Testamentary Discretionary Trusts – Part 2

Our last blog outlined some of the major points about testamentary discretionary trusts.

This blog will address some of the other key features of a testamentary discretionary trust (TDT).

As previously discussed, two of the main benefits of a TDT are asset protection and tax minimisation. You can read more about these benefits here (link Lauren’s blog).

Some of the other benefits of a TDT include the ability to:

  • incorporate the terms of a Special Disability Trust (SDT);
  • defer capital gains tax (CGT) liability;
  • stream capital gains and franked distributions to beneficiaries; and
  • “mere expectancy” asset protection.
  1. Special Disability Trust

A TDT can be drafted to incorporate the terms of an SDT.

One of the major benefits of a SDT is that contributions by immediate family members to the trust do not impact on the mean test concessions for the beneficiary to the extend the contributions do not exceed the total amount which can be gifted to a trust (currently $500,000).  

There are also significant CGT exemptions for any asset donated to a SDT, including the main residence exemption.

If the amount to be distributed to a SDT exceeds the assets test assessment exemption (up to $694,000 indexed 1 July each year) then the balance of funds can be held by a separate TDT.

Incorporating a SDT under a TDT maximises the benefit for a disabled beneficiary. 

  1. CGT Rollover

The assets transferred to a beneficiary pursuant to a Will, will not trigger a CGT event, until the assets are sold or transferred to a third-party. This is referred to as CGT rollover.

The same CGT rollover also applies to an asset transferred to a beneficiary from the Trustee of a TDT.

This position was confirmed by the ATO in Practice Statement LA 2003/12. It states:

The cost base and reduced cost base of the asset in the hands of the beneficiary is calculated in the same way as it would have been if the asset had passed to them from the deceased’s legal personal representative.

The principal place of residence exemption under s 118-195 of the Income Tax Assessment Act 1997 may also apply to beneficiary of a TDT exercising a right of residence granted by the terms of the Will. It is imperative the Will gives each beneficiary a qualified right of residence in relation to property.

  1. Income and Streaming Powers

Provided it is not prevented in the Will, a TDT can stream capital gains and franked dividends.

This is the same as an inter vivos trust, subject to the terms of the TDT.

The benefits of a Trustee’s power to stream were set out by the ATO as follows:

This allows beneficiaries to offset capital gains with their capital losses, apply applicable discounts and, subject to integrity rules, get the benefit of any franking credits attached to a franked distribution.

  1. Asset Protection

Also discussed in our previous blog was the protection that a TDT gives to a beneficiary in the event of a family law claim or bankruptcy.

However, to afford such protection, the testator must be willing to impose strict controls, exclusions and fetters on the terms of the TDT. 

In the Family Law context, the Court has not been inclined to consider the assets in a TDT as matrimonial property, or the financial resources of a party, in circumstances where a beneficiary has a “mere expectancy”.

Factors relevant to considering whether a party has a mere expectancy include:

  • Whether the party is a beneficiary to a trust;
  • The number of beneficiaries in the trust; and
  • History, frequency and value of the distributions made to the party during the operation of the trust.

A key question is whether a beneficiary’s interest in the trust is really “discretionary”.  For this reason, a single testamentary trust controlled by all children arguably provides better asset protection than separate testamentary trusts for each child. This may be worth considering if the prospect of a family law claim against a beneficiary is likely.

To discuss TDTs further, we encourage you to call Elizabeth Ulrick on 07 3317 4311 or email her at elizabeth.ulrick@perspectivelaw.com.