Background to the tax concessions for minors
Broadly speaking, income derived by a minor (i.e., a person under the age of 18 at the end of the relevant income year) is taxed at penalty rates in accordance with Division 6AA. This includes income derived directly by the minor, as well as income distributed to the minor from a trust (including a testamentary trust). This is designed to discourage taxpayers from splitting income amongst their children and grandchildren in order to minimise tax.
Despite the general proposition that a minor’s income is taxed at penalty rates, there are two important exceptions to this rule, being:
- Where the minor is an ‘excepted person’ (which includes minors that are engaged in full-time occupation on the last day of the income year, or who suffer from a disability) – refer to S.102AC.
- Where the income received by (or distributed to) the minor is ‘excepted income’ (or ‘excepted trust income’) – refer to S.102AE and S.102AG respectively.
In the context of testamentary trusts, where the trust income distributed to the minor qualifies as ‘excepted trust income’, significant tax planning opportunities can be achieved for testators with minor children and/or grandchildren, as excepted trust income is generally taxed at ordinary resident adult tax rates (i.e., the penalty rates of tax will not apply).
Specifically, S.102AG(2)(a) provides that an amount included in the assessable income of a trust is ‘excepted trust income’ in relation to a beneficiary to the extent to which the amount is assessable income of a trust estate that resulted from:
- a Will, codicil or a court order that varied or modified the provisions of a Will or codicil; or
- an intestacy or a court order that varied or modified the application, in relation to the deceased estate, of the provisions of the law relating to the distribution of the estates of persons who died intestate.
In other words, as long as the trust that derived the income resulted from the Will, all the assessable income of the trust in relation to a minor beneficiary will be ‘excepted trust income’, in which case the penalty rates in Division 6AA will not apply. By its very nature, a testamentary trust will be a trust that resulted from a Will, therefore, in determining the tax payable (if any) on the minor beneficiary’s share of the trust’s net (taxable) income, the resident adult tax rates will apply.
TAX TIP – Division 6AA exception for testamentary trusts
By design, the concession in S.102AG(2)(a) is intended to apply for a testamentary trust where one or more assets owned by the deceased is directed by their Will to be held as part of the testamentary trust.
Where this is the case, all of the assessable income generated by those assets will be excepted trust income. In addition, if the assessable income derived from those assets is used to generate further assessable income in a later income year (i.e., the earnings on earnings), that assessable income will also be excepted assessable income.
In the event that such an asset is sold, and the proceeds are re-invested in another asset, the assessable income derived from that other asset will also be excepted assessable income (i.e., it does not matter that the other asset was not owned by the deceased).