Trust Issues: Testamentary Trusts and the New Era of Tax

When the Australian Government introduced sweeping changes to the taxation of trusts as part of their controversial budget earlier this year, attention quickly turned to whether testamentary trusts would be drawn into the net of the new regime.

The reforms included two proposed 30% minimum taxes: one targeting discretionary trust income and the other targeting capital gains. If applied to testamentary trusts, these measures could have significantly disrupted both testamentary trust planning and the pre-death structuring of estates.

Fortunately, testamentary trusts have largely escaped the new tax regime, but not without strings attached. To qualify as exempt from the tax changes, a testamentary trust must satisfy strict conditions designed to distinguish genuine testamentary trusts from arrangements engineered to obtain favourable tax treatment.

That is where the uncertainty lies. The boundary between legitimate estate planning and tax-driven structuring is not always clear, particularly while questions remain about how the Commissioner will interpret and administer the proposed laws. Of particular concern, testamentary trusts established on or after 1 July 2028 may lose the exclusion if their beneficiary classes extend to companies or existing family trusts. Existing wills containing broad beneficiary definitions may therefore require review before the testator’s death.

This article examines the two proposed 30% minimum taxes, the testamentary trust exemptions and the potential friction between the new rules and established estate-planning strategies.

 How it works: 30% Tax on Trust Income

The Treasury Laws Amendment (Tax Reform No. 3) Bill 2026 (Cth) (the 30% Trust Tax Bill) was introduced on 14 October 2026. The proposed reforms introduce a 30% minimum tax on relevant discretionary trust income from 1 July 2028. Genuine testamentary trust income will generally be excluded, but the exemption comes with important restrictions on asset sources, beneficiary classes and avoidance arrangements.

According to the 30% Trust Tax Bill, tax would be payable by the trustee, calculated on the trust’s taxable net income that falls within the minimum tax rules. Where the trustee already pays tax on that income, the new tax would operate as a top-up to 30%, rather than an additional 30% charge.

Eligible non-corporate beneficiaries would continue to include their share of trust income in their tax returns and receive a non-refundable tax offset reflecting the minimum tax. Higher-taxed beneficiaries may therefore pay further tax, while beneficiaries with insufficient tax liability would not receive a refund of the unused offset.

Importantly, corporate beneficiaries will not receive the offset and will remain subject to ordinary company tax on their distributions.

Estate Planning Ramifications of the new Trust Income Rules

Under the 30% Trust Tax Bill, testamentary trusts will be exempt from the minimum 30% tax on trust distributions if that meet the requirements of being a “genuine testamentary trust”.

To be considered a genuine testamentary trust:

• the income must be sourced from the estate, or the reinvestment of funds sourced from the estate;
• where the testamentary trust is established after 1 July 2028, all of the beneficiaries of the testamentary trust must be individuals or exempt entities; and
• the income of the trust must not be derived directly or indirectly under a scheme entered into or carried out for the purpose, or for purposes that include the purpose, of gaining access to the exemption.

Drafting a testamentary trust to include companies as potential beneficiaries is a reasonably common strategy in estate planning. Generally, such arrangements are drafted so that related companies are included as potential recipients of trust income, pending the trustee’s discretion.

This is generally drafted to provide flexibility for a deceased’s family – allowing income or capital to be distributed into whichever vehicle or entity that provides financial structure for a deceased’s estate.

This is a major concern for estate planning. Because a testamentary trust is established on the testator’s death rather than when the Will is executed, the proposed commencement rule may affect Wills signed years earlier. Existing Wills that permit distributions to companies, family trusts or other ineligible entities should therefore be reviewed and amended to address these changes.

Capital Gains

The Treasury Laws Amendment (Tax Reform No. 1) Bill 2026 (CGT Bill) was introduced in October 2026. Under this bill, a minimum tax rate of 30% is also imposed on capital gains.

Once again, however, a specific exemption has been included for “genuine testamentary trusts”. In this context, a testamentary trust will be exempt from the minimum 30% CGT so long as:

• the capital gain is made on assets sourced from the estate, or the reinvestment of funds sourced from the estate; and
• the capital gains must not be derived directly or indirectly under a scheme entered into or carried out for the purpose, or for purposes that include the purpose, of gaining access to the exemption.

The source of funds

 To gain access to both exemptions, the assessable income must originate from:

• assets transferred from the deceased estate, including superannuation death benefits paid to the estate;
• qualifying accumulations and reinvestments of those assets; and
• replacement assets acquired through genuine arm’s-length transactions.

The rules do not apply income derived from assets and funds subsequently injected into the trust post-death.

Nor does it extend to a beneficiary’s later personal sale of an asset received from the trust.

The exemption concerns qualifying gains arising through the trust, not an enduring exemption attached to inherited property.

Further, if two spouses separately establish testamentary trust wills for their children, it will not be possible to “combine” those two testamentary trusts into one. This is still a common estate planning strategy, however, so any such provisions in testamentary trust wills need to be carefully reviewed.

When is a testamentary trust not “genuine”?

Both minimum taxes deny the testamentary trust exemption where income is derived under a scheme with a purpose of securing that exemption.

They specifically target schemes that cause property to become part of the deceased’s estate pre-death with a purpose of obtaining access to the testamentary trust exemptions.

The policy direction of both Bills is clear: preferential treatment is intended to remain available for genuine testamentary arrangements, but not where assets or structures are deliberately manipulated to bring income or capital gains within the testamentary trust concessions.

However, two concerning issues arise for estate planners:

• gaining access to the exemption just needs to be a purpose, not the sole or dominant purpose – even if there are genuine estate reasons for testamentary trusts, if tax benefits are also sought, the exemptions may be denied; and
• proving intention following the death of the testator can be problematic in tax cases, particularly where the testator has not documented their reasons for establishing testamentary trusts – or where documents such as letters of wishes focus heavily on the tax benefits of testamentary trusts.

The Conflict with Estate Planning Strategies

 The above integrity rules effectively serve as a disqualifier for testamentary trusts seeking to claim an exemption. If the assets and income of the testamentary trust don’t meet the standards of both rules, the law effectively sees them as identical to any other discretionary trust (and thus, equally as taxable).

There is no explicit requirement for any supposed scheme under either integrity rule to take place after death, meaning that the Commissioner may seek to question restructures or changes in asset ownership in the time period prior to a taxpayer’s death.

The draft legislation and accompanying explanatory memorandum makes it clear that the integrity rules are directed at “contrived schemes”. It also expressly states that the rules should not apply merely because steps are taken to increase the value of an estate left to beneficiaries.

The explanatory memorandum distinguishes contrived arrangements from genuine estate and succession planning, as considering tax consequences when choosing how to achieve a substantive succession objective will usually be incidental. This should not, however, be interpreted as an unconditional safe harbour.

There are a number of legitimate estate planning strategies that ultimately have the effect of transferring assets into an estate that would not otherwise have naturally formed part of a testamentary trust.

In these circumstances, despite the legitimate nature and aim of these strategies, the Commissioner could potentially argue:

• the assets only became estate assets because of a scheme; and/or
• a purpose of the scheme was to obtain access to the testamentary trust exemptions.

The following considers common testamentary trust and estate arrangements that may interact uneasily with the proposed integrity rules.

Superannuation

 A common estate planning strategy involves withdrawing funds from superannuation shortly before death. If a member of a superannuation fund passes away leaving their death benefits to a person who does not qualify as a spouse or a dependant, then death benefit tax applies.

By withdrawing the funds while alive and retaining the cash personally before death, the assets will ultimately pass through the estate (and into a testamentary trust structure if established), potentially avoiding death benefits tax on the deceased’s superannuation.

However, viewed through the lens of the new integrity rules, withdrawing super before death could be seen as a deliberate scheme to place assets into the estate so that future investment gains or income qualify for the testamentary trust exemptions, not just as a means of managing death benefits tax liabilities.

Even if the primary purpose of the transfer was to mitigate the death benefits tax, the Commissioner may form the view that another purpose of the transfer was to for the super assets to gain access to the concession.

 Liquidating family trust assets before death

 Another common strategy is undertaken where an aging client controls a family discretionary trust.

Instead of allowing trust assets to remain in the trust structure after death, the trust may be wound down and assets distributed or sold. The proceeds are then held personally by the client and ultimately pass through the estate into testamentary trusts established under their Will.

The motivation is often administrative simplicity. Families may wish to eliminate complexities associated with appointor succession, trustee replacement and multigenerational discretionary trust administration. The imposition of the impending minimum 30% tax on discretionary trusts may provide a further incentive to unwind those structures.

As discussed above, if assets are intentionally removed from an inter vivos trust and placed into the deceased’s personal ownership shortly before death, a question could arise as to whether part of the purpose was to ensure those assets formed part of the estate and thereby gained access to the exemption.

And again – such purpose need only be more than incidental. Whether such an arrangement would be regarded as a legitimate exercise or a disqualifying scheme will turn largely on the Commissioner’s assessment of the intention behind the restructure.

The key issue would therefore be evidentiary: whether access to the testamentary trust exemptions was more than an incidental purpose of the restructure. Contemporaneous evidence identifying succession, governance and administrative objectives prepared and signed by the testator may may become especially important in this context.

Surviving spouses renouncing benefits under a will

 A further scenario arises where spouses have mirror wills creating testamentary trusts for children or descendants.

Following the first spouse’s death, the surviving spouse may be entitled to inherit assets personally but elects to renounce or disclaim that entitlement so the assets pass directly to testamentary trusts established for the next generation. Again, such arrangements may genuinely be motivated by asset protection and genuine succession planning.

Unlike the previous examples, the assets already form part of the deceased estate. There is no immediate restructuring before or after death. The integrity rules are focused on ‘contrived arrangements’ that artificially or deliberately move assets into an estate to ‘cash in’ on the concession.

Despite this, the integrity measures also apply to any arrangement that has the purpose of gaining access to the exemptions. As such, if one of the purposes behind the renunciation is to gain concessional tax treatment, the strategy may fall foul of the rules.

Conclusion

The new tax reforms and proposed integrity rules are not the death knell for testamentary trusts that many estate planning practitioners feared. However, they do mark a clear shift in focus from structure to purpose, and therein lies the murky uncertainty.

Strategies such as pre-death superannuation withdrawals, deathbed asset transfers, the unwinding of family trusts and post-death renunciations all serve perfectly legitimate estate planning objectives. The difficulty is that some, if not all, of these same strategies may also have the effect of bringing assets within a testamentary trust exemptions that would not otherwise have been available – potentially bringing these strategies into conflict with the proposed integrity rules.

That is why clarity and gathering evidence will be critical. Advisers and taxpayers need a reliable and definitive stance on where the line will be drawn between ordinary, commercially sensible succession planning and arrangements that are sufficiently tax-driven to offend the integrity rules. Until that line is more clearly articulated, caution should be exercised when recommending or implementing strategies that move, redirect or preserve assets for the benefit of a testamentary trust.

Additionally, if the draft legislation is not amended, existing Wills and testamentary trust provisions should be reviewed and, where appropriate, redrafted so as to eliminate corporate and trust beneficiaries. Otherwise, these testamentary trusts face the risk of losing access to the exemption altogether.

For now, the key takeaway is that testamentary trusts have not and likely will not lose their place in estate planning.

However, estate planners must turn their minds from structure to intention, from strategy to purpose, and consider that the future tax treatment of a testamentary trust will depend on how, why and when the relevant assets came to sit within it.

Benjamin Kett
Solicitor