below.

34 s 95 AB


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may choose to tax the income, whether distributed to the beneficiary or not, at the top marginal tax rate.

However, the beneficiaries of a deceased estate may become personally liable to pay tax on the undistributed income of the estate that is before the administration of the estate has been completed if the executor has made provision for all debts (incurred by the deceased prior to death and by the estate as a consequence of death) and made provision for distributions of assets even if an interim distribution has not been made to a beneficiary. That is because at this point, it will be possible to ascertain the residue with certainty, the beneficiaries will be presently entitled to the income of the estate even though the executor may not have made all the required transfers of property.

3.2.2 Tax-free threshold only available to deceased estate for 3 years

Part I of Schedule 10 to the Income Tax Rates Act 1986 provides that the marginal rates applicable under section 99 depend upon whether the deceased estate is that of a person who died less than three years before the end of the income year. If the deceased died less than three years before the end of the year of income then the personal representative of the estate will be taxed at ordinary progressive marginal rates. Ordinary progressive marginal rates of tax will also apply where the deceased died more than three years before the end of the year of income but the personal representative will not be entitled to the tax-free threshold.

The trustee of the deceased estate of his late wife included the deceased’s share of the proceeds from the sale of cattle in the trust return, expecting to receive the benefit of the tax-free threshold. The Commissioner exercised his discretion to assess the trustee under section 99 rather than under s 99A. However, because the deceased died more than three years before the end of the relevant year of income, the income of the estate was subject to tax at the marginal rate of 17%.35

3.2.3 Streaming of capital gains and franked distributions to beneficiaries for tax purposes

The changes made by Tax Laws Amendment (2011 Measures No. 5) Act 2011 have been discussed in many forums previously but are worthy of mention to the extent that the application of the statutory requirement for specific entitlement is different for deceased estates. Under the changes, a beneficiary who is specifically entitled to a capital gain made by a trust, or a franked distribution received by a trust, will generally be assessed for tax on that gain or distribution. The beneficiary will also be entitled to the benefit of any franking credits attached to a franked distribution (subject to existing integrity rules). A trustee may be specifically entitled to a trust capital gain but cannot be specifically entitled to a franked distribution.

During the course of the administration of a deceased estate, the legal personal representative is generally taxed as a natural person subject to the 3 year rule. However, when an interim distribution is made to a beneficiary, the beneficiary becomes liable to tax on the income distributed or where an asset has been distributed on the income referable to the asset. It is beyond the scope of this paper to consider these issues further save to highlight that the statutory requirement for specific entitlement may become an issue upon the distribution (or any earlier present entitlement) of CGT assets and dividend income to beneficiaries.

3.3 Testamentary capacity

In order to ensure the validity of a will it is important to be able to prove that the will maker understood the terms of the will at the time they signed it. In recent years there has been a large increase in the number of challenges to testamentary capacity and a few claims against lawyers where a will was held not to be valid.

35 Trustee for the Estate of EV Dukes referred to in the Australian Master Tax Guide, CCH, 52nd Edition, 2013, p222.


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Consequently, when drafting a will, a lawyer will be more concerned with ensuring the will maker understands the true nature and effect of the will than including all of the provisions which are commonly contained in a modern inter-vivos trust deed. Therefore, it is often appropriate when drafting a will which creates a testamentary trust to include short form provisions only rather than extensive powers in the will. The extent of the short form provisions will depend upon the will maker’s personal circumstances including their ability to comprehend a long or complex will.

In fact, regardless of the length of the will trust provisions, before passing a resolution in favour of the trustee doing something (action), it is strongly recommended always to ensure that the will trust provisions expressly grant the trustee power to take the action. If the trustee does not have power to take the action and a broad power of amendment is contained in the will trust provisions then the desired outcome may be achieved by amending the trustee’s powers in accordance with and subject to the terms attached to the power of amendment.

The drafting of the will trust provisions may therefore have important tax consequences for trustees and beneficiaries for the term of the trust. For example, without an amendment to the will trust provisions, it may not be possible to stream franked dividends.

Consequently, the most important terms of the will trust provisions are the power of amendment and the description of the class of beneficiaries.

If the will trust provisions contain a broad power of amendment and the named trustee(s) of the testamentary trust are advised upon the establishment of the testamentary trust to amend the will trust provisions as appropriate prior to the end of the first financial year following the establishment of the testamentary trust, there should not be any unexpected tax consequences.

In any event, when consulted on the tax or accounting affairs of a testamentary trust, it is important to review the will trust deed to determine whether it empowers the trustee to administer the testamentary trust in the manner desired and to take instructions from the client as to whether to amend the will trust provisions.

4 Excepted Trust Income - Distributions to MinorsIn 1980 the Federal government passed legislation to impose a punitive income tax rate upon minors to whom trust distributions are made. The purpose of Div 6AA of ITAA 36 was to create a disincentive to the practice of splitting trust income and distributing it to minors, in some cases infants, in order to maximise the use of available lower income tax thresholds.36 In effect, the provisions impose tax at the highest marginal rate on minor beneficiaries in receipt of trust distributions in excess of a tax free threshold of $416 (Children’s tax).37 Div 6AA is effectively an anti-avoidance measure.

In the 2012 - 2013 tax year, the relevant marginal tax rates for the Children’s tax are as follows:

Income to which Children’s tax applies Tax Rates

$0 - 416$417 - $1,307Over $1,307

Nil66% of the excess over $416 45% of the total amount of other income

In addition to income tax, the Medicare Levy is payable.38 The low income tax offset previously provided a limited opportunity to distribute income to minors without a significant tax cost being incurred but the governing legislation has now been repealed.39

36 Taxation Laws Amendment Bill (No. 4) 1994 (Cth); Explanatory memorandum para 2.7

37 At current rates. See Income Tax Rates Act 1986 (Cth) s13 and Sch 11.

38 Medicare Levy Act 1986 (Cth) s6.

39 The changes came into place in relation to income from the 2011-2012 income year: Sch 2 Tax Laws Amendment (2001 Measures No. 4) Act 2011(Cth).


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The Children’s tax is introduced in section 102AG(1), which reads:

Where a beneficiary of a trust estate is a prescribed person in relation to a year of income, this Division applies to so much of the share of the beneficiary of the net income of the trust estate of the year of income as, in the opinion of the Commissioner, is attributable to assessable income of the trust estate that is not, in relation to that beneficiary, excepted trust income.

Prescribed person is defined in section 102AC(1) to include any person, other than an ‘excepted person’ who is under the age of 18 at the end of the income year.40 Excepted person is defined in section 102AC(2) and includes minors who are engaged in full time employment, in receipt of or the subject of certain benefits under the Social Security Act 1991 (Cth), are permanently disabled or have lost both of their parents. Hence, most minors are prescribed persons under Div 6AA. Unless the income in question comes within the definition of “excepted trust income”, prescribed persons are taxable at the Children’s tax rates set out above on their proportionate share of the net trust income.

An exception to the general rule applies to the income of minor beneficiaries of testamentary trusts (as opposed to inter-vivos trusts), which falls within the definition of “excepted trust income”. Section 102AG(2) defines excepted trust income to include:

“assessable income of a trust estate that resulted from:

(i) a will, codicil or an order of a court that varied or modified the provisions of a will or codicil; or

(ii) an intestacy or an order of a court that varied or modified the application, in relation to the estate of a deceased person, of the provisions of the law relating to the distribution of the estates of persons who die intestate;”.

Thus, if the trust estate results from a will, codicil or out of an intestacy, or a variation of these by the court,41 then unless the anti-avoidance provisions apply (discussed later), the assessable income of the trust estate is classified as excepted trust income. The significance of this classification is that the Children’s tax does not apply and the trustee is instead taxed on the beneficiary’s share of the net income of the trust at adult marginal tax rates.

4.1 Increase in tax-free threshold

In addition, the adult tax-free threshold applies.

The increase in the tax free threshold from $6,000.00 to $18,200.00 effective from the 2012 - 2013 financial year makes the use of testamentary trusts even more attractive to will maker’s with young children or those with grandchildren who wish to benefit those children because a minor beneficiary of a testamentary trust can receive up to $18,200 without attracting any taxation liability.42 In a family with more than one child aged under the age of 18, the amount of potential tax savings can be significant. The income can be used by the children for their own maintenance and education. These expenses would otherwise have been paid by the children’s parents after the payment of income tax which, in all likelihood, would have been levied on the same income at higher marginal rates in the hands of the parents.

Example:

Jeremy provides for a testamentary trust in his will for the benefit of his wife Karen and their daughter Sophie. Jeremy dies and after his estate has been administered,43 the testamentary

40 Excepted person is defined in section 102AC(2) ITAA 36.

41 See in Trustee for the Estate of the late A W Furse No 5 Will Trust v FCT (1990) 21 ATR 1123; 91 ATC 4007 (Furse’s case)

42 The individual income tax rates for 2012-2013 are 19c for each $1 over $18,200, plus 32.5c for each $1 over $37,000, plus 37c for each $1 over $80,000, plus 45c

for each $1 over $180,000. The Medicare Levy of 1.5% will normally apply on top of these rates.

43 Although the line can sometimes be difficult to ascertain in practice, an estate can be said to be administered when all of the assets and liabilities have been

ascertained by the executor who thereafter holds the balance as trustee for the beneficiaries: Commissioner of Stamp Duties (Qld) v Livingston [1965] AC 694 (NB:

Livingston has some negative history but has not been reversed or overruled); Re Leigh’s Will Trusts [1970] Ch 277.


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trust comes into existence. In 2013, the trustee distributes 20 per cent of the trust income to Sophie, then aged 15.

As Sophie is a minor and therefore considered to be under a legal disability,44 under section 98, the trustee will be liable for tax on Sophie’s behalf on 20 per cent of the net income of the trust estate at adult marginal rates (plus the Medicare Levy) subject to the tax-free threshold of $18,200 on Sophie’s behalf.

If the trust were an inter-vivos trust, the trustee’s tax liability on behalf of Sophie would be assessed in accordance with the Children’s tax at 45% (plus the Medicare Levy).

For the sake of completeness, it should be mentioned that although the best outcomes can be obtained by the use of a testamentary trust, in some circumstances, it is possible to achieve similar tax outcomes by gifting or transferring estate assets into an inter vivos trust. Minor beneficiaries of this inter-vivos trust, if drafted correctly, may benefit from the exception to the Children’s tax.

Section 102AG(2)(d)(ii) extends the definition of excepted trust income to assessable income of a trust estate which:

(d) Is derived by the trustee of the trust estate from the investment of any property:

(i) …

(ii) that was transferred to the trustee for the benefit of the beneficiaries by another person out of property that devolved upon that other person from the estate of a deceased person and was so transferred within 3 years after the date of the death of the deceased person;

This enables the person upon whom the property devolved from the deceased estate to transfer it into an existing or new inter vivos trust and any minor beneficiaries may benefit from the exception to the Children’s tax.

However, there are also significant limitations to this approach related to the:

1. timing of the payment into the trust;45

2. beneficial ownership to the trust property;46 and3. amount of income which would come within the definition of excepted trust income.47

The exception only applies when the property in question devolved for the benefit of the beneficiary from the estate of a deceased person or upon the person who transferred it into the trust for the benefit of another (for example, their child) and so does not apply to all distributions from deceased estates.48

Although outside the scope of this paper, it should also be noted that the CGT and State Duty implications for inter vivos trusts may also be different from those which may arise under testamentary trusts.49

44 See ATO ID 2002/238 and ATO Private Ruling ‘Minor Beneficiaries – excepted trust income’ (Authorisation Number: 38202)

45 s102AG(d)(ii)

46 s102AG(2A)

47 S102AG(7). See generally C Leslie, above

48 S102AG(2)(d)(i) and (ii)

49 See the table in C Leslie, above p 596


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5 Adding to the Corpus of a Testamentary Trust

5.1 Making gifts into a testamentary trust

There is some debate about whether additions may be made to the corpus of a testamentary trust with the income tax advantages of income distribution to minors being retained.50 Whether a gift may be made to the corpus of a testamentary trust will be determined by the terms of the trust as set out in the will. If there is no specific power in the will to accept gifts, it seems likely that any property gifted to the trustee to hold on trust will be held on some other trust and not on the same trust that is set out under the terms of the will.

However, this does not determine the tax status of income distributions to minors which derive from any valid gifts into the trust. In Furse’s case51 the Federal Court of Australia held that the tax concession in section 102AG(2) applied in circumstances in which the assessable income of the trust estate resulted from a will, even though the property from which the income was derived was not property sourced from the deceased estate.

In Furse’s case, the sum of $1 was left to the trustee to hold upon the trusts in the will. The trustee borrowed a further $10, some of which was used to purchase units in a unit trust. Income from the unit trust was distributed to the testamentary trust and then to minor beneficiaries. The question arose as to whether this income was excepted trust income within the terms of section 102AG(2).

The Court confirmed the tribunal’s ruling that the income was excepted trust income.52 This was because section 102AG(2)(a) applies when the income in question is income of a trust estate which arises from a will, codicil or intestacy. It does not require that the “assessable income of the trust estate itself be sourced in the will or property of the deceased”.53

It is therefore clear that the application of section 102AG(2)(a) is not limited to income derived from a deceased estate and that in some circumstances, other income of the trust estate attracts the same tax treatment. In Furse’s case, the question of whether property gifted to the trust could be excepted trust income did not arise and was not examined.

5.2 Arm’s length transactions

The answer may lie in the anti-avoidance provisions of Div 6AA. There are two anti-avoidance provisions, which are designed to prevent misuse of the exception to the Children’s tax in section 102AG(2). Section 102AG(3) provides that only such income as would have derived from a particular transaction if it had been undertaken at arm’s length will be classified as excepted trust income.

The concept of an ‘arm’s length’ transaction arises in a number of places in the ITAA 36.54 It has also been addressed a number of times by the courts.55 The enquiry into dealing at arm’s length can be distinguished from whether the parties were at arm’s length per se. This is because parties could be ostensibly at arm’s length but deal with one another in a manner which is not at arm’s length.56 There is no presumption that parties who are at arm’s length will deal with one another at arm’s length. Similarly, parties could be closely related and yet deal with one another at arm’s length. It is the nature of the transaction which is in question and not the relationship between the parties, except in so far as this sheds light on the nature of the transaction or gives rise to a

50 See comments in A Macdonald ‘Testamentary Trusts: Not Just “Another Trust”?’ (December 2006) 4(2) eJournal of Tax Research 153 at 161

51 Above at 41. Applied in Healey v Federal Commissioner of Taxation*(2012) 208 FCR 300, 2012 ATC 20-309.

52 para 57-58

53 para 57

54 See TaxCounsel Pty Ltd, ‘Arms length issues’, Taxation in Australia (2011) 45(10) 581-584

55 FCT v AXA Asia Pacific Holdings [2010] FCAFC 134; Allen & Anor (as trustees for Allen’s Asphalt Staff Superannuation Fund ) v FCT [2010] FCA 1276; Re Australian

Trade Commission v WA Meat Exports Pty Ltd [1987] FCA 308; Collis v FCT 96 ATC 4831; Granby Pty Ltd v FCT 95 ATC 4240;NB: Collis and Granby have some negative

history but have not been reversed or overruled.

56 FCT v AXA Asia Pacific Holdings above at 107


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presumption one way or the other. For example, if parties are not at arm’s length, the inference may be more easily drawn that they did not deal with one another at arm’s length.57

To provide an example, in Allen & Anor (as trustees for Allen’s Asphalt Staff Superannuation Fund v FCT,58 the Court identified that the parties to the relevant transactions were not at arm’s length from one another and that also the dealings between the parties could not be said to be at arm’s length.59 Judge Collier accepted the submission of the Commissioner that “the nature of the dealings was infused by the close and self-serving relationships between the parties”. Although the facts in Allen’s case did not relate to excepted trust income under Div 6AA, the interpretation of the meaning of arm’s length dealings is consistent to that applicable under section 102AG(3).

The interpretation of (a previous version of) section 102AG(3) was examined in Furse’s case. The issue in that part of Furse’s case was whether the income derived from the units in the unit trust purchased with money borrowed by the trustee was “derived by a trustee directly or indirectly, under or as a result of an agreement ... any 2 or more of the parties to which were not dealing with each other at arm’s length in relation to the agreement”.60

The Court stated that there were two issues to be resolved under section 102AG(3). The first was “whether the parties to the relevant agreement were dealing with each other at arm’s length in relation to that agreement.” The second was “whether the amount of the relevant assessable income is greater than the amount referred to in the subsection as the “arm’s length amount”.”61

In relation to the two issues, the Court stated that: 62

The first of the two issues is not to be decided solely by asking whether the parties to the relevant agreement were at arm’s length to each other. The emphasis in the subsection is rather upon whether those parties, in relation to the agreement, dealt with each other at arm’s length. The fact that the parties are themselves not at arm’s length does not mean that they are not, in respect of a particular dealing, dealing with each other at arm’s length.

The Court stated further that:63

What is required in determining whether parties dealt with each other in respect of a particular dealing at arm’s length is an assessment whether in respect of that dealing they dealt with each other as arm’s length parties would normally do, so that the outcome of their dealing is a matter of real bargaining.

The explanatory memorandum to the bill which introduced amendments to Div 6AA in 1994 listed a third issue, being “whether or not the income is derived directly or indirectly as the result of an agreement”.64 With respect, section 102AG(3) does not require an ‘agreement’ (except in so far as an agreement can be said to be inherent in any ‘transaction’). The requirement for an ‘agreement’ does apply to section 102AG(4), discussed below.

It seems likely that a pure gift to the trustee would qualify as “an act or transaction directly or indirectly connected with the derivation of that excepted trust income” in the terms of section 102AG(3). The donor and the trustee would not be dealing with each other at arm’s length because the transaction, the making of the gift would not be a matter of real bargaining.

This interpretation is consistent with the view expressed by the Commissioner in Private Ruling 50621. In that case money left to minors in a will and other gifts made to the same minors by

57 above at 17

58 [2010] FCA 1276.

59 above at 91

60 s102AG(3) as it then stood

61 para 35

62 para 36

63 para 37

64 Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 4) 1994 para 2.24


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persons still alive were held upon trust, invested by the trustee and income was derived. The Commissioner was of the view that the investment earnings from the money left in the will would be excepted trust income but that the investment earnings from the lifetime gifts were not.

That view was reiterated in Private Ruling 1011602878465. In that case, the beneficiary received an income distribution from the investment of money which had partially come from a deceased estate and partly by gifts from relatives. The Commissioner held that the income from the investment of funds derived from the deceased estate was excepted trust income but that the other amounts were not. The Commissioner stated that:

In contrast to such income, which arises from property inherited through a will or intestacy, any income derived from amounts given to a child by a living person or given to a trustee to hold on the child’s behalf will not be ‘excepted assessable income’ or ‘excepted trust income’.

The result was that only a certain proportion of the interest income was treated as excepted trust income. The property was determined by how much of the original amount came from the deceased estate and how much came from other sources.

5.3 Agreements for purposes of securing that assessable income would be excepted trust income

Section 102AG(4) states that “agreements” for the purpose or for purposes which include the purpose of securing that assessable income would be excepted trust income do not achieve that objective. Incidental purposes are not included.65 Section 102AG(4) is designed to prevent transactions which take place to channel income from elsewhere through a testamentary trust in order to take advantage of the exception from the Children’s tax, and thus enable income to be spread amongst a family.

Taxation Ruling 98/4 is the Commissioner’s key ruling on Child Maintenance Trusts (CMT) (another type of trust to which section 102AG(2) applies).66 TR 98/4 discusses the circumstances in which the purpose of an agreement might be said to be more than incidental and refers to Case 44/95 in which income from an existing discretionary trust was routed through a CMT.67 Given that the trustee of the discretionary trust could have distributed directly to the minor beneficiary, it was held that by routing the payment through the CMT the purpose contravened section 102AG(4). One would expect the same reasoning to apply to distributions made by the trustees of discretionary trusts through testamentary trusts to minor beneficiaries.

The Commissioner also discussed the view that at least in CMT cases, if the income in question does not count as excepted trust income, it is reasonable to assume that it would be paid in some other form.68 However, this cannot be assumed in the case of payments through testamentary trusts – it may be that the payment would not be made at all, if the status of excepted trust income is not applicable. In the case of testamentary trusts, it may therefore be even more burdensome to show that obtaining the exception to the Children’s tax is more than incidental to any other purposes.

Other than perhaps in rare cases, in which a distribution to a testamentary trust is made in circumstances beyond the knowledge of the trustee (and in which case there would be no ‘agreement’), it is hard to imagine a set of facts in which a distribution of income derived from a gift into a trust will qualify as excepted trust income under section 102AG(2) without contravening either section 102AG(3) or section 102AG(4). This is in keeping with the purpose of the legislation which is to prevent income splitting.

65 s102AG(5)

66 s102AG(2)(c)(viii) 67 Para 86 onwards

68 Para 90


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In order to distribute income derived from property other than that having its source in (inherited from) a deceased estate through a testamentary trust to a minor and retain the benefits of the concessional tax treatment, very careful consideration would need to be given to the circumstances surrounding the transfer of the property into the testamentary trust and the derivation of the income.

6 Asset Protection BenefitsSpecific asset protection measures which may be adopted in determining the type of testamentary trust(s) the client wishes to establish by their will and appropriate structuring of the trust include:

• limiting the class of beneficiaries, the role of appointors and the powers of trustees having regard to the limitations of testamentary discretionary trusts;

• the use of capital protected trusts having regard to their taxation and duty consequences; and • the grant a lifetime occupation right without creating a life interest.

6.1 Beneficiaries

There is a great deal of flexibility in the types of persons who may or may not receive income or capital from a discretionary trust.

Whilst for an inter vivos trust it is usually desirable to have a very broad membership of the class of beneficiaries for the purposes of maximum flexibility in the administration of the trust and the types of purposes for which it may be used, a will maker is likely to be more focused on who is to benefit from the testamentary trust and what the trust is to be used for. That is, usually the will maker knows to whom they wish to gift their assets and chooses to establish a testamentary trust to benefit those persons because they wish to protect their assets from potential claims by their beneficiaries’ creditors or spouses and sometimes, from children born to the will maker’s spouse from a previous relationship.

Therefore, it is becoming increasingly common for parents, wishing to protect their family assets from being used to satisfy their children’s family law property settlements, to limit the beneficiaries of a testamentary trust to their surviving spouse and lineal descendants (commonly referred to as a “bloodline trust”, an expression in respect of which copyright has been claimed69) or to exclude their children’s spouses as capital beneficiaries.

In this paper, the expression “bloodline trust” is used as a generic term to describe a testamentary trust which restricts or limits the class of beneficiaries of the trust (and thus the distribution of assets) to the lineal descendants of the will maker and all references to “bloodline trusts” are to be construed accordingly.

As a beneficiary’s taxation liabilities and rights under trust law are always affected by the terms of the trust deed, it is imperative the advisor reads the deed before advising a client in respect of the trust or preparing minutes of trust distributions. For example, the description of the class of general beneficiaries may:

• prevent ex nuptial or step children from inheriting family wealth; (this is achieved through careful drafting of definitions such as “spouse” or “children”);

• only include companies or trusts in which lineal descendants hold/have an interest; or • enable income generated by the trust’s assets to be distributed to persons outside the bloodline

(e.g. in-laws). That is, there may be a different class of income and capital beneficiaries. In some cases it may be appropriate to include specific exclusion clauses in the trust deed. For

69 Queensland lawyers, Cleary Hoare have advised that Michael Hart and Brett Hart as trustees for the LRC Unit Trust are the proprietors of registered Australian trade

mark numbered 786488 in respect of classes 16 (legal documents) and 42 (legal services) and wish to be attribute d as the creator and provider of “Bloodline trusts”.


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example, a disaffected child may specifically be excluded from being a beneficiary. Alternatively, persons such as step children or spouses may be included as income beneficiaries but not as capital beneficiaries.

6.1.1 Asset protection benefits of limiting class of beneficiaries

Under common law, if a person (for example, a spouse) is not a beneficiary of a trust and has never been a beneficiary then the courts cannot order the trustee of the trust to distribute any property of the trust to the person.70

This does not mean that assets of the trust cannot be taken into account by the Family Court as a financial resource of a spouse who is a beneficiary of the trust (a financial resource being funds which may be applied to maintain a beneficiary spouse).71 This, in itself, will not necessitate the sale or distribution of the assets of the trust as part of a family law property settlement. Further, the fact that the Family Court may consider trust property to be a financial resource does not oblige the trustee to support the beneficiary spouse through income or capital distributions.

In Essex v Essex72 a “bloodline trust” was established for the husband’s children who were the sole capital beneficiaries, the husband being an income beneficiary only (S Trust). The husband’s wife was not a beneficiary. However, because the husband’s children were minors, the S Trust provided that payments of capital could be made to a parent or guardian of the children during their minority. Both the trial judge and the Full Court of the Family Court found it would be a breach of trust for the husband or wife to use the capital for their own benefit. The power to vary the S Trust prevented any change to the class of capital beneficiaries.

The majority of the Full Court of the Family Court found that the assets of the S Trust should have been treated as a financial resource of the husband as there was compelling evidence the husband would receive distributions from the S Trust and gain control of the S Trust after the conclusion of the proceedings.

Following the decision in Essex, unless a party to a marriage has never been a beneficiary of a trust it is difficult for the party to argue that the trust is not a financial resource.

For completeness, however, it is noted that valuation of a financial resource is very difficult. Factors the courts may take into account in determining the value of a financial resource include contributions made by a party to the marriage to the trust assets, the value of the trust assets and distributions of income and capital from the trust fund made to a party to the marriage over the life of the trust or marriage.73

Essex is still the leading authority for the view that the mere “possibility” of a party to a marriage receiving distributions from a trust is sufficient to support a finding that the trust is a financial resource.

The position is the same for testamentary trusts. As the Full Court of the Family Court stated in Bonnici v Bonnici74:

property does not fall into a protected category merely because it is an inheritance.

However, property held in a testamentary trust is less likely to be found to be property of the marriage than property held in an inter vivos trust.

In Ward v Ward75, the court found that assets held in a testamentary trust and in respect of which

70 Hitchcock v Pratt [2010] NSWSC 1508; Simmons v Simmons [2008] FamCA 1088

71 Essex v Essex

72 [2009] FamCAFC 236;

73 All references in this paper to marriage, where the context permits, include relationships governed by the FLA.

74 [1992] FLC 92-272

75 [2004] FMCAfam 193


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there was no evidence of any expectation of any distribution to any of the beneficiaries (who were the husband and his children but not the wife) were merely a financial resource of the husband as his sisters controlled the trust which the court noted had been established to protect the husband’s inheritance.

However, the issue of control over the distribution of trust assets is paramount in determining whether trust assets should be treated as property of the marriage or a financial resource.

In Lovine v Connor76, the court held assets that had not been distributed from a testamentary trust established 9 years prior to the separation of the parties still formed property of a party to the marriage because the husband, although a joint trustee with his sisters, had real control of the trust as the sisters played no active role and it was his intention to distribute the assets to either himself or his children at some time in the future.

From a family law perspective, Lovine suggests a statement in a will (the trust deed) that the primary purpose of the creation of the trust is to benefit the lineal line affords little or no protection where effective control of the trust is with a person who is the subject of a property dispute under the Family Law Act 1975 (Cth) (FLA).

In MacDowell & Williams and Ors77, Justice Kent refused an application by the husband to subpoena the wife’s parents’ wills. The husband sought to argue that an expectancy of inheritance should be taken into account in proceedings for a division of the property of the marriage. The court noted the comments of the Full Court in White & Tulloch v Tulloch78 that it may be just and equitable to admit to evidence the will of a party’s parent(s) where there was evidence of their likely death in circumstances where there may be a significant estate. In Tulloch the mother was a widow aged approximately 82 years, in reasonable health and had two children. The Full Court held to require production of the mother’s financial records would not be “in accordance with proper practice in these matters”.

Kent J then noted comments made by Moore J in C v M79 that a party’s prospective inheritance would only be of relevance to a property dispute in a “narrow band of circumstances” and “is not an invitation to intrude and offend by a ghoulish pursuit” of the will or value of the property of a parent of advanced years.80

The application of the principles espoused in the above cases may be limited by the recent High Court decision in Stanford & Stanford.81

In Stanford, the High Court held the threshold question to the Family Court exercising jurisdiction under section 7982 is whether it is ‘just and equitable’ to make an order altering the property interests of parties to a marriage whereas before Stanford, this question was asked last after determining the asset pool and the contributions and future needs of parties. The ‘just and equitable’ ground is clearly set out in section 79(2) of the FLA:

The court shall not make an order under this section unless it is satisfied that, in all the circumstances, it is just and equitable to make the order.

A most important consequence of the High Court’s decision in Stanford is that it is now clear that Kennon v Spry has not overturned basic trust principles. That is, “palm tree justice” must not apply. The power of the Family Court is not to be exercised by reference to any “unguided judicial discretion” or sense of “moral obligations”. Instead, the Family Court must decide whether it is

76 [2012] FamCAFC 168 referred to in paper, Trust assets and estate planning: How Has The Dust Settled After Kennon v Spry? by Matthew Burgess for 28th National

convention 13-15 March 2013

77 [2012] FamCA 479

78 (1995) FLC 92-640

79 [2000] FamCA 1086

80 Ibid 11

81 [2012] HCA 52.

82 Under section 79(1)(a) of the FLA, the Family Court has power to alter the interests of parties to a marriage in property.


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just and equitable to make an order having regard to the same legal titles and equitable principles as govern the rights of any two persons who are not spouses.

6.1.2 Power of amendment

As a result of the decision of the Full Federal Court in Commissioner of Taxation v Clark83 and the special leave application by the Commissioner to the High Court being refused, the Commissioner withdrew his views on resettlements as set out in the document Creation of a new trust - Statement of Principles August 2001 and issued Taxation Determination TD 2012/21.84

It is now beyond doubt that amendments made to a trust deed pursuant to and in accordance with a power of amendment contained in the deed will not effect a resettlement and therefore will not trigger a CGT event unless the changes “destroy the necessary continuity”85 in the essential features of a trust, namely:

• a trustee; • trust beneficiaries; • trust property; and • trust terms that require the trustee to hold and administer the property for the benefit and on

behalf of the trust beneficiaries. In Kearns v Hill86, the court held that a clearly worded power to the trustees to amend any of the provisions contained in the trust deed (with two exceptions) empowered the trustees to add beneficiaries.

Where the power to add or remove beneficiaries is not clear, it may still be relevant to consider the doctrine of “substratum” or purpose of the trust as expressed in re Dyer87. In Kearns, the court noted if there were a substratum that it was for the benefit of the descendants of a particular person.88

Therefore, it may be relevant to the power to add or remove beneficiaries in a “bloodline trust” if the trust is named by reference to a particular family or there is a recital to that effect.

In any event, it is most important to the integrity of a “bloodline trust” to ensure that the power of amendment does not permit any change in the class of beneficiaries and that the power of amendment itself cannot be amended.

In BP and KS89 the wife applied for an order that her husband transfer his shares in the trustee company of the S Family Trust to her to enable her to enforce a section 87 maintenance agreement by making herself a beneficiary of the trust so she could transfer trust assets to herself to satisfy her claim for maintenance90.

In the writer’s view, if the power of amendment in the trust deed for the S Family Trust had prevented the wife from adding herself as a beneficiary then she could not have successfully sought the order.

83 [2011] FCAFC 5

84 Income tax: does CGT event E1 or E2 in sections 104-55 or 104-60 of the Income Tax Assessment Act 1997 happen if the terms of a trust are changed pursuant to a

valid exercise of a power contained within the trust’s constituent document, or varied with the approval of a relevant court?

85 Commissioner of Taxation v Commercial Nominees of Australia Limited [2001] HCA 33 [36]

86 (1990) 21 NSWLR 107

87 [1935] TLR 273

88 Referred to by Grahame Young, Where Are We At With Amending Trust Deeds After Clark? presented to 28th National Convention 13-15 March 2013, 32

89 [2002] FamCA 1454

90 In the event, the court did not grant the wife’s application because it was a “pre-determination” or fetter on the rights and duties of the trustee but the result may

have been different had the application been brought after the introduction of Pt VIIIAA of the Family Law Act 1975.


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6.2 Joint and multiple appointors

The appointor of a discretionary trust usually has the power to remove and appoint trustees. The trust deed or will trust provisions will determine if there is an appointor, who that person(s) is and govern the relationship between the trustee and the appointor. Consequently, it is important to review who is the appointor as the circumstances and relationships of the creator of the trust or will maker change.

In particular, in cases of insolvency and family property disputes in which there is a claim against trust assets, the courts will have regard to who holds the position of appointor in determining who controls trust assets and therefore could transfer them to a creditor or disaffected spouse.

Whilst trust law is unequivocal that the power of an appointor is not “property” which vests in a trustee in bankruptcy if the appointor becomes bankrupt91 and the position of appointor is only one indice of “control” of a trust, the cases of Wily v Burton92 (bankruptcy), Richstar93 (corporations law) and Kennon v Spry94 (family law) all show that where the appointor comprises only one natural person, the courts may intervene to prevent the appointor acting in a manner which would enable trust assets to be transferred out of the trust so that they cannot be accessed by creditors or disaffected spouses.

Furthermore, a party to a “financial case” in the Family Court is obliged to disclose in their financial statement which must be filed in the FC95 details of:

(d) any trust:

(i) of which the party is, or has been since the separation of the parties, the appointor or trustee;

Therefore to protect trust assets from any trustee in bankruptcy of a will maker’s child or spouse and against claims in respect of future or second marriages or relationships, it may be preferable to have more than one natural person as an appointor or alternatively to appoint a corporate appointor.

In order to ensure that if persons are appointed jointly as appointor and one dies or ceases to act (e.g. by reason of resignation) the survivor can continue to act as an appointor and has power to appoint a replacement second appointor the trust deed must provide for survivorship of the appointor’s powers. Otherwise, there may not be any lawfully appointed appointor and, depending upon the terms of the trust deed, the role of appointor may default to the trustee.

If the person appointed as appointor is not the sole appointor then the powers of the appointor must be exercised jointly by all of the persons comprising the appointor unless the trust deed specifies otherwise.

That is, unlike the position of an executor, if two or more persons are appointed jointly as appointor and one ceases to act then unless the trust deed expressly provides otherwise the survivor may become the sole appointor and not be able to appoint a co-appointor or the office of appointor may become vacant with no power to anyone to appoint a replacement appointor.

6.2.1 Asset protection

Whether the decisions of the persons comprising the office of appointor (Constituents) are required to be unanimous or determined by majority vote depends upon the terms of the trust

91 Wily v Burton at 560; and Dwyer v Ross (1992) 34 FCR 463 at 466

92 ibid

93 Australian Securities and Investments Commission; In the Matter of Richstar Enterprises Pty Ltd ACN 099 071 968 v Carey (No 6) [2006] FCA 814

94 [2008] HCA 56

95 Rule 13.04 of the Family Law Rules 2004 (FLR)


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deed and, in particular, two factors:

• the terms of the appointment; and • the provisions as to how determinations are to be made.

When considering issues of control, requiring a power to be exercised unanimously may provide protection against a majority gaining too great a control over decisions or preventing “tyranny by the majority”. On the other hand it must also be considered whether the veto vote given to each individual by requiring unanimity for decision making may result in “tyranny by the minority” on critical decisions. Therefore in succession planning careful consideration must be given as to which powers and rights require a unanimous decision by all appointors and which decisions are better dealt with by a majority of them.

In addition if the consent of the appointor is required to any capital distributions or variation of the trust deed or winding up of the testamentary trust, not only will the choice of appointor be critical but the terms of appointment will also be important.

6.2.2 Terms of appointment

If two or more persons are appointed jointly or together by name then the power cannot be exercised by a majority of those persons or, absent express provision in the trust deed, by the survivor of them. In Farwell on Powers96 Farwell concluded that the results of the authorities mean:

A bare power, given to two or more by name, cannot be executed by the survivor.

This is not because there is anything in a power incompatible with it surviving, but if a man says he will trust two, the law will not say he shall trust one; it is a joint confidence. It will be otherwise if the power be limited to the survivor; that is saying that he will trust two as long as they live, and afterwards one of them (Mansell v Mansell, Wilm. 43).

Where a naked power is vested in two or more nominatim, without any reference to an office in its nature liable to survivorship, as an executorship is, it without doubt would be a contradiction of the general rule to allow the power to survive….(Farwell then referred to the cases of Montefiore v. Browne97 and Atwaters v. Birt).98

Further, Farwell noted:99

In Brassey v Chambers, the Master of the Rolls says that it is settled by repeated authorities that when a naked power is given to several persons it cannot be executed by the survivor. It is a power the execution of which is entrusted to several individual persons jointly, which can only be executed by them all, and if one of them should die, the authority will not survive. It is also equally settled, that if the power be annexed to the office, any persons who fill the office of executor will have also the power which is attached to that office (emphasis added).

It is noted that statute law may reflect or alter the position at common law100.

In view of the common law rule against survivorship of a “bare power”, the trust deed should specifically give the survivor of a joint power (should one die or resign or become disqualified from acting) the power to act as appointor in their own right.

96 Second Edition 1893, pp 454,455

97 7 H.L.C. 241

98 Cro. Eliz. 856

99 Farwell on Powers, Third Edition 1916, p 516. Farwell on Powers is considered to be the leading text on powers.

100 For example, the survivor of attorneys appointed jointly but not severally cannot act under an enduring power of attorney in Victoria; s 125R(2) Instruments Act

1958 (Vic).


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Further, at trust law, it is arguable there is no survivorship of the right of the last surviving appointor to appoint someone to replace them as appointor on their death. Therefore, such a power must be specified in the trust deed.

6.2.3 How determinations are to be made

Unless the trust deed specifies otherwise, where two or more persons have been appointed as the appointor, (whether as multiple or joint appointors) the powers of the appointor must be exercised jointly that is with the unanimous consent of the Constituents. This means that unless all of the Constituents agree on a matter or thing (such as whether to remove the trustee) the “status quo” will be preserved (for example, the trustee could not be removed).

Some trust deeds provide that determinations of the appointor may be made by a majority vote instead of with the unanimous consent of all of the Constituents. That is, the majority decision of the Constituents of the appointor will prevail.

Irrespective of whether the trust deed requires decisions to be made in writing, best practice is to record all decisions of the appointor in writing.

Depending upon the number of trusts to be established, the dollar value of the estate and whether it is likely the trusts will exist for the whole of the perpetuity period relevant to them, the appointment of a corporate appointor may be preferred, especially where the decision of the appointor is to be made by a majority of persons. The constitution of the corporate appointor will govern meetings and voting including whether the chair has a casting vote and like matters and also the appointments of successive directors.

Finally, it is most important that consideration be given to whether the will maker is an appointor of a discretionary trust because some trust deeds provide for the legal personal representative (LPR) or a nominee of the last appointor of the trust to become the replacement appointor. Consequently, the choice of LPR will become important or in the case of a nomination, the will must expressly nominate the person to succeed the will maker as appointor.

6.2.4 Taxation consequences

An amendment to a trust deed to provide that the majority decision of the Constituents will be the determination of the appointor may be void if the amendment is beyond power. If the amendment is void then there is no resettlement such that the amendment will not trigger a CGT event.

Many amendment clauses are ill suited to amendments to the identity, successors and powers of the appointor.

In Jenkins v Ellett,101 the court found that a power to vary the trusts of a trust deed did not authorise a variation to name a different person as the “protector” (guardian).

In a recent paper,102 Grahame Young, summarised the position regarding amendments to appointor provisions as follows:

Two questions arise: the first whether a general power of amendment can be used to appoint successors in place of the particular provisions and the second whether that general power can be used where there is no provision for succession and the deed contemplates that there may be no successor.

101 [2007] QSC 154

102 Above 56.


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In answer to the first question I suggest that there is a real danger that the amendment will be invalid as a fraud on the power or as excessive execution of the power. The argument is that the general power of amendment is subject to the specific provisions of the deed and cannot be used to overcome them. This can cause real problems where appointments have been made but cannot be changed because they are irrevocable, or from incapacity or unwillingness.

In the second case, there is no specific power to be overridden but on a reading of the trust deed as a whole it may be argued that there is an implied restriction on use of the general power of amendment. On balance I suggest that argument is less likely to be successful because of the wide construction given to amendment clauses.

In an earlier paper, Young noted:103

A clause for variation of the trusts is clearly insufficient; as is a clause for variation of the powers concerning the trust fund although the power to appoint a trustee, but not an appointor or guardian, is probably a power concerning the trust fund. As noted above, your [Tax] Institute argued that the identity of an appointor or guardian was not a term of the trust; if that were correct then a power to amend the terms of the trust deed would be insufficient to amend the deed to change their identity.

If the power is to amend the terms and consideration herein before contained will it matter that the schedule follows the amendment clause?

In the writer’s view, it does matter if the schedule follows such a power of amendment. The courts have consistently found104 and the Commissioner has indicated in numerous publications that trust deeds should be read literally and the procedure for amendment must be strictly followed. Otherwise, any amendments will be invalid and ineffective.

6.3 Powers and limitations of testamentary trusts

The client’s priorities and unique circumstances will determine which of the myriad of possible strategies might be adopted in structuring a testamentary trust and the powers of the trustee which in turn will, in part, depend upon the intended use or purposes of the testamentary trust and the types of assets it is likely to hold. Accordingly, a testamentary trust is a powerful estate planning tool.

The limitations of a testamentary trust primarily relate to taxation laws, in particular division 7A of the ITAA 36 and family trust elections, and the powers of the Family Court to take the assets of trusts into account in determining the pool of assets available for a matrimonial property settlement. It is beyond the scope of this paper to consider these limitations further save to say that from the perspective of taxation, relationship breakdown and the exposure of a particular beneficiary to commercial risk, a gift of an asset by a will maker directly to an individual will expose the asset directly to the exposures of the individual whereas making the gift to a testamentary trust of which the individual is an object or potential beneficiary will not.105

The challenge is to get the right combination of persons as trustees, directors, shareholders, appointors and beneficiaries and, in appropriate cases, to customise the terms of the trust deed and possibly also, the terms of the constitution of a corporate trustee in order to minimise attacks on the assets of the trust without compromising the flexibility and control of the trust from the point of view of asset protection, taxation, business succession and estate planning to include answers to basic questions such as:

103 In his paper Amending Trust Deeds presented to 14th National Tax Intensive Retreat on 18 August 2006

104 As noted in Hillcrest (Ilford) Pty Ltd (No 2) [2010] NSWSC 285

105 But in relation to family law see paper op cit at note above


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• how many trusts are needed? • who should be trustees?

– when to use a corporate trustee • who should be appointors?

– when to use a corporate appointor • who should be (or not be) beneficiaries?

– exclusion of non-lineal descendants or spouses from being capital beneficiaries – consideration of non-resident beneficiaries

• what restrictions (if any) are needed? – access to capital – lending by the trustees – security to be provided for loans – disqualifying events

• what should be the vesting date?106

6.4 Capital protected trusts and taxation and duty consequences

Capital protected trusts (life interest trusts) allow the creator to split capital itself from the income the capital produces. Under these trusts the creator can dictate that the income which the capital produces is to go to one beneficiary (the life tenant) for the duration of that beneficiary’s life and then upon the beneficiary’s death the capital itself will vest in the remainder beneficiaries. This type of trust is designed to protect and preserve assets for the benefit of a beneficiary or for future generations. They are often used where:

• there is a concern that the beneficiary is unlikely to be able to manage their own financial affairs (for example by reason of being a spendthrift, wasteful or having a disability);

• the client wishes to maximise the chances that assets will survive the beneficiary for the benefit of a subsequent generation; or

• there are concerns that a spouse may re-marry and children will miss out on the asset. Capital protected trusts can also be established in such a way as to allow a limited portion of the capital assets in any year to pass to the life tenant in addition to the income stream107.

If the client’s concern is to ensure the surviving spouse may occupy the main residence (MR) whilst ensuring the ultimate sale proceeds of the MR pass to their children, it is generally preferable not to create a life interest in the MR but to gift the MR to a testamentary trust subject to the grant of rights of occupation to the surviving spouse. This aspect is discussed in detail at paragraph 6.5.

A capital protected trust will end on the occurrence of one of the following;

1. death of the life tenant;2. a specified event detailed in the will (e.g. marriage or divorce); 3. the execution of a deed of arrangement (agreement between the life tenant and remainder

beneficiaries); 4. surrender; 5. disclaimer. The last three methods of ending a capital protected trust (voluntary disposals) in effect

106 See paper written by A Morton, Estate Planning for the Blended Family dated 25 March 2010 delivered by Rob Jeremiah at the TEN 4th Annual Estates and Asset

Protection Conference at point 5.2, pages 13-15 and Fireproofing the Family Trust from Third party Attack at points.2-10, pages 3-15 (see fn 4).

107 Perpetual Trustees Victoria Ltd v A-G (Vic) – BC201104803 (case also relevant re court’s power of amendment of trust deed)


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represent voluntary disposals of life and remainder interests otherwise than in accordance with the will creating those interests because the disposals are not contemplated by the will. Consequently, these disposals may trigger CGT and duty liabilities depending on the nature of the assets of the trust. Issues may also arise in relation to family trust elections and generally, if the class of remainder beneficiaries is not closed because it is defined by reference to the lifetime of a surviving life tenant.

6.4.1 Taxation consequences

There are important tax consequences which result from the creation of a capital protected trust or what the Commissioner refers to as equitable life and remainder interests in Taxation Ruling TR 2006/14.108

Upon the creation of an inter-vivos trust, CGT event E1 occurs and the creator will make either a capital gain or a capital loss depending upon whether the value of the asset the subject of the gift by the creator exceeds its cost base. The Commissioner notes that if the trust is created under a will then CGT event E1 happens:

when the administration of the deceased’s estate in respect of the original asset is completed. Any capital gain or loss made by the deceased from the event happening is disregarded under section 128-10 [ITAA 97].109

Although there are no CGT consequences upon the creation of life and remainder interests, the law governing the CGT consequences upon the voluntary disposal of life and remainder interests is complex because of issues relating to the market value of life and remainder interests at the time of their voluntary disposal.

A further issue relevant to the surrender of life interests is the determination of the cost base of the life interest.

6.4.2 CGT consequences for trustee

The debate continues as to the value of the interest to which the remainderman succeeds on the death of the will maker and whether that value is affected by the value of the interest of the life tenant or their life expectancy. Specifically, if market value is the value a reasonable purchaser would pay then from a commercial perspective, the price the purchaser would pay would be discounted by the life tenant’s interest in the property. For example, in considering the market value of a lifetime right to reside in a dwelling, in the Commissioner’s view it is relevant to have regard to what a willing but not anxious buyer would be prepared to pay for such a right. 110

Item 8E in the table to section 109-55 ITAA 97 sets out the time of acquisition of the

CGT asset by a beneficiary in the estate of a deceased individual as when the deceased acquired the asset. Neither sections 109-55 nor 115-30 nor does Div 128 refer to the interest of a remainderman. However, from a practical perspective, the Commissioner has resolved this issue by distinguishing between the cost base of an equitable interest (an interest in property held on trust) and a legal interest (but only in respect of an interest in land (not personal property) that is not held on trust).111

108 TR 2006/14 distinguishes between life and remainder interests in property held on trust (equitable interests) and life and remainder interests in land not held on

trust (legal interests).

109 Above para 15

110 Para 110.

111 TR 2006/14 does not deal with life and remainder interests in personal property that is not held on trust, para 3.


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In example 1 to TR 2006/14,112 the Commissioner expresses the view that upon the death of the life tenant, the remaindermen are taken to have acquired the asset on the day the will maker died at the trustee’s cost base and reduced cost base as referred to in paragraph 18 of the ruling:

If the trust is created as a result of the death of an individual, the trustee acquires the original asset at the date of the deceased’s death: (subsection 128-15(2)). The trustee’s acquisition cost is determined under subsection 128-15(4)…

That is, in the Commissioner’s view, the cost base of the equitable interest of the remainderman is unaffected by the life interest.

Whereas, in example 2 to TR 2006/14,113 the cost base of the legal interest of the remaindermen is affected by the market value of the legal life interest calculated at the time of creation of the legal life interest.

A legal life and remainder interest may be created by will114 where the terms of the will provide that land owned by the will maker is to be given to the life tenant for life and to the remainderman for the remaining time (as opposed to being held upon trust for them) such that there is to be an apportionment of the cost base of the LPR across the percentage interests in the land held by the life tenant and the remainderman.115 In example 2, the Commissioner says it is reasonable to apportion the cost base of the land based upon the relative market values of the life and remainder interests at the time of their creation.116

For completeness it is noted that the Commissioner distinguishes a mere right of occupancy from a legal or equitable life interest.117 However, the main residence exemption may apply to the grantee of the right such that any capital gain which may arise from a CGT event happening in respect of that right may be disregarded.118

A trustee of a trust may make a capital gain or loss from a CGT event happening to an original asset after it commences to be held on trust for life interest and remainder owners.119 However, the trustee may be able to disregard a capital gain or loss from certain CGT events happening to a dwelling occupied by an individual who was given a right to occupy the dwelling under the deceased’s will (sections 118-195 and 118-210 ITAA 97). Any capital gain or loss the trustee makes is taken into account in working out the trustee’s net capital gain or loss.

6.4.3 CGT consequences for life interest and remainder owners

The following paragraphs are extracted from TR 2006/14:

24. Equitable life or remainder interests are acquired when they commence to be owned: (subsection 109-5(1))…

25. The first element of the cost base and reduced cost base of an equitable life or remainder interest is the sum of any money and the market value of any property given to acquire it: (subsection 110-25(2)).

26. If, as is generally the case, no money or property is given to acquire an equitable life or remainder interest, section 112-20 provides that the first element of the cost base and reduced cost base of the interest is its market value at the time it was acquired.

112 Para 126.

113 Para 135.

114 Para 95.

115 Paras 85 and 99.

116 Para 135.

117 Paras 105 to 120.

118 Paras 119 and 120.

119 Para 20.


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27. However, a market value cost base cannot be obtained for an equitable life interest that arose (other than as a result of someone’s death) if:

• nothing is actually paid or given to acquire it; and • it is not acquired by way of assignment from another entity…

28. Note that for the purpose of paragraph 112-20(1)(a), equitable life and remainder interests are considered to have been acquired as the result of CGT event E1 happening. That is, a market value acquisition cost is not denied on the basis that the interests resulted from CGT event D1 happening or no CGT event at all happening.

6.4.4 Life interest or remainder owner disclaims interest

29. No CGT event happens to a life interest or remainder owner in respect of the effective disclaimer of their interest.

30. An effective disclaimer must be intentional and show unequivocally that the nominated life or remainder owner rejects their interest. The right to disclaim is lost if that person has engaged in positive conduct indicating an acceptance of their interest. The right may also be lost if it is not exercised within a reasonable time, in that someone who remains silent beyond the time when they may be expected to disclaim the interest may be presumed to have accepted it. If a life or remainder owner effectively disclaims their interest, they are retrospectively disentitled to it.

32. If the remainder interest is disclaimed, the interest will vest from the beginning in the original owner (inter vivos trust) or residuary beneficiaries (deceased estate trust).

6.4.5 Deed of arrangement to vary terms of deceased’s will

33. Beneficiaries in a deceased estate who have been granted life and remainder interests may be dissatisfied with the provision that the deceased person made for them under their will. The beneficiaries may enter into a deed of arrangement under which they agree to share the deceased’s assets rather than their life and remainder interest.

34. Assets may pass to them as a beneficiary in the estate under paragraph 128-20(1)(d). If this occurs, there will be no consequences for the life and remainder interests as the intended owners of those interests are treated as if they had not been bequeathed them.

35. A deed of arrangement will be effective for the purposes of paragraph 128-20(1)(d) provided that it is entered into:

• to settle a claim to participate in the estate; and • any consideration given by the beneficiary consisted only of the variation or waiver of

a claim to an asset or assets that formed part of the estate. 36. For the purposes of paragraph 128-20(1)(d) a deed of arrangement must be entered into prior to the administration of the estate being completed unless the beneficiary can demonstrate that a court would, at the time the deed was entered into, have entertained their application for family provision, or an extension of time in which to make such an application. (Paragraphs 209 to 223 of this Ruling further explain this requirement. Importantly, determining whether a Court would entertain applications such as these depends on the succession laws in each State.)

37. A taxpayer is not required to commence legal proceedings in order to establish, for the purposes of paragraph 128-20(1)(d), that they have a claim to participate in the distribution of the assets of the estate. A claim may be established by a potential beneficiary communicating to the trustee their dissatisfaction with the will.


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6.4.6 Dealings between life interest and remainder owners

66. If a life interest or remainder owner surrenders or releases their interest CGT event A1 (in section 104-10) rather than CGT event C2 (in section 104-25) happens. The Commissioner considers that CGT event A1 is the applicable event, as there is a change of ownership of the interest from one party to the other, rather than a mere ending of it.

67. Whether the surrender of a life interest constitutes a conveyance of that interest was considered in Platt and others v. Commissioners of Inland Revenue (1953) 46 TC 418. The Court held that deeds, described as deeds of surrender and release operated as conveyances or transfers of the life interests which were the subject of the deed:

It seems to me to be, on principle, perfectly plain that these documents... did operate as voluntary dispositions inter vivos; they had the effect of accelerating or bringing into operation interests which, but for their execution, would not have existed.... I think they were conveyances or transfers, and no less so because they have chosen to be described as surrenders or releases or deeds, or by any other name; they did in fact operate as voluntary dispositions inter vivos, and if authority be required for that proposition it is undoubtedly to be found in the case ... Stanyforth v. Commissioners of Inland Revenue [1930] AC 339.

68. If the surrender or release is for no capital proceeds the market value substitution rule in subsection 116-30(1) applies to determine the amount of capital proceeds from the event.

69. If capital proceeds are given for the surrender, the market value substitution rule applies if those proceeds are more or less than the market value of the interest surrendered and the parties did not deal at arm’s length: subsection 116-30(2).

70. The party acquiring the interest may be taken to have paid market value if no expenditure is given to acquire it or they did not deal at arm’s length in relation to the acquisition: subsection 112-20(1).

Scope of exception in CGT events E5 to E8: ‘trust to which Division 128 applies’

77. CGT events E5 to E8 (in sections 104-75 to 104-100) contain an exception for trusts ‘to which Division 128 applies’. If the exception applies, the Commissioner takes the view that it is not necessary to consider whether any other CGT event has happened.

79. In the context of CGT events E5, E6 and E7, the exception will apply if, as part of the administration of a deceased estate, an asset the deceased owned when they died passes to a beneficiary in accordance with section 128-20. (Note that in certain circumstances where an asset passes to a beneficiary the Commissioner treats the trustee of a testamentary trust in the same way as he treats a legal personal representative: Law Administration Practice Statement PS LA 2003/12).

Based on the Commissioner’s views it can be concluded that the cost bases of the interests acquired by the trustee, life tenant and remainderman are the market values of the relevant interests at the time the interests are acquired that being the date of death on which the interest is created. There are no CGT consequences for the life tenant or remainderman upon their respective interests passing to them because a capital gain is disregarded upon the happening of the relevant CGT event (E5, E6, E7).120 But upon the ultimate disposal of the interest a capital gain or loss may arise.

In the case of the remainderman, CGT event E8 happens when the remainderman disposes of its interest to a third party. That is, even though a trust under division 128 is an exception to CGT event E8, the Commissioner takes the view that a trust is a trust over an asset of the deceased

120 There is also no CGT consequence for the remainderman of a legal interest upon the life tenant’s death, though their interests are thereby enlarged. TR 2006/14

para 137.


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as distinct from the remainderman’s absolute entitlement to the asset such that the exception does not apply unless the remainderman disposes of their interest prior to the completion of the administration of the estate.

TR 2006/14 sets out the Commissioner’s views as to the CGT consequences of voluntary dispositions. However, a number of legal issues arise. For example, when does a disclaimer become a surrender of a life interest or the CGT consequences to the remainderman of surrender of a life interest and upon any subsequent surrender by the remainderman of that interest including issues regarding any merger of equitable interests.

The Commissioner takes the view that an interest may be disclaimed as soon as the beneficiary becomes aware of it but if that only occurs after the administration of the estate is completed then whilst there may not be any CGT consequences of the disclaimer in determining whether duty is payable in respect of a disclaimer of dutiable property, state revenue authorities may take the view that the property has vested in the beneficiary and therefore, the transaction is more properly characterised as a surrender rather than a disclaimer of a life interest.

The duty consequences of disclaimers and surrenders of interests in dutiable property are set out below. For completeness it is noted that duty may also be payable upon any variation in the property rights of beneficiaries under a deed of arrangement which falls within the provisions of section 128-20(1)(d) of the ITAA 97 (s128 deed) because exemption from duty is generally limited to transfers of property made in accordance with the terms of the will.

Therefore, if beneficiaries of a will wish to “relinquish” any interests or “redistribute” the property gifted to them under a will then the following matters should be considered in determining how best to proceed and before any interests are transferred from the LPR to a beneficiary:

• the market value of the interest a beneficiary wishes to surrender as the market value will determine how significant any taxable capital gain which is triggered will be;

• whether the property is dutiable property and the calculation of any duty payable should there be a redistribution of the beneficial interests in the property under the will; and

• whether a s128 deed would, even if CGT and duty consequences were no object to entering into the deed, achieve the client’s objectives (for example, only will beneficiaries may be party to a s128 deed not non will beneficiaries).

6.4.7 Duty consequences

The exemption from duty will apply to transfers under the terms of a will and under the laws of intestacy.

Where administration of an estate has not been completed, a residuary beneficiary has no interest in the underlying assets:121

Even so, in some states, a disclaimer before administration is complete may be dutiable. The Duties Act 2000 (Vic) specifically provides for a head of dutiable transactions that applies to the disclaimer of an interest or a right in respect of dutiable property in the estate of a deceased person “irrespective of whether the ... estate has been fully administered”: s 7(1)(b)(ii) Duties Act 2000.

…………..

The surrender of an interest in land that has vested would generally be dutiable. In NSW, Victoria, Queensland and Tasmania, a surrender of land (or an interest in land) is specifically listed as a “dutiable transaction”: NSW: s 8(1)(b)(iii) of the Duties Act 1997; ACT s 7(3) of the Duties Act 1999; Vic; s 7(1 )(b)(ii) of the Duties Act 2000; Qld s 9(1 )(c) of the Duties Act 2001; Tas: s 6(1 )(b)(iii) of the Duties Act 2001.

121 CSD (Qld) v Livingston (1964) 112 CLR; [1965] AC 694


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In South Australia, the surrender or renunciation of an interest in property subject to a trust is deemed to be a conveyance operating as a voluntary disposition inter vivos: S 71(3)(v) of the Stamp Duties Act 1923. In Probert v Commr of State Taxation (SA) (1998) 72 SASR 48; 40 ATR 261 (at 52 SASR), both parties accepted that ad valorem stamp duty would have been payable if the disclaimer had occurred after the estate had been fully administered.

In Western Australia, the position with regard to surrender is unclear. Prima facie, a surrender of a life interest after it has vested will attract stamp duty under s 11(1)(g) of the Duties Act 2008. Section 139 of the Duties Act 2008, however, provides for nominal duty on a transfer of dutiable property for no consideration that gives effect to a distribution in the estate of a deceased person under the will. The effect of this exemption arguably is that a transfer to a remainderman as a result of the surrender by the life tenant might not attract stamp duty. 122

6.4.8 Settled Land Acts

If the capital in the trust involves real estate it is important that consideration is given to relevant State and Territory legislation. The creation and surrender of life interests may be dutiable. Further, legislation may govern who can be the trustees of trusts holding land the subject of a life interest (such as by preventing the life tenant from being the sole trustee) and may give life tenants additional powers. It may be possible to exclude the operation of certain statutory provisions such as the powers given to life tenants under the Settled Land Act 1958 (Vic).

However, all legislation must be read carefully in order to determine what if any of its provisions may be excluded. For example, it is not possible to exclude liability under duties legislation but it is possible for parties to contract privately as between themselves as to who should pay the duty.

6.5 Grant of lifetime occupation right without creating a life interest

Given the tax and potential duty consequences of creating a life interest and the ability of the trustee of a testamentary trust to access the main residence (MR) exemption in respect of the occupation of the MR by the surviving spouse, it is generally preferable not to create a life interest in the MR but to gift the MR to a testamentary trust subject to the grant of a right of occupation to the surviving spouse.

Occupancy of a dwelling under a right granted under a will does not affect the entitlement of a trustee or beneficiary to the main residence exemption contained in section 118-195(1) of ITAA 97. Section 118-195 exempts from CGT an individual who has an ownership interest in a dwelling that passed to them as a beneficiary of a deceased estate. Access to the full exemption depends upon the surviving spouse (or other individual having a right to occupy the dwelling under a will) occupying the MR from the deceased’s death until the ownership interest ends.

The ability to give the survivor the right to occupy the MR and use its contents without triggering any tax liabilities whilst retaining all the asset protection advantages of owning the MR in a trust makes a testamentary trust a very valuable estate planning tool. For completeness, it is noted that in some jurisdictions there may be land tax consequences which would not arise if the MR were gifted by will to the surviving spouse but they would be the same for a Capital Protected Trust.

The extent of the right to occupy the MR depends upon the client’s instructions and circumstances.

For example:

• the will maker owns the MR and gives it to a testamentary trust (created by the will) and gives the surviving spouse a life interest in the MR so that the capital can only be accessed by the 122 Death & taxes: Tax Effective Estate Planning 5th Edition, Miranda Stewart, Michael Flynn 2012, Thomson Reuters at pp 408-409.


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beneficiaries of the testamentary trust upon the death of the survivor. In Hills v Chalk,123 the survivor of the marriage was not able to sell the MR (which he did not own) to pay for assisted accommodation as the will of the deceased wife provided that the MR was to be sold and the sale proceeds paid to the wife’s children of a former relationship as soon as the husband ceased to live in that residence. In Hills v Chalk the couple had also entered into a pre-nuptial agreement which mirrored the terms of their wills;

• the will maker owns the MR and gives the MR to a testamentary trust with a right to the surviving spouse to occupy the MR but does not give any power to the trustee to acquire a replacement residence or to sell the MR to pay for nursing accommodation for the survivor;

• the will maker owns the MR as tenant in common with the surviving spouse and gives their interest in the MR to a testamentary trust with a right in the survivor to occupy the MR until the survivor remarries; or

• the will maker owns the MR and gives the MR to a testamentary trust with a right to the surviving spouse to occupy the MR and empowers the trustee to sell the MR and purchase another residence or acquire residential accommodation rights for the survivor (including payment of an accommodation bond).

In general, a person who is granted a right to reside or who takes a life tenancy of property under a will is treated as the owner for land tax purposes and so is eligible for exemption from land tax even where the property is owned by a testamentary trust.124

In all States and Territories, there is an exemption from duty (or only nominal duty) applicable to the vesting of dutiable property in the personal representative of a deceased person and to transfers of assets to a beneficiary of a deceased estate.

7 ConclusionThis paper outlines the tax and asset protection benefits gained through the creation of a testamentary trust.125

By reason of the advantages testamentary trusts provide in estate planning, consideration should always be given to whether in view of their individual circumstances, a client may prefer to establish one or more testamentary trusts by their will. The benefits of establishing a testamentary trust depend upon the personal assets and circumstances of the client and the people whom they wish to benefit by their will. It is not only high net wealth individuals who may wish or should consider providing for the creation of a testamentary trust by their will.

In summary, the tax and asset protection benefits of establishing a testamentary trust include:

• enabling the testator (to some extent) to dictate the manner in which their assets are managed after their death;

• favourable tax treatment of testamentary trusts compared with trusts created inter vivos: – excepted trust income – distributions to minors (a benefit which is even more attractive following the abolition of the low income tax offset); and

– main residence exemption from CGT; and 123 [2008] QCA 159

124 For a summary of State and Territory conditions for eligibility for the principal place of residence exemption or concession from land tax see “Principal

residence exemption” “Death & taxes: Tax Effective Estate Planning” 5th Edition, Miranda Stewart, Michael Flynn 2012, Thomson Reuters, pages 302 to 303.

125 The writer wishes to acknowledge the significant contribution made by Rhonda Tombros, lawyer to writing sections 1, 4 and 5 of this paper.


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• protecting family assets: – from trustees in bankruptcy; – by restricting beneficiaries to lineal descendants; – protecting capital for successive generations whilst providing income stream to surviving spouse (capital protected trusts); and

– by minimising the risks of assets being transferred to a disaffected spouse. A client’s objectives and priorities will determine the importance of the above potential benefits in assessing whether the client should create a testamentary trust(s) under their will and if so, its structure.

Amanda Morton Senior Associate 03 9611 0113 [email protected] www.sladen.com.au

Sladen Legal Level 5, 707 Collins Street

Melbourne 3008 Victoria Australia

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Technical Paper 031

Creating a Testamentary Trust - Sladen Legal · PDF filefi˚˛ LADE EGA fi˚ CTBER fi˙ Wills...

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Transcript of Creating a Testamentary Trust - Sladen Legal · PDF filefi˚˛ LADE EGA fi˚ CTBER fi˙ Wills...