by John Wojtowicz (Director - Law Central Legal)

Testamentary trusts have become, over the last 20 years, ever more popular as a structure used for estate planning purposes. This increase in popularity largely revolves around the asset protection and tax benefits associated with these trusts.

What is a testamentary trust?

A testamentary trust is a trust established under a Will. It usually contains provisions similar to a discretionary trust allowing the trustee of that trust to distribute income and capital to a broad range of beneficiaries.

The testamentary trust only comes into existence once the Will maker has died.

It is possible for a Will to contain more than one testamentary trust (i.e. separate trusts for each child of the Will maker).

Advantages of a testamentary trust

1. Tax Advantages:

   1. income received by a child beneficiary will be taxed at adult rates - section 102AG Income Tax Assessment Act  1936 (Cth) (“ITAA”).

   2. flexibility of distributing income and capital of the testamentary trust.

2. Asset Protection: similar protection afforded to discretionary trusts.

3. Potential protection in family law litigation where a spouse makes a claim for certain family assets being part of the matrimonial pool. (See case study of Bernard v Bernard below).

4. Protecting such part of the estate that is placed into the testamentary trust from wastrel beneficiaries or beneficiaries with substance abuse issues.

Disadvantages of a testamentary trust

1. Control of the assets in the testamentary trust is in the hands of the trustee who may make decisions that are not in line with the beneficiaries’ or the Will maker’s expectations.

2. Added degree of complexity to the estate resulting in additional administration costs – for example tax returns and accounts.

Adding capital to testamentary trust post establishment

The initial property used to establish the testamentary trust comes from the deceased estate pursuant to the terms of the will. Additional property can then be injected into the trust over time which may earn extra income for the trust. The tax treatment of that income (insofar as it relates to minors) was a hot topic of discussion prior to the 2018 Federal Budget announcements.

In our previous 2017 Bulletin (Issue 509) we wrote: “contributing property to a testamentary trust, post its establishment, that derives income may result in the minor not receiving the tax concessions in relation to that income  see s 102AG(3) and s 102AG(4) )”.

Since the 2018 Federal Budget on testamentary trusts, the Government introduced subsection (2AA) into section 102AG of the ITAA. The new rules (which came into force on 1 July 2019) seek to further limit the income that can qualify for concessional tax rates when distributions are made to minor beneficiaries of testamentary trusts.

Now assets unrelated to a deceased estate which are injected into a testamentary trust will not have the income generated or derived from those unrelated assets being treated as “excepted trust income” for the purpose of its tax treatment for minors.

Parties to a testamentary trust

Trustee: person or entity controlling the trust. Has powers (subject to the trust terms) to decide what investments the trust should have as well as determining what income and capital distributions are made to which beneficiaries.

Settlor: unlike a discretionary trust, there is no settlor involved as the bequest made in the Will by the Will maker constitutes the settlement.

Beneficiaries: the beneficiaries will normally include family members, related entities of the Will maker and charities. The beneficiaries do not have any proprietary right in the assets of the trust, only a right to ensure that they are considered and that the trust is administered properly.

Appointor: not an essential requirement to have such a position in the testamentary trust. Usually put in place to allow a mechanism for removing the trustee. The appointor usually has the power to replace the trustee of the testamentary trust and appoint a new one.

The position of the appointor in a testamentary trust, as with a discretionary trust, raises some important issues regarding how their rights and powers are dealt with in the terms of the trust. Platinum and Gold members read on to see commentary on this issue.

Guardian/Controller (optional): the person holding this position normally has a power of veto to block certain decisions of the trustee, for example amending the terms of the trust, capital advancements etc. Some testamentary trust precedents give this power to the Primary Beneficiary or the appointor without the need of having a guardian/controller appointed under the will.

Recent family court decision involving testamentary trust and control of the trust – Bernard v Bernard

In the recent Family Court case of Bernard v Bernard (2019) Fam CA 421 the Court reviewed a testamentary trust to determine whether the assets held in the testamentary trust formed part of the matrimonial pool for division.

The facts in this case were that the husband and his sister each had a testamentary trust established under the will of their late father. Both of them were trustees of each other’s testamentary trust but they were not a beneficiary of the other’s testamentary trust. The husband had no power to appoint and remove trustees. The wife claimed that the assets of the husband’s trust formed part of the matrimonial pool for division. The husband contended that the testamentary trust did not form of the matrimonial pool for division and was only a financial resource.

The Court held that the assets in the husband’s trust should not be included in the matrimonial pool as the husband had no direct or indirect control of the trust.

His Honour, Henderson J, in paragraph 66 of the judgment stated “…. the husband does not have legal title to any asset of the trust, nor does he have any power to appoint a trustee or appoint the assets of the fund to a beneficiary. He is a mere beneficiary, albeit described as a primary beneficiary. The husband is dependent upon the trustee of his trust to distribute income, accumulate income, and the trustee has complete discretion in determining any distributions made by the trust.”

The wife’s lawyers argued (as surmised by the Judge in paragraph 74) that “the reality is the husband and his sister operate their business as a partnership and that their trusts are mirrors of each other” with both the husband and sister “having effective control of the assets in their trusts and therefore those assets are matrimonial property of the husband”. The Judge, in paragraph 81, held that the “facts do not support such a finding”.

The judgment, in paragraph 96, quotes from a decision in Harris v Dewell [2018] Fam CAFC 94: “Control is not sufficient of itself. What is required is control over a person or entity who by reason of the powers contained in the trust deed can obtain or effect the obtaining of a beneficial interest in the property in the trust.”

The case raises the interesting issue of who should control (directly or indirectly via the appointor’s position) a testamentary trust . The particular circumstances of the Will makers’ family will have a large bearing on who should be given the position of appointor of the testamentary trust.

Platinum members should continue reading for further discussion relating to appointors in a testamentary trust.

Disclaimer: The content of this Bulletin is general information only. It is not legal advice. Law Central Legal recommends you seek professional advice before taking any action based on the content of this Bulletin.