Child Maintenance Trusts

Introduction

Many marriages end in divorce. More than half the break ups involve children under 18 years of age. The two best times to tax plan are at death and divorce. Before you divorce, do a Binding Financial Agreement with the help of your Advisers and Tax Lawyers. After you divorce, if you have young children, you can consider a Child Maintenance Trust (“CMT”). They are often also called a Family Maintenance Trust.

Simply put, this is a trust established for the benefit of the child. Control stays with the non-custodial parent.

The benefit of establishing a Child Maintenance Trust is that for the purpose of the Income Tax Assessment Act a child under the age of 18 is able to receive for unearned income an adult tax rate. Otherwise, the child pays tax on unearned income at a rate of 66%.

 This effectively means that the amount required to be derived by the non-custodial parent in order to pay their maintenance obligation is less than if they were just paying maintenance directly to the custodial parent.

 The requirements for such a trust are set out in section 102AG(2)(c)(vii) and section 102AGA, Income Tax Assessment Act 1936. Essentially, a transfer of property to the trustee of the trust is required. The income from the trust, which is "from the investment of any property" (i.e. the trust cannot be used as a business entity), is applied for the benefit and well-being of the child.

Do I have a legal financial obligation to my children?

Yes you do. When you break up you have 12 months after the divorce to divide up your booty - either by a Binding Financial Agreement, by consent or the court will decide. You must ensure that your children of the relationship are appropriately provided for.

By consent or in the court order the parties may agree to include a Child Maintenance Trust in the orders. But, you do not need to include a Child Maintenance Trust in the order before you set up a CMT.

What kind of order? You may or may not have a court order, but, generally all you need is a Child Support Agency assessment. That is enough. The Tax Act needs a direction that the husband has to pay money to the kids. A Child Support Agency assessment is enough.

You also have an obligation for children that come from a one-night stand. You don’t need to have had a “relationship” with the other parent. You are liable and you can do a CMT in these circumstances.

 How does the Child Maintenance Trusts save me tax?

When a child gets “unearned” income their tax rate after $643 climbs to 66%! However, income from a CMT allocated to the child is treated as ‘excepted trust income’. The child is then given, for this income, an adult tax rate.

Detailed manual on the tax consequences of a Child Maintenance Trust

What do I have to do?

• You cease living together on a genuine domestic basis (includes both married and de facto couples).
• One of you is the child’s natural, adoptive, step parent, legal custodian or guardian.
• An ‘order, determination or assessment’ is made wholly or partially because the couple cease to live together. Since October 1989 on an assessment by the Child Support Agency is generally available.
• A ‘court, person or body’ makes the order, determination or assessment. Once again this is now pretty much only from the Child Support Agency.
• The effect of the order is that you become subject to a legal obligation to maintain, transfer property to or do some other thing for the benefit of the child or the spouse.
• The ‘person’ under the legal obligation can be anyone including a company - not just you.
• The transfer of the property to the CMT is done to satisfy the legal obligation.
• The child ultimately receives the trust capital. This is not necessarily when your child turns 18 years of age. It is when the trust ends. Trusts can go for up to 80 years from the date they start. However, if your CMT earns more than you have to pay to that child then you can distribute the extra income to other persons - just like a normal family trust. Once again, please note that the capital has to one day end up in the child's hands - but not the excess income.
  

What “assets” can go into a Child Maintenance Trust?

With the help of the Adviser, you can put assets in the CMT that have small capital value at the end of the day. The assets must have some “real value”. These include annuities, cash, shares, managed funds, real property and even things like sheep. You need to comply with Tax Ruling TR 98/4.

Do the assets needs to correlate proportionally to the amount of income generated by asset being transferred? No, the legislation does not require this. Property of insubstantial value, which generates healthy income that is sufficient to satisfy child support payments, satisfies the legislation requirements. However, the transfer of the asset needs to be at arm's length - true value.

Example

Consider Ryan & Angelina. They have a wonderful daughter called Marcia. Ryan & Angelina separate.

Ryan looks after the child. Angelina has an obligation to pay child maintenance to Ryan. Angelina is paying the maintenance with after tax dollars. That is she is paying tax on her income and then handing over the money to Ryan for the child.

Hemal & Narelle agree to set up a Child Maintenance Trust for Marcia. They may have agreed this or it may be part of the Family Court’s consent orders.

The Tax Lawyers establishes the trust and transfer “assets” to the trustee.

The “assets” earn income e.g., income from a bank account and that income goes towards the child maintenance. Angelina doesn't pay tax on that income.

What is the cost and taxes involved?

When you split your assets via a Family Court order then no CGT is payable on the transfer. Rather the CGT obligation on the assets is only payable when the receiving spouse sells the assets. This is called CGT “roll over” relief.

Sadly, the transfer of assets into the Child Maintenance Trust doesn’t receive any CGT rollover relief. The triggering of CGT is just another cost.

Also, watch out for stamp duty.

The Adviser and Tax Lawyers need to work closely together on the cost/benefit analysis of setting up a Child Maintenance Trust. Together we consider the following:

1. Do I need a CMT? What are the advantages and disadvantages?
2. Is it worth setting it up and maintaining it? Will the adviser and accountant do a cost benefit analysis?
3. What am I going to put in it? (Remember, within 80 years those children must get whatever is left of the capital.) Can I put discretionary assets and rights in like special discretionary shares or units? Could a farmer put sheep in the CMT?
4. How do I get the capital (that is expected to generate the income) into the CMT without paying Capital Gains Tax and Stamp Duty? Can I use the Family Law roll over relief?

Legislation requirements can be complex. However, the Tax Act permits these considerable tax concessions if the family law settlement and child support obligations are structured correctly.