Revenue aspects of testamentary trusts

The carry-forward of losses in trusts generally is regulated by the provisions of Schedule 2F of the 36 Act (Trust Loss Provisions). That Schedule applies a universal “income injection” test which, broadly speaking, prevents tax losses in a trust being utilised by income distributions being made to that trust from other entities, unless those distributions are made within a defined family group (see further below).

In addition to the above general “income injection” test, the Schedule applies a series of different tests for fixed trusts and non-fixed trusts which must be satisfied by all trusts other than excepted trusts.

Any trust established under a will is an excepted trust for the first 5 years from the date of death of the testator.[21] Further, because most trusts established by will fall into the category of fixed trusts the tests for carry-forward of losses are usually readily satisfied. Accordingly, there is considerable slack cut for deceased estates generally.

However, because a testamentary trust is a discretionary trust, the limitations imposed on non-fixed trusts by the Trust Loss Provisions will apply[22], and they are far more stringent.[23] Indeed, for most discretionary trusts the tests are impossible to satisfy with any certainty.

The contentious tests can be avoided however, if the trust makes a family trust election. The result of making the election is that the trust becomes an excepted trust for the purposes of the Trust Loss Provisions[24] and the specific test requirements for the carry-forward of losses will cease to be a problem.

Accordingly, at the end of the fifth tax year from the date of death of the deceased, if there are losses in a testamentary trust, a family trust election must be made in the trust’s tax return for that year if those losses are intended  to be carried for use in subsequent years. Similarly, if there are no losses arising in a testamentary trust during the first 5 years, but a loss is incurred in any year after the fifth tax year, a family trust election must be made in the tax return for the year of the loss to enable that loss to be carried forward to future years.

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