Legal Tip 191: Testamentary Trusts and Bucket Companies

Discussion in 'Wills & Estate Planning' started by Terry_w, 4th Feb, 2019.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Testamentary Trusts and Bucket Companies

    It is possible to incorporate the bucket company strategy with a testamentary discretionary trust.

    I have described the bucket company strategy here :

    Tax Tip 108: Using Bucket Companies to Save Tax Tax Tip 108: Using Bucket Companies to Save Tax

    And Testamentary trusts here:

    Legal Tip 9: What is a Testamentary Discretionary Trust? Legal Tip 9: What is a Testamentary Discretionary Trust?


    Not many realise that the bucket company strategy can also work well with testamentary discretionary trusts as well. The company can be set up many years after the death as long as the definitions of the beneficiaries allows for it to be a beneficiary it can then receive income.


    Example
    Bart’s parents die in an accident and they leave $2mil to the trustee of a testamentary discretionary trust set up under their will. Bart is the appointor of the trust and a primary beneficiary of the trust as is any company in which he is a director.


    Bart is single and has no kids and he is earning $200,000 pa from his employment which he will continue.

    Ideally, he wants the have the trust invest the money and the income go to a company as the company would be taxed at just 30% whereas he would be taxed at 47%. He has read my tip on the effect that tax has on compounding* and knows this will make a significant difference. So, Bart sets up a company with himself as director and the shares held by a discretionary trust trustee and has the testamentary trust divert income to the company with the company lending money back to the TDT or another discretionary trust.



    To see how much effect tax can have on compounding see:

    * Tax Tip 154: The effect Tax has Compounding of investments Tax Tip 154:The effect Tax has on Compounding of investments
     
  2. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    I recently saw a disc trust deed which excluded beneficiaries who were not a direct lineal descendant. Strangely the deed applied far more onerous tests on other entities and provided those other entities had other parties involved it in the past excluded them now.

    And the amendment rules did not allow changes to this descendants clause.

    I referred them on to a trusts lawyer to advise on this matter and their response who simple - The spouse company cannot be a beneficiary as her former husband (long divorced) is a former shareholder. However their advice did suggest that a new trust could be formed as beneficiary of the problem trust (provided it limited its perpetuity period to less than that of the problem trust) and that it could distribute to the spouse company and that was not a breach of terms of the trust. However it did not address the 2018 tax year income since at 30 June 2018 that trust did not exist.

    Apparently many lineal trust clauses contain this weakness They limit some distributions but they still can be bypassed.
     
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  3. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    I advise clients who want only blood descendant beneficiaries to consider the consequences and to reconsider the problems that can arise like this.
     
  4. Trainee

    Trainee Well-Known Member

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    Terry once distributed to the bucket company, does the income lose its minor taxed as adult nature? Ie future dividends from the company distributed to minors would be ordinary income.
     
  5. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Probably it would. I.e dividends would not be excepted trust income.

    That's why children should be considered before bucket companies as beneficiaries.
     
  6. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    I was thinking.
    The will of the deceased could have instructed the executor to set up a second testamentary trust and set up a company with the shares of this company held by the second trust.
    This could be a way to get the bucket company income to come out as excepted trust income.

    Seek legal advice for this untested theory.
     
  7. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    For tax purposes the tax charecter of trust income is unimportant as excepted income applies to each type of income based on charecter eg cgt amounts, foreign, franked distributions.

    When a TT produces income its necessary how much of its trust income came from the deceased and how much was injected after. Lets assume that is $0 injected after. So 100% of TT income would arise from a deceased estate and be excepted income to a minor providing the trust distributes.

    Your income if you are under 18 years old

    Interposing a new corporate beneficiary may fail as it was not the property of the deceased. Ensuring the shares in BucketCo are held as TT trust assets may be all that is required. A second trust may have some merits. However if the company accumulates further income rather than distributing by way of dividends it may affect the % of TT income that is excepted.

    Companies make poor vehicles for excepted income sources after the 2019 changes. These rules basically force income to be paid out and not reinvested and accumulated. The examples in the link above - Consider these if a company was a party.
     
  8. Trainee

    Trainee Well-Known Member

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    So the will might say allow creation of a discretionary testamentary trust and specifically state also create company ABC, all shares to be owned by the trust. Then in effect the testamentary trust can retain income that keep its TT nature?
     
  9. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    A trust shouldn't own shares in a company which it pays income to. So the will should set up a second trust. If the trustee of this trust starts a company, perhaps as directed by the will, then this company could hold income from the first trust. Then this company could later pay a dividend to the second trust and out to minor beneficiaries at adult tax rates - in theory
     
  10. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    No. That portion would not be excepted income. A TT since 2019 cant accumulate non death asset income. This includes accumulation of income aftre death. This doesnt mean that a child will be impacted. They could be. Hmmm thinking about that comment its not quite right. If atrust accumulated income then distributed toa child some of the child income would be nonexcepted and then the trustee is taxed on that % of income, rather than the child.

    TTs cant accumulate income any more. And retain full concessions for excepted income. Its a prortionionate reduction. Is it material ? However it does compound progressively
     
    Last edited: 21st Aug, 2020

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