In September I wrote that testamentary trusts, the trusts created under a will after death, had survived the Government's new 30% minimum tax on discretionary trusts, but that the drafting battle had just begun. The exposure draft pointed one way and its Explanatory Memorandum pointed another. The question was whether the exemption turned on who actually receives distributions from the trust, or on who the will allows to potentially receive it.
We now have the answer. It's the wrong one.
The Treasury Laws Amendment (Tax Reform No. 3) Bill 2026 was introduced on 14 October. The testamentary trust exemption is still there, with the same three conditions: the trust must arise from a will, court order or intestacy; its income must come from estate assets; and, for trusts established on or after 1 July 2028, the beneficiaries must be limited to individuals, tax-exempt entities such as charities, and special disability trusts.
The first two are sensible. On the third condition, the Bill has taken the broader reading. It looks at who the will allows to benefit from the trust, not who actually gets paid.
For decades, lawyers (me included) have drafted testamentary trusts with a wide class of potential beneficiaries. Children and grandchildren, yes, but also their family companies, family trusts and sometimes the estate of a beneficiary who has died. Nobody expected the trustee to use all of them. Indeed, some of them may never even exist. The point was flexibility. If your daughter later runs her business through a company, or sets up a family trust for her own children, the trustee can respond.
The Bill doesn't care whether any of those options are ever used. The Explanatory Memorandum is clear: one ineligible beneficiary in the class of potential beneficiaries costs the whole testamentary trust its exemption, even if it never receives a cent.
Timing makes it worse. A testamentary trust generally comes into existence when assets pass to the trustee after death, not when the will is signed. So a will signed in 2010 by someone who dies in 2030 is judged against a test written in 2026. And once the will-maker has died, the drafting is locked in.
The result is that if the Bill passes as drafted, anyone whose will gives a testamentary trust the power to benefit a family company, family trust or deceased beneficiary's estate will need to redraft it to keep the exemption. That is most testamentary trust wills in Australia. You could avoid the problem by dying before 1 July 2028, although most people would probably prefer a legislative solution.
Many testamentary trusts give the trustee a power to vary the trust's terms once it is up and running. It's tempting to think the trustee could simply use that power after death to remove the companies and family trusts from the class. That is unlikely to work. The test reads the will that established the trust, not a later amendment. A broad power to vary can itself be the problem, because if the trustee could add ineligible beneficiaries back in, they remain potential beneficiaries. And a variation made after death to qualify for the exemption sits uncomfortably close to the anti-avoidance rule. Don't count on it.
Who pays
Testamentary trusts exist to look after people. A child who has lost a parent. A surviving spouse. A family member who can't manage money alone.
Under current law, a child receiving income from a testamentary trust is taxed at adult rates with the tax-free threshold, rather than the penalty rates that normally apply to children's unearned income. That concession is much of the reason these trusts exist.
Take a child with $20,000 of trust income. At adult rates, they pay little or nothing. If the trust loses its exemption, the trustee pays 30% tax, or $6,000 on that income. The child gets a non-refundable offset for that tax, which is worth nothing when they have no tax to offset. That's $6,000 a year, every year, lost to a clause in a will that may never have been used.
We've solved this before
The Government's concern is legitimate. It doesn't want testamentary trusts used to channel income from unrelated assets to children at concessional rates, or to feed family companies.
Parliament dealt with almost exactly this problem in 2019. People were putting non-estate assets into testamentary trusts so income could flow to children at adult rates. The fix, section 102AG(2AA) of the Income Tax Assessment Act 1936, limited the concession to income from assets that came from the estate. Not one will had to be rewritten.
The Bill keeps that rule as its second condition, then adds the beneficiary test on top. One test asks where the money came from. The other asks who could receive it, even if they never do.
Off to the Senate
On 15 October the Bill was referred to the Senate Economics Legislation Committee, which is due to report on 13 November. Lawyers and advocates, me among them, will no doubt repeat what we said during consultation. It was ignored the first time. Let's hope the Senate listens more closely than Treasury did.
I should declare an interest. Those of us contributing to this debate, myself included, stand to benefit financially if the Bill proceeds as drafted. Forcing Wills to be redrafted is good for business, and professionals like us get paid to do it. Yet we are arguing for a better outcome, one that avoids unnecessary cost and inconvenience for families. When the people who would profit from a mess are asking the Government not to make one, they might be worth listening to.
There are two simple fixes.
- Apply the test to wills, not trusts. The beneficiary condition should apply only to wills signed on or after 1 July 2028, not to every testamentary trust that happens to come into existence after that date. People making a will from then on will know the rules. People who signed years ago couldn't have.
- Tax what happens, not what might. Apply the minimum tax to income actually distributed to ineligible beneficiaries, rather than disqualifying the whole trust because of a clause that may never be used.
Either would protect the revenue without forcing a wave of redrafted wills.
What to do now
The Bill hasn't passed and the exemption could still change. If your will doesn't set up a testamentary trust, none of this affects you. If it does, what you should do depends on one question: does your will need updating for reasons that have nothing to do with this Bill?
If yes, redraft now. If no, review now and wait before redrafting.
Your will needs updating anyway: do it now
A new grandchild, a separation, a change in your business or assets, a change in who you want to provide for, or concerns about losing capacity are all reasons to act regardless of this Bill. An outdated will does not become less outdated because Parliament is considering tax legislation.
A new will can be drafted to meet the proposed exemption. Since the exposure draft came out on 3 September, I have been drafting testamentary trusts that limit the potential beneficiaries to individuals, tax-exempt entities such as charities, and special disability trusts. The will can also stop the trustee adding assets from outside the estate and require records that trace income back to estate assets, which covers the other two conditions.
The cost is flexibility. The trustee can no longer distribute to a family company or family trust, even if that might one day have been useful. For many families, that is a cost worth accepting, especially for a new will where everyone knows the rules. If the final law turns out more generous, you will have given up some flexibility, but not the tax exemption.
Your will is otherwise up to date: review now, redraft later
Ask your lawyer to check the class of potential beneficiaries in your testamentary trust. You will find out whether the proposed rules affect your will, and by how much. The issue may be less significant than you feared.
If your will is affected, wait before redrafting, but don't forget about it. The Senate committee reports on 13 November and the rules may still change. If they don't, your will needs to be redrafted to keep the exemption. The beneficiary test applies to trusts that come into existence from 1 July 2028, so aim to have the redraft signed before then, and certainly while you still have capacity. Wait for the law to settle, then redraft once rather than twice.
Either way
Find your will. Check who can benefit. Don’t count on a power to vary after you die to save it.
The Government got the policy right and the drafting wrong. Unless the Senate fixes it, families will pay tax on flexibility they never used, built into wills they signed in good faith.
Rachael Rofe is an estate planning lawyer and Principal Solicitor of Rofe + Counsel, a legal practice advising families nationally on testamentary trusts, intergenerational wealth transfer and structured giving. She made submissions on the testamentary trust exemption during Treasury’s consultation.
This article is general information only and is not legal advice.