Problem with the existing provisions
Unfortunately, a shortcoming has been identified in the way in which the provisions are worded that has resulted in a perceived loophole. This flaw can potentially allow the concessions to be exploited in a way that is not intended to be available.
Specifically, if an asset is injected (e.g., transferred or loaned) into a testamentary trust, the assessable income derived from that ‘injected asset’ would also get the benefit of being excepted assessable income, even though the asset was not directed by the Will of the deceased to be held by the testamentary trust.
Division 6AA is currently safeguarded by two anti-avoidance provisions within S.102AG, which are, broadly, as follows:
- If any two or more parties to any act or transaction directly or indirectly connected with the derivation of excepted assessable income were not dealing at arm’s length (e.g., the testamentary trust receives above-market rent from a related party for a rental property), only the amount that would have been derived from an arm’s length dealing is excepted assessable income. Refer to S.102AG(3).
- If any assessable income derived directly or indirectly as a result of an agreement or scheme entered into for the purpose (other than an incidental purpose) of securing that assessable income would be excepted assessable income (e.g., a discretionary trust distributes income to the testamentary trust), then that assessable income will not be excepted assessable income. Refer to S.102AG(4).
Consequently, if an asset was transferred to a testamentary trust for less than its market value (i.e., for non-arm’s length consideration), the assessable income derived from that asset would likely attract the operation of S.102AG(3). In which case, whilst the assessable income derived (e.g., rent or dividends) may be arm’s length amounts, it may be the case that if the testamentary trust and the transferor dealt at arm’s length, that no asset would have been transferred at all. If no asset was transferred, then no assessable income would be derived, meaning that none of the assessable income derived from the asset will be excepted assessable income.
It would appear that these existing anti-avoidance provisions may apply to inappropriate injections of assets into a testamentary trust, thereby preventing the identified loophole from being exploited. However, despite this, the Government proposes to introduce a new integrity measure to put this beyond doubt.