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Budget breaks put the trust back in testamentary trusts

Author: Graeme Heckenberg from Heckenberg Associates Solicitors

In the recent 2006-07 Federal Budget, Federal Treasurer Peter Costello announced the Government would exclude certain income beneficiaries of testamentary trusts from the “franking credit” holding period rules, with effect from 1 July 2002.

This means the Government has amended the income tax law to allow income beneficiaries of testamentary trusts (such as life tenants) greater access to franking credits on dividends received by the trust.

Under the franking credit holding period rules, franking credits and associated tax offsets are not available to taxpayers who have not held shares at risk for more than 45 days.

According to Assistant Treasurer Peter Dutton, this means:

• Beneficiaries, who have a vested interest in the dividend income of the testamentary trust but not the current beneficial ownership of the underlying shares, will be excluded from the franking credit holding period rules.
• The amendment will not apply to income beneficiaries who make related payments in respect of trust distributions.

Mr Dutton said transitional arrangements would be developed to give trustees who have made family trust elections, an opportunity to revoke those elections where they were made primarily for the purposes of obtaining franking credits and associated tax offsets.

So what are testamentary trusts and why are they established under wills? 

A "trust" is where one person holds the legal title of property for the benefit of another person. A "trustee" is the person who takes the ownership in "trust" for another person, known as the "beneficiary". "Testamentary" is a legal term meaning that which relates to the making of a will.

Putting all these terms together, a “testamentary trust” is a trust created by a will to appoint a trustee to use property for the benefit of the beneficiary according to the terms specified in the will. However, it does not come into effect until after the death of the person making the will.

From an estate planning perspective, testamentary trusts offer flexibility and significant long-term financial protection. This is because a testamentary trust has two significant advantages for a will maker and the nominated beneficiaries:

• Significant taxation advantages; and
• Protection of the bequeathed assets from any financial or other difficulties that beneficiaries may suffer.

Tax breaks through “income splitting”

One of the most essential features of testamentary trusts is the opportunity for tax savings as a result of the concessional tax rates afforded to them.

With the use of a testamentary trust, the deceased’s assets can be distributed or “split” across one or more of the beneficiaries of the trust under the age of 18, in a manner that allows these beneficiaries to have the benefit of adult income tax marginal rate scales, as opposed to the usual penal rates that apply to such income.

Flexibility and long-term financial security

A properly structured testamentary trust tailored to your needs, can ensure that income tax is effectively distributed to your children or even children’s children. This flexibility means the trust allows you to have influence over the assets for a period beyond that usually available.

Furthermore, a testamentary trust offers long-term control and protection of financial assets. This is because testamentary trust shifts control over assets from beneficiaries, who may overspend, make ill-advised investments or misuse the funds, to an “independent trustee” who has professional investment expertise. The funds can then be distributed once the beneficiaries have reached a certain age.

What should I consider before establishing a Testamentary Trust under my will?

A testamentary trust will protect your bequeathed assets. However, a well-prepared trust involves sound professional legal and financial advice, as well as ongoing maintenance costs. The main disadvantages of testamentary trusts result if they are not drawn up skilfully.

Factors that you should consider include:

• Whether the income generated by your estate is sufficient to make the establishment of a testamentary trust worthwhile.
• Any special needs such as a beneficiary with an intellectual impairment.
• The binding effect of a trust upon you and your family, which may bind the beneficiaries to an agreement after relationships have broken down. 

Sometimes family members feel unfairly excluded from the will challenge a testamentary trust in court. If a dispute arises and the beneficiaries can no longer agree, a trust may have to be wound up.

If you are considering setting up a testamentary trust, you should consult a solicitor to ensure that you are aware of all the advantages and disadvantages relevant to your individual circumstances. Speak to us at Heckenberg Associates Solicitors today so that we can help put the trust in your testamentary trust.

www.hecken.com.au