Edited version of private advice

Authorisation Number: 1051924150871

Date of advice: 25 November 2021

Ruling

Subject: Excepted net income

Question

In the Commissioner's opinion, under subsection 102AG(1) of the Income Tax Assessment Act 1936 (ITAA 1936) would a dividend from DCo1 be 'excepted trust income' of DTT1 where the assets of DCo1 are originally sourced from an income distribution from MTT1, under subsection 102AG(2) and subsection 102AG(2AA) of the ITAA 1936?

Answer

Yes. The Commissioner considers that income from the relevant trust assets would be excepted trust income for the purposes of section 102AG of the ITAA 1936.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

A is the sole director of a corporate trustee. A is the controlling mind of several testamentary discretionary trusts established via the wills of A's parents. The trusts have a very broad beneficiary class but are primarily for the benefit of A and each of A's children.

The corporate trustee is trustee for testamentary trusts DTT1, DTT2 and MTT1. DTT1, DTT2 and MTT1 hold shares in ECo1 and ECo2, which mainly invest in listed securities and similar investments.

Each testamentary trust holds an unequal proportion of shares in ECo1 and ECo2. As such, each testamentary trust created for the benefit of each of A's children has an unequal value. This was not the intention of the deceased and came about via an equalisation of the estate of A's late parents between A and A's sibling.

A wishes to distribute income from the assets of the testamentary trusts, to equalise the values in the testamentary estates created by A's late parents between the testamentary trusts established for A's children.

It is proposed that in the year ending 30 June 20XX, the testamentary trusts will each incorporate a new company, DCo1, DCo2 and MCo1. The paid-up capital of each of these companies will be $x and these funds will be sourced from assets that were transferred to the respective testamentary trust from the estate of A's late parents respectively.

ECo1 and ECo2 will then sell their listed investments on market and pay tax at the corporate tax rate of 30% on any net capital gains. ECo1 and ECo2 will then declare a dividend to their respective shareholders, being the testamentary trusts DTT1, DTT2 and MTT1.

On 30 June 20XX, DTT1 will distribute to DCo2, DTT2 will distribute to MCo1 and MTT1 will distribute to DCo1. The present entitlements will be satisfied in cash by the trustee to the beneficiaries shortly after 30 June 20XX.

It is proposed that, in the years ending 30 June 20XX to 30 June 20XX, DCo1 will distribute amounts to its shareholder DTT1, which will make a minor beneficiary presently entitled to franked income each year. The minor beneficiary is not an excepted person.

Each beneficiary is an eligible beneficiary in accordance with A's late parent's wills and are also within the same family group for the purposes of the family trust elections, where A is the specified individual.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 6AA

Income Tax Assessment Act 1936 subsection 102AA(1)

Income Tax Assessment Act 1936 section 102AC

Income Tax Assessment Act 1936 subsection 102AC(2)

Income Tax Assessment Act 1936 section 102AG

Income Tax Assessment Act 1936 subsection 102AG(1)

Income Tax Assessment Act 1936 subsection 102AG(2)

Income Tax Assessment Act 1936 paragraph 102AG(2)(a)

Income Tax Assessment Act 1936 subparagraph 102AG(2)(a)(i)

Income Tax Assessment Act 1936 subsection 102AG(2AA)

Income Tax Assessment Act 1936 subsection 102AG(3)

Income Tax Assessment Act 1936 subsection 102AG(4)

Reasons for decision

Division 6AA of the ITAA 1936 was amended by the Treasury Laws Amendment (2019 Measures No. 3) Act 2020 (Cth) to insert subsection 102AG(2AA) into Division 6AA of the ITAA 1936. The amendments apply in relation to assets acquired by, or transferred to, the trustee of a trust estate on or after 1 July 2019. Broadly, the purpose of Division 6AA of the ITAA 1936 is to effectively apply higher rates of tax to income distributions made to prescribed persons. The law amendments seek to apply higher rates of tax where the income was derived from assets unrelated to the relevant deceased estate.

Section 102AC of the ITAA 1936 provides that a person is a prescribed person if that person is less than 18 years of age on the last day of the year of income, and that person is not an excepted person. Subsection 102AC(2) of the ITAA 1936 provides the circumstances in which a person would be deemed to be an excepted person in respect of Division 6AA of the ITAA 1936. In your circumstances, the minor beneficiary will be a prescribed person because that beneficiary will be under the age of 18 as at 30 June 20XX, and the minor beneficiary is not an excepted person because the circumstances described in subsection 102AC(2) of the ITAA 1936 do not apply to them.

Subsection 102AG(1) of the ITAA 1936 provides that where a beneficiary of a trust estate is a prescribed person in relation to a year of income, Division 6AA of the ITAA 1936 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.

Subparagraph 102AG(2)(a)(i) provides that an amount that is included in the assessable income of a trust estate is excepted trust income in relation to a beneficiary of the trust estate, to the extent to which that amount is assessable income, of a kind covered by subsection 102AG(2AA) of the ITAA 1936, of a trust estate that resulted from a will, amongst other things. Subsection 102AG(2AA) of the ITAA 1936 provides that, for the purposes of paragraph 102AG(2)(a), assessable income of a trust estate is of a kind covered by subsection 102AG(2AA) of the ITAA 1936 if the assessable income is derived by the trustee of the trust estate from property; and the property, amongst other things, was transferred to the trustee of the trust estate to benefit the beneficiary from the estate of the deceased person concerned, as a result of a will.

The meaning of the phrase "a trust estate that resulted from a will..." is explained in The Trustee for the Estate of the Late AW Furse No. 5 Will Trust v Federal Commissioner of Taxation [1990] 21 ATR 1123; 91 ATC 4007. It was explained at page 4018 that "all that is necessary to fall within sec. 102AG(2)(a) is that the assessable income be assessable income of the trust estate, that trust estate being one of the forms of trust estate referred to in sec. 102AG(2)(a)(i) or (ii) (that is to say not an inter vivos trust)."

The testamentary trusts established by the wills of A's the parents primarily exist to hold assets for the benefit of A and A's children. The trusts, being "trusts that resulted from a will" satisfy subparagraph 102AG(2)(a)(i) of the ITAA 1936. Therefore, an amount included in the assessable income of such a trust is excepted trust income for the purposes of section 102AG(2) of the ITAA 1936.

In your circumstances, DTT1 arose out of the will of A's late parent. Dividends received by DTT1 from DCo1 will be excepted trust income because the requirements of subsection 102AG(2AA) of the ITAA 1936 are satisfied. The requirements of subsection 102AG(2AA) are satisfied because the dividends received from DCo1 will be assessable income derived by DTT1 from property, being shares in DCo1. Property is defined in subsection 102AA(1) of the ITAA 1936 to mean property whether real or personal, and includes money. The shares in DCo1 are acquired by DTT1 investing part of the property transferred from the deceased estate of A's late parent. The shares are not externally injected into the family group and are not unrelated to the deceased estate of A's late parent. There is a connection between the shares in DCo1 from which the dividend is derived, and the deceased estate of A's late parent that gave rise to DTT1.

In other words, assessable income of a trust estate will be of a kind covered by subsection 102AG(2AA) of the ITAA 1936 if the income is derived from trust property which was transferred to the trust that benefits the beneficiary, and was transferred from the estate of the deceased person concerned, and subsections 102AG(3) and 102AG(4) of the ITAA 1936 do not apply to the arrangement.