Private ruling: Excepted trust income
Date of advice: 14 April 2016
Published: June 2016
Ruling period: Year ended 30 June 2025
Date scheme commenced: 1 July 2016

Ruling: Q1: Will the child maintenance trust (CMT) satisfy the conditions set out at subparagraph 102AG(2)(c)(viii) of the Income Tax Assessment Act 1936 (ITAA 1936)? | A1: No. | Q2: Will income from the CMT distributed to the children be excepted trust income under subsection 102AG(2) of the ITAA 1936? | A2: No.

Relevant facts and circumstances: A and B were married and had two children C and D. A and B are now divorced and they do not expect to live together again on a genuine domestic basis. Consent orders were made by the family court which obligated A to pay child support for both children. A proposes the creation of a Child Maintenance Trust (CMT) for the benefit of the children. The trustee of the trust will be an incorporated company. A proposes to transfer cash into the CMT and that cash will be used by the trustee to invest in the purchase of units in a unit trust. The unit trust will supply services to a business which is 50% owned by A.

Relevant legislative provisions: Division 6AA of the Income Tax Assessment Act 1936 | Subsection 102AC(1) of the Income Tax Assessment Act 1936 | Subsection 102AC(2) of the Income Tax Assessment Act 1936 | Section 102AG of the Income Tax Assessment Act 1936 | Subsection 102AG(2) of the Income Tax Assessment Act 1936 | Subparagraph 102AG(2)(c)(viii) of the Income Tax Assessment Act 1936

Reasons for decision: Summary: Division 6AA of the Income Tax Assessment Act 1936 (ITAA 1936) ensures that special rates of tax and a lower tax free threshold apply in working out the basic income tax liability on taxable income, other than excepted income, derived by a prescribed person. A prescribed person is defined in subsection 102AC(1) of the ITAA 1936 to include any person, other than an excepted person (as defined in subsection 102AC(2) of the ITAA 1936), who is under 18 years of age on the last day of the income year. In this case, both C and D are under 18 years of age, and are a prescribed person for the purposes of subsection 102AC(1) of the ITAA 1936. Where the beneficiary of a trust is a prescribed person, Division 6AA of the ITAA 1936 will apply to so much of the beneficiary's share of the net income of the trust that is not excepted trust income (subsection 102AG(1) of the ITAA 1936). Subsection 102AG(2) of the ITAA 1936 lists the various types of income of a trust estate which are excepted trust income in relation to the beneficiary of the trust estate. Assessable income derived by the trustee of the trust estate from the investment of any property transferred to the trustee for the benefit of the beneficiary as the result of a family breakdown (subparagraph 102AG(2)(c)(viii) of the ITAA 1936). Taxation Ruling 98/4 deals with child maintenance trusts. In particular paragraph 10 of the ruling provides income derived by the trustee of a CMT which is not excepted trust income under subparagraph 102AG(2)(c)(viii) of the ITAA 1936 in any one of these five situations: a) it does not derive from the investment of property transferred beneficially to the child (situation 1); b) it does not derive from the investment of property at all by the trustee (situation 2); c) the property has not been transferred beneficially to the child as the result of a family breakdown (situation 3); d) it derives from the investment of property, but exceeds an arm's length return on the investment of the property (situation 4); or e) it is derived as a result of an agreement entered into or carried out to secure the assessable income as excepted trust income (situation 5). In situation 1, income does not derive from the investment of property transferred beneficially to the child where, under terms of the trust, the child will not acquire the trust property, or will acquire it only as trustee, when the trust ends. Express provisions reinforce this rule with effect for income derived on or after 7 March 1994. Examples include cases where: • no property is transferred to the trustee; • the trust property will or may (perhaps as a matter of discretion) go to someone other than the child; and • the trustee is denied any power to deal with the property in the interests of the child. Parargraph 37 of TR 98/4 states: Subparagraph 102AG(2)(c)(viii) of the ITAA 1936 has the same effect whether income was derived before or after 7 March 1994. Any child who is the beneficiary of a CMT arrangement must derive income from the investment of property transferred beneficially to that child. The child must have an absolute vested interest in the property from the inception of the trust. Where several children are beneficiaries of the same CMT, each child must have an absolute beneficial interest in its own part of the trust property. That part of the trust property is the child's and must form part of the child's estate in the event of the child's death before the trust ends. If part of a child's share of a trust is advanced to the child during the trust, then that child's property is reduced and so is the capacity of the trust to produce excepted income of that child. In this case, as per the trust deed, the trustee has the discretion to sell the original asset, to which the beneficiary is entitled, and replace it with another asset which the beneficiary might not be entitled. Therefore, each beneficiary does not have an absolute vested interest in the property from the inception of the trust. The arrangement would fall under situation 1 of TR 98/4 as the trust property will or may (perhaps as a matter of discretion) go to someone other than the child. Accordingly, income derived by the trustee of the CMT will not be excepted trust income under subparagraph 102AG(2)(c)(viii) of the ITAA 1936. In this case, the trust does not meet the any of the requirements in subsection 102AG(2) of the ITAA 1936. Therefore, any income derived by the trustee of the CMT is not excepted trust income and will be taxed at the highest marginal rates.