In July I wrote about Treasury's consultation paper on the proposed 30% minimum tax on discretionary trusts, and the direction it set for testamentary trusts. The paper promised an exemption from the minimum tax and left the mechanics for later. Later has arrived. The exposure draft legislation is out, and it does two things a discussion paper could not.
It shows how Treasury means to build the exemption. And it opens a question the paper was free to leave alone, because a paper can be silent where legislation has to commit to words. Those words now point in two directions at once.
The policy battle is over. Testamentary trusts have survived the 30% minimum trust tax. A testamentary trust is the discretionary trust your will creates when you die, long used to shield an inheritance from creditors, bankruptcy and family breakdown, and to let income reach children and grandchildren at ordinary tax rates. The drafting battle is the one to watch now, and it turns on a single question the draft does not cleanly answer: who is allowed to be a beneficiary?
Three tests
The exemption is not a single tick. Income escapes the minimum tax only where three requirements are met.
First, the trust must arise under a will, a codicil, an intestacy or a court order in a deceased estate. A trust set up between living people does not qualify, however it is dressed up.
Second, the income must come from the estate: assets that came from the deceased, or assets bought with them, including whatever those assets have since been reinvested into. Unrelated wealth tipped in later falls outside the exemption.
Third, for testamentary trusts that come into existence on or after 1 July 2028, the income must reach an individual or a tax-exempt entity, such as a charity. That date is not the date you sign your will. A testamentary trust comes into existence when you die, so a will signed today will be judged against this third test if you live past 1 July 2028, which most people signing a will now will.
For an ordinary testamentary trust, the first two look after themselves. The trust is made by a will, and it holds what the estate left behind. The third is where the draft stops being routine, because it raises a question the consultation paper never had to answer: who counts as a beneficiary?
The fork in the draft: Who counts as a beneficiary?
Everything now turns on that third requirement.
Most testamentary trusts are drafted with deliberately wide beneficiary classes. Alongside children and grandchildren, they routinely name a spouse, family companies, other discretionary trusts and related entities. That width is not exotic. It has been standard practice for decades, because it lets the trustee deal with circumstances no one can map at the time the will is signed. The broader the class, the more room the trustee has to provide for people who may not even have been born when the will-maker died.
The draft puts that width in question, and it can be read two ways.
The operative provision, the words of the proposed law itself, looks to the beneficiary who actually receives the income. On that reading, a company or a trust sitting in the class does no harm by itself, as long as the income from the trust is only paid to an individual or a tax-exempt entity. Most existing wills would need no change, and the trustee would simply have to watch who receives distributions. The exemption also applies income-by-income, not at total trust level. Pay income to a company and the 30% applies to that slice alone; the rest of the trust, and the income that goes to individuals or charities, stays exempt. Nothing is tainted by association.
The explanatory memorandum, the companion document that says what the law is meant to achieve, reads wider. Its language can be taken to mean that a testamentary trust set up after 1 July 2028 must be capable of benefiting only individuals and tax-exempt entities, whether or not a company ever receives a cent. On that reading, the mere presence of a company or a taxable trust in the class is fatal to the exemption, even where it is paid nothing.
The distance between those two readings is enormous. On the first, this is an administration issue: mind the distributions after death and carry on. On the second, it is a drafting issue on a national scale, because a wide beneficiary class is not the exception in testamentary trust wills. It is the standard.
The second reading would produce a result that is hard to defend. People who paid for careful estate planning years ago would be told to amend documents that were perfectly sound when they were drawn. Some of them can no longer amend anything, having lost capacity in the meantime. They did the right thing while they could, and their families would be left with fewer options because the rules moved underneath them. Lawyers would certainly be busy. Whether that is fair is another question.
Treasury should say plainly which reading it means before the legislation is settled. The difference between regulating who receives income and regulating who could potentially receive income looks small from Canberra. For the thousands of families with testamentary trust wills today, it is the difference between doing nothing and redrawing everything.
Old machinery, new job
The draft reaches for section 102AG, and that choice tells you how the whole exemption is meant to work. Section 102AG is the long-standing rule that lets children take income from inherited assets at ordinary rates rather than penalty rates. Rather than write a fresh carve-out, Treasury has given that machinery a second job: deciding whether testamentary trust income escapes the new minimum tax. Old machinery, new job.
There is good sense in that. The regime rests on ideas advisers have worked with for years, not a fresh test with no history behind it. It also signals what the coming arguments will cover, because they are the arguments the excepted income rules have always thrown up: where the assets came from, how the income is traced, and whether the arrangement is truly testamentary.
That choice is also what puts teeth in the second requirement. The exemption is not a blanket pass for anything held in a trust made by a will. Income traceable to estate assets, or to what those assets have since been reinvested into, can qualify. Unrelated assets tipped in later do not, and the draft backs that with tracing rules and anti-avoidance provisions aimed at property pushed through an estate mainly to reach the exemption. That distinction, subtle as it sounds, is the whole game.
So, should you redraft your will?
Redraft, perhaps not.
The better question is whether your will would still work under either interpretation. For many families, that can be assessed long before any decision to amend documents needs to be made.
The Government wants the reforms enacted this year, potentially as soon as the Parliament's mid-October sittings.
For families with testamentary trust wills, that means the period of uncertainty is likely to be relatively short. In most cases there is little value in rushing to amend documents before the final position is known. What does make sense is understanding whether your will could be affected by the outcome. If the legislation ultimately adopts the narrower reading of the operative provisions, many existing wills may require no change at all. If it adopts a broader restriction on beneficiary classes, some families may need to act promptly. Knowing which camp you fall into means you are ready to respond once the legislation is settled.
There is also a broader point. Most wills are reviewed far less often than people imagine. The will that felt comprehensive when it was signed in 2012 may have been written before the family business was sold, before the investment portfolio grew, before grandchildren arrived, or before relationships within the family changed. Life has a habit of moving on while documents stay where they were left.
That is why the sensible response is neither panic nor procrastination. Understand whether the legislation could affect you and use the opportunity to make sure the rest of your estate plan has kept pace with your life.
If you do not currently have a testamentary trust in your will, there is another message in the draft legislation. In preserving the exemption, the Government has effectively confirmed the continued role of testamentary trusts as one of the most effective tools available for passing wealth between generations. That should not be overlooked.
Where this leaves us
The consultation paper told us testamentary trusts would keep their place. The exposure draft tells us how. By tying the exemption to section 102AG, Treasury has protected these structures and imported decades of settled thinking about tracing and the source of assets. That part is good news.
The remaining uncertainty is narrower, but important. The draft has not yet definitively answered whether the new rules focus on who actually receives income from a testamentary trust or whether they also restrict who can be included in the beneficiary class itself. For many existing wills, that distinction will determine whether nothing changes or whether amendments become necessary.
That question is unlikely to remain unresolved for long given the Government wants the legislation enacted this year.
The argument about whether testamentary trusts survive has already been won. The argument about how they are drafted will soon be settled.
Rachael Rofe is an estate planning and wealth transfer lawyer who works across giving in every form it takes: to community, to family, across life and on death. Her focus sits where tax, asset protection and values meet. She also reads exposure tax reform legislation like this one so you don’t have to.
This article is general information only. It is not legal, tax or financial advice, and you should obtain advice specific to your circumstances before acting. The legislation discussed is in exposure draft form and may change.