Child maintenance trust income – this is the second part of our interview about the excepted income in child maintenance trusts.
Child Maintenance Trust Income
In this episode, Patrick Ellwood of Clover Law in Brisbane will give you answers to questions # 8 to # 15 in our list of questions.
Here is what we learned but please listen in as Patrick explains all this much better than we ever could.
To listen while you drive, walk or work, just access the episode through a free podcast app on your mobile phone.
Child Maintenance Trust Income
In the last episode, Patrick Ellwood of Clover Law in Brisbane covered seven questions with you about the excepted income in Child Maintenance Trusts.
In this episode, let’s look at the remaining eight questions.
8 – 102AG(2)(c)(viii) of the Income Tax Assessment Act 1936
The dispute with the ATO and the focal point of TR 98/4 is all about s102AG. Does 102AG(2)(c)(viii) of the Income Tax Assessment Act 1936 exclude CMT income as excepted income?
That is the question everything depends on. Because excepted trust income is not taxed at penalty rates under Div 6AA ITAA36. That is what it is all about.
s102AG:
“(2) ….an amount included in the assessable income of a trust estate is excepted trust income in relation to a beneficiary of the trust estate to the extent to which the amount:….(c) is derived by the trustee of the trust estate from the investment of any property transferred to the trustee for the benefit of the beneficiary:….(viii) as the result of a family breakdown (see section 102AGA).”
9 – 102AE(2)(b)(viii) of the Income Tax Assessment Act 1936
The companion to s102AG(2)(c)(viii) is s102AE(2)(b)(viii). AG is about the trust, AE is about the beneficiary’s individual tax.
“(2) …an amount included in the assessable income of a person (in this subsection referred to as the minor ) is excepted assessable income to the extent to which the amount:…..(b) is derived by the minor from the investment of any property transferred to the minor;….(viii) as the result of a family breakdown (see section 102AGA)”
If the income is excepted under 102AG, then it is also excepted under s102AE. The two go hand in hand. You can’t have one without the other.
10 – No issue if Excepted Persons
The children could be excepted persons under s102AC ITAA1936, ie children in full-time employment, minors with a disability or double minor orphans.
If that is the case, ie if the beneficiaries of the CMT are excepted persons, then you don’t need to worry about whether the income is excepted or not. The person is excepted anyway.
So the whole question of whether CMT income is excepted is only relevant when the beneficiary children are not excepted persons.
11 – s51-50 (1) and (2) ITAA97
s51-50 is about child support payments outside of a CMT. When one parent pays child support to the other parent, that payment is exempt income per s51-50.
12 – s51-50 (3) ITAA97
Para. 3 says:
“(3) The maintenance payment is not exempt if, in order to make it or a payment to which it is attributable, the maintenance payer:
(a) divested any income-producing assets; or
(b) diverted * ordinary income or * statutory income upon which the maintenance payer would otherwise have been liable to income tax.”
(b) makes sense. If you ask your family trust to pay AUD10k to your spouse to meet your child support obligations, then that AUD 10k is not exempt.
But what about (a)? Why is (a) an issue? This is about when the family trust transfers assets directly into the CMT. That is a taxing point. So the family trust pays capital gains tax on the transfer.
13 – When all goes wrong
The trustee declares the income on behalf of the children and pays tax on it using adult tax rates. As outlined in para. 7, TR 98/4,
“Amounts qualifying as excepted trust income are assessable to the trustee and are taxed at normal rates.”
If the children do lodge a tax return, since for example, they have other income as well, then the children do declare the CMT income and receive a credit for the tax the trustee already paid on their behalf.
Para. 8, TR 98/4 describes this like this,
“If the amounts are included in the income of the child, under section 97 or 100 (that is, where the child is not under a legal disability or derives income from other sources, respectively), they are excepted assessable income under paragraph 102AE(2)(e) and likewise subject to tax at normal rates in the hands of the child.”
Process Doesn’t Change
The process doesn’t change. If the trust qualifies as a closely held trust and TFN withholding rules don’t apply, then it depends on what the deed says. Usually, it says that the trust can withhold the tax so the trustee would just pay out the net amount to the children. As discussed last week in question # 3.
And if the trust deed doesn’t say that and the TFN withholding rules don’t apply, then the trustee can pay out the full amount and they reimbursed the trustee by the trust assets. Although there might be a circular reference, so it is best practice to have the trustee withhold the tax.
But what if the trustee, so the father usually, thought the trust would qualify as a CMT, he didn’t get a private ruling or ABA, and suddenly the ATO has done a review and it is all falling apart and the ATO is assessing the income at Div 6AA penalty rates.
But the trustee has already paid out the income and just withheld tax at the lower adult tax rate. What then?
We didn’t check this with Patrick Ellwood, but our gut feeling is that the trustee then pays the tax and the trust then reimburses the trustee through the trust assets.
14 – Is a CMT a discretionary trust?
In our show notes for ep 314, we say that the CMT is a fixed trust since the trustee usually has no discretion on how to distribute the income or capital.
But then lots of people on the internet say it is a discretionary trust and then Patrick seems to say it can be one or the other depending on how many children there are.
So we emailed Patrick and asked,
“So a CMT for one child is a fixed trust, since no discretion, that one child received all income and all capital eventually. And if the CMT is for two children or more it is a discretionary trust since while the children received all income and all capital, there is discretion on who exactly gets what. Is that what you are saying?”
Fixed or Hybrid Trust
And so Patrick kindly wrote back with the following.
“In respect of the fixed/discretionary trust element – if there is a single beneficiary then yes it is a fixed trust.
If there are two or more beneficiaries then they would have a fixed entitlement to capital but they can either draft the income entitlement to be fixed or discretionary. If it is discretionary then we effectively have a hybrid trust where we preserve the capital for the children in fixed proportions but the trustee can vary the distributions of income between the children each year. I’d say it is more common just to have it as a fixed trust though.”
So that means a CMT is either a fixed trust or a hybrid trust. So not a discretionary trust how many people are saying on the internet.
One result of this is that as a fixed or hybrid trust, the CMT would not be a closely held trust (since not a unit trust or a discretionary trust) and hence the TFN withholding rules would apply.
15- Unpaid present entitlements
In para. 7, TR 98/4 says,
“… include both undistributed income to which the minor beneficiary of the CMT is presently entitled and income that the trustee has paid to or for the benefit of the minor beneficiary..”
So a CMT can have UPEs. The issue with UPEs in trusts – and so also in CMTs – is s100A. However, it doesn’t happen often that a CMT has a UPE. All income is usually paid out.
If that income is higher than the agreed child support, then you can have a tally sheet. This tally sheet would then track overpayments and then offset against shortfalls in other years. Simon Bacon discusses this in his episode with you.
Because remember that a child support agreement usually includes a clause that if the payments from the CMT fall under a certain amount, the father has to top up his support with direct payments.
Family Tax Benefit
One topic we didn’t cover is the Family Tax Benefit. Since the child maintenance trust distributions go to the children and not the mother, does it affect the mother’s Family Tax Benefit?
As you remember both the Family Tax Benefits A and B are income tested and they include child support. So once child support reaches a certain level, the parent loses first Family Tax Benefit A and then B.
But possibly not when that child support is coming through a child maintenance trust. Because then the payments are going directly to the children, so have nothing to do with the mother.
So that – in theory – would be another benefit of having a CMT. However, the additional costs in accountant and lawyer fees to set up and run a CMT usually outweigh the payments you get under the Family Tax Benefit. So you wouldn’t set up a CMT just to keep your family tax benefits.
However, we will ask Simon Bacon this question in episodes 390 and 391. And the answer is very different to what we suggest here.
In the next episode, episode 388, let’s focus on TR 98/4. In TR 98/4 the ATO discusses five situations involving child maintenance trusts that will make CMT income non-excepted income. So let’s go through those situations in the next two episodes.
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Child Maintenance Trust Questions
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