Sent: 08-12-2009 09:20:02
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Testamentary Trusts and Disappearing Capital
Three issues to discuss this week:
a. ATO Interpretative Decision 2009/144
This was released by the Tax Office at the end of November. It covers the tax treatment of a testamentary trust (that is, a trust established as part of a person's Will).
In this case the testamentary trust has a life tenant (who was the deceased's child and an Australian resident for income tax purposes) and remaindermen (the deceased's grandchildren). The trust's purpose was to principally hold shares.
Under the terms of the trust the life tenant was to get all the income distributed from the trust and upon death the grandchildren would receive the capital.
The testamentary trust had made some capital gains and under the terms of the trust these had to remain in the trust whilst the life tenant is alive.
The trustee had not elected to have these gains taxed in the trust.
As a result the taxing point of the capital gains became the income beneficiary of the trust - the life tenant - even though he was not able to benefit from these gains.
Under the tax law, which has applied since 1 July 2005, the trustee could have elected to have these capital gains assessed in the trust if the beneficiary does not have a "does not have a vested and indefeasible interest in trust property representing that share, nor has had such property paid or applied for its benefit."
A time limit applies when this provision has to be activated unless the ATO allows a longer period of time.
In this case the problem occurred during the operation of the trust.
But this type of problem is typical of testamentary trusts. Sometimes the solicitor drafting the Will doesn't know the tax rules well enough and the client's accountant also doesn't know the legal aspects well enough. (There have been examples of lawyers using ignorance of the tax laws as a defence and being knocked down.)
It's left to the "piggy in the middle" which if the client is lucky enough will be an experienced financial planner.
b. The next issue involves an interesting article in the latest edition of the US Financial Planning magazine titled, "Disappearing Act". You should be able to look at this article by going on line and registering on the www.financial-planning.com website.
The article looks at various portfolio constructions for an income stream style product.
It's good research and finds that investment timing is fundamentally important ("extremely sensitive") especially when a high equity component is selected for income paying strategies. I have been arguing this point for a long time and it's always nice to have someone else reach a similar conclusion but coming from a very different angle from my original starting point.
It would appear that the portfolios used in the article have been constructed around a total return approach (income and gains are combined). I have been arguing for a long time that a total return approach does not work for retirement income products but no one seems very keen on getting rid of them.
Will the Henry or Cooper Reviews reach the same conclusions and suggest regulatory reform? We can only hope.
c. Finally please consider purchasing a copy of my book. You can look at the contents page at the following link: http://www.atcbiz.com.au/r.php?r=0mjd6ne
Two options are available - once only subscription - $55 inc GST - or an annual subscription will gives you access to all the updates made throughout the year ($120 inc GST).
The book can be purchased at the following link: http://www.atcbiz.com.au/r.php?r=5a4agqb
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