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CMT excepted income is what a child maintenance trust is all about. If you don’t have excepted income, then there is little point in having a CMT.
CMT Excepted Income
When you try to optimise child support, you will almost certainly come across child maintenance trusts. They are complex and not as prevalent as you would think, but still very useful to reduce tax.
We have done two episodes about child maintenance trusts before – the first one in ep 309 with Simon Bacon and the second one in ep 314 with Patrick Huang.
In this episode and the following three (ep 387B, 388 and 389) let’s do a four-part mini-series about the excepted income of CMTs with Patrick Ellwood of Clover Law in Brisbane. 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.
CMT Excepted Income
In this (and next episode) let’s go through the excepted income in child maintenance trusts as per s102 AG and AE. Because in the end, this is what it is all about. When is CMT income ‘excepted’ and when not?
Usually, children pay penalty income tax rates. Unless the income is excepted income. So a child maintenance trust is all about getting CMT excepted income into the children’s tax returns.
s102 AG and AE
The tax savings from a child maintenance trust depend on whether the income received by the trust qualifies as excepted income under Subdiv 102 AG and 102 AE.
If it does NOT qualify, you apply penalty tax rates under Div 6AA ITAA 1936 to the income distributed to the children. Just like any other passive income that is paid to minors and doesn’t qualify as excepted income.
But if the income DOES qualify as excepted income, then this income is taxed at adult tax rates, saving you a lot of tax since your children usually have lower marginal tax rates than you do.
So whether the income within a child maintenance trust is excepted or not, is the all-deciding question.
The answer starts with s102 AG and 102 AE of ITAA 36. Or more specific s102 AG (2) (c ) (viii) and AE (2) (b) (viii). These two will determine whether the child maintenance trust saves you tax or not. They will tell you whether the income the trust receives qualifies as excepted income or not.
s102 AG (2) (c ) (viii)
Here is what s102 AG (c ) (viii) says,
“….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 [*]).”
*s102AGA is actually very interesting because it goes into quite a bit of detail about what needs to happen to actually have a family breakdown.
Why does s102 AG Matter?
Why is there so much fuss about s102 AG? You need s102AG to determine whether the income distributed to the children qualifies.
s102AG is the rule book around this. If you don’t meet the conditions, the income is taxed at penalty tax rates under Div 6AA ITAA 1936, similar to any other passive income paid to minors.
Why a CMT
Why a CMT and not just a ‘normal’ discretionary or unit trust?
If you move assets into a discretionary trust (DT) or unit trust (UT) and then distribute the income to children, they pay penalty rates under Div 6AA ITAA36. But if you move assets into a CMT, they pay normal adult tax rates.
That is what this is all about.
BUT…. they only pay normal adult tax rates, if the income qualifies as excepted income. So the big question for a CMT is whether its income qualifies as excepted income.
Taxpayer changes in a CMT
When children and/or spouses receive child support directly from the father, they receive these payments as exempt income per s51-50 ITAA97. The father already paid tax on that income, i.e. he pays the child support out of his after-tax income.
But when children receive payments from a CMT, they pay tax on these payments via the trustee. The father pays no tax on these payments (but of course the original contribution to the CMT was made out of after-tax income).
Who declares the excepted trust income?
Usually, a trust just files a trust tax return, lists all beneficiaries – by name and tax file number – who received trust income and lists how much they received.
The beneficiaries then declare this trust income in their tax return and pay tax on it. The trustee has nothing to do with their payment of tax. But of course, you already know all this.
And you already know that this changes when the distribution is to a non-resident or a minor. Then the trustee is the one who organises the payment of tax.
The big difference between non-residents and minor children is, that the withholding rules do not apply to minor children in closely held trusts, which a CMT is.
So if this is the case, who pays the tax?
For that let’s look at four rules that wrap around this question.
1 – The trustee should receive reimbursement from the trust for any tax the trustee paid
Any trustee has a right to reimbursement through the trust. That is a general right as per Trust Act. The Trust Act gives the trustee a general right to be indemnified out of trust assets for any expenses they incur.
That general right is usually supplemented by an express right contained in the relevant trust deed. So while not necessary, most modern trust deeds give the trustee the right to be indemnified as well.
For a CMT this means, that the trustee can use CMT assets to pay the children’s tax debt. In other words, the dad can use CMT assets to pay his children’s income tax.
2 – Minor beneficiaries don’t need to lodge a tax return if they have no other income.
If minor beneficiaries don’t have any other income apart from the relevant trust distribution, then they don’t need to lodge a tax return. The trustee already took care of their tax obligations by declaring their income as assessed to the trustee and paying the tax on it.
But if minor beneficiaries have other income, then they need to lodge a tax return, including the other income as well as trust distributions, and receive a credit for the tax the trustee already paid.
So applying this to a CMT, if the children receive CMT income and nothing else, then they don’t have to lodge a tax return.
But if the children DO have other income, then they need to lodge a tax return listing this other income plus the CMT income and receive a credit for the tax their father already paid.
3 – No TFN withholding rules on distributions to minors in a CMT
So now it will get complicated. Usually, the trustee has to withhold tax at 47% (including Medicare) if an individual beneficiary does not provide their TFN. But these TFN withholding rules don’t apply if the beneficiary is a minor. And the trust is a closely held trust.
And as you will see below, these apply to a CMT, hence the TFN withholding rules don’t apply to a CMT.
A – Is a CMT a closely held trust?
YES: A closely held trust is a unit trust where 20 or fewer individuals hold 75% or more of the units, OR a discretionary trust, unless it is an excluded trust.
A CMT is a discretionary trust, hence it is a closely held trust unless it is an excluded trust.
B – Is a CMT an ‘excluded trust’ for the definition of closely held trust?
YES: A CMT is not an excluded trust.
C – Are the beneficiaries of a CMT excluded beneficiaries for the TFN withholding rules?
Minors are excluded beneficiaries for the TFN withholding rules.
So that means the TFN withholding rules don’t apply to minors as beneficiaries of a CMT.
So now we come to the big question. If there is no withholding for minors in a closely held trust, who pays the tax?
4 – The trustee has the option to withhold or pay the tax directly and indemnify
A CMT will generally be a closely held trust and the TFN withholding rules won’t apply to distributions from a CMT to minors. However, the trustee is still responsible for paying tax on the distributions to the minors for a CMT (pursuant to s102AG rather than the TFN withholding rules).
The second question then is whether the distribution to the minor includes or excludes the tax component.
This hinges on what the trust deed and distribution resolutions actually say and get us into Bamford territory – exploring the interaction between s97, s99 and s99A in respect of liability for tax on trust distributions / accumulations.
5 – The deed usually prescribes payment of the net post-tax amount
For a CMT, the trust deed and distribution resolutions usually state that the child only receives the net benefit of the distribution
Example
Let’s say the income is AUD 100,000 for two children together and the income tax is AUD 7,000 per child (since excepted income).
In that case, the resolutions would usually be drafted to allow the trustee to pay the AUD 14k tax out of the AUD 100k of income, leaving a net payment to the children of AUD 86k.
So to make this simple: The trust deed should state that the trustee is to withhold tax even though the TFN withholding rules don’t apply.
Private Rulings
The ATO has an entire web page about applying for a private ruling regarding the income from a child maintenance trust. Private rulings clearly play a big role for CMTs.
Information Required for a Private Ruling
The ATO notes that for a private ruling, they need a copy of the trust deed plus amendments as well as copies of any relevant court orders and maintenance agreements. That is not a lot but keep in mind that
A – the ATO already got all lodged tax returns, and
B – if you want to obtain clarity about the treatment of income, you have to explain the income. The ruling doesn’t apply to facts and circumstances not listed in the application.
PR v ABA?
You can only apply for a private ruling (PR) if you have already established the CMT. So if you don’t have a CMT yet, you apply for administratively binding advice (ABA).
The PR form includes a tick box for an ABA.
Together against the ATO
With child support agreements not involving a CMT, the parents are alone.
With child support arrangements, it is one parent against the other, with Services Australia facilitating the calculation and collection.
There is possibly Family Tax Benefit A but otherwise no interest from the ATO (unless there is tax fraud or evasion).
But with child support agreements involving a CMT, it is both parents together against the ATO. Because both stand to gain if the CMT works and they (and their children) share the benefits of the CMT. And the ATO very much stands to lose if the CMT goes through. Hence the ATO focuses on CMTs since that is attacking its tax revenue.
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And so this is what we covered in Part A. The episode was too long (over 60 minutes), hence we cut it into two parts. So you will find the remaining questions # 8 to # 15 in Episode 387 Part B.
Summary
The big ah-ha moment in this episode is the advice around withholding. Yes, in theory, the TFN withholding rules might not apply – but then again they might – but either way, just make sure that the trust deed stipulates that the trustee can withhold the tax from any distributions.
This is only a very short extract of some of the points we discuss. Please listen to the episode since we go into a lot more detail.
In the next episode 387 B we will cover the remaining eight questions. We will talk about:
- How 102 AG and AE work hand in hand.
- Whether you need to worry about excepted income for an excepted person
- And then s51-50 ITAA97. This is an important section for all child support payments that paid directly and not through a CMT.
- Question #12 is a big one where Patrick Ellwood will discuss with you what happens when all goes wrong.
- After that, we’ll cover UPEs in CMTs and how s100A comes in.
- And then last but not least Patrick Ellwood will talk with you about when a CMT vest. When can the children demand a payout of the CMT’s capital? And how can you postpone that?
So that is the plan for episode 387 B, again with Patrick Ellwood of Clover Law in Brisbane.
MORE
Child Maintenance Trust Questions
Disclaimer: Tax Talks does not provide financial or tax advice. All information on Tax Talks is of a general nature only and might no longer be up to date or correct. You should seek professional accredited tax and financial advice when considering whether the information is suitable to your or your client’s circumstances.
Last Updated on 23 October 2023
Tax Talks spoke to Patrick Ellwood - Director at Clover Law - for more details.
