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We have been asked to clarify the correct application of section HH 3B of the Income Tax Act 2004 (the minor beneficiary rule exemption).
This QWBA sets out the operational guidelines regarding the minor beneficiary rule exemption.
(Please note: All legislative references in this QWBA refer to the Income Tax Act 2004).
Section HH 3A(1) states:
If a minor derives beneficiary income,-
Section HH 3B states:
Section HH 3A does not apply if the amount of beneficiary income derived by a minor in relation to a tax year is $1,000 or less.
Section HH 3A(1) provides that if a minor derives beneficiary income from a trust the trustee must pay income tax on that beneficiary income as if it were trustee income. The beneficiary income is not income of the minor.
However, section HH 3B contains a de minimis exemption to this rule. It provides that where the amount of beneficiary income derived by a minor in relation to an income year is $1,000 or less, the beneficiary income is taxed at the minor beneficiary's marginal tax rate and not at the trustee's tax rate.
The Commissioner is aware of the uncertainty over the application of section HH 3B. That is, it is unclear whether section HH 3B applies on a "per beneficiary" basis or a "per beneficiary per trust" basis.
The Commissioner has reviewed the statement regarding HH 3B in the Tax Information Bulletin, Vol 13, No 5 (May 2001) and past practices. The operational guidelines are clarified as follows.
Discussion - correct application of section HH 3B
The Commissioner considers that section HH 3B must be applied in the context of sections HH 3A and HH 3C which are formulated on a "per beneficiary per trust" basis. Accordingly, the reference to "beneficiary income" in section HH 3B can only mean the beneficiary income derived from a specific trust that would be treated as trustee income for that trust under section HH 3A.
The underlying purpose of section HH 3B also supports this interpretation. The purpose of section HH 3B is to provide an exemption to the general rule in section HH 3A. Therefore the exemption can only apply in respect of the beneficiary income derived from a particular trust to which section HH 3A applies.
Accordingly, section HH 3B should be interpreted as applying to each beneficiary for every trust from which they derive income. If a beneficiary receives beneficiary income from a number of trusts the $1,000 exemption in section HH 3B will apply to the income that is received from each trust. That is, the aggregate exemption can exceed $1,000.
Although there is no express limit on the number of trusts that can make distributions of $1,000 or less to the same minor beneficiary and benefit from the section HH 3B exemption a settlor must have a legitimate purpose in establishing multiple trusts. The Commissioner may consider the application of the general anti-avoidance rules if people establish multiple trusts to obtain a greater than $1,000 exemption.