The taxation of minors in Division 6AA is an anti-avoidance provision. Anybody channeling certain income to minors is hit with punitive tax rates.
Taxation of Minors Div 6AA ITAA36
Without Div 6AA adults could channel income to their under-age children not paying any tax on that income. And a discretionary trust would be the perfect way to do that.
Example: Bob earns a high income and has $1m to invest earning a 10% return. If he invested this in his own name, he would pay 45% tax.
But if there wasn’t Div6AA, he could put the investment into a discretionary trust and then distribute to his six grand-children, paying zero tax. he will pay zero tax on that income if there wasn’t Div 6AA. But there is. This is exactly the scenario that Div 6AA tries to capture. But there are exceptions.
And so Division 6AA of ITAA36 looks at the income of children and applies high punitive tax rates to this income unless an exception applies. It is no coincidence that Div 6AA sits right next to Division 6.
Division 6AA starts with a wide net. It includes any child and any income of that child. But then it carves out two exceptions. And these two exceptions are excepted persons and excepted assessable income.
Division 6AA does not apply to cxcepted persons and excepted assessable income. While prescribed persons feel the full force of Div 6AA for their eligible assessable income.
Excepted Person
s102A (2) outlines who is an excepted person. There are three groups of excepted persons. Anybody else is a prescribed person.
An excepted person is completely exempt from Div6AA tax rates. They pay tax like any adult.
Full-Time Occupation
The first one is any minor in a full-time occupation on 30 June. So the minor could have left school on 28 June and started a full-time occupation on 29 June.
Disability
The second one is a minor with a disability. There are a number of ways a disabled child can qualify as an excepted person.
Receiving a disability support pension for a period that includes the 30 June is one. Being the principal beneficiary of a special disability trust is another. And the third one is providing the Commissioner with a medical certificate testifying that the child has a disability or continuing inability to work.
There are two more – receiving a double orphan pension or providing a medical certificate that shows that the child is unlikely to be able to engage in a full-time occupation due to a permanent disability. But these two have a huge BUT attached though. If a child is wholly or substantially dependent for support on a relative, then these scenarios don’t qualify for the exception.
Carer Allowance
And the third group of excepted persons are minors who have to care for somebody else and hence receive a carer allowance
Prescribed Person
A prescribed person is any child who is not an excepted person.
s102AC (1): …a prescribed person…if…less than 18 years of age on the last day of the year of income and…not an excepted person…
Excepted Assessable Income
Excepted assessable income is the second exemption. A child might be a prescribed person but if the child only receives excepted assessable income, then the Div 6AA tax rates still don’t apply.
s102AE (2) lists excepted assessable income. It is a long list.
The most important exception is at the very top of the list under (a). Employment income and business income. So if a teenager under 18 works at McDonalds or founds a start-up, adult tax rates apply.
Next under (b) come payments for personal injury, workers compensation, criminal injury, life insurance, super and more. But at the very end there is a really important one: …(viii) as a result of a family breakdown. That is huge topic and hence outlined further in s102AGA.
Next under (c) come testamentary trusts. The main or at least an important reason why most modern wills include a testamentary trust.
Then there is (d) covering partnership income.
And then under (e) there is a really important one: Trust Income.
s102AE (2)(e):…excepted assessable income …is included in the assessable income of the minor under section 97 or section 100.
So s102AE starts out taking trust income out of Div 6AA income. But then s102AG brings it back in unless it is excepted trust income. So that is what we need to look at now.
Excepted Trust Income
Unless trust income is excepted trust income, it is taxed under Div 6AA.
s102AG (1): Where a beneficiary…is a prescribed person…, this Division applies to…assessable income of the trust estate that is not…excepted trust income.
So what is excepted trust income? The answer links back to the original list in s102AE(2).
If a direct payment to the child would have been excepted, then the payment via the trust is excepted as well. It doesn’t matter whether income goes directly to the child or via a trust to the child. Either way the income is excepted.
That is the short answer. s102AG doesn’t say this explicitly but rather lists word for word the different types of income (again), but you won’t find anything in s102AG that you can’t also find in s102AE.
Eligible Assessable Income
Any assessable income that is not excepted is eligible assessable income and taxed at Div6AA rates.
s102AE (1): Eligible assessable income…is…assessable income…as is not excepted assessable income.
So a child might be a prescribed person but still avoids Div6AA rates if none of their income is eligible assessable income. A prescribed person is only hit with Div6AA rates for their eligible assessable income.
Div 6AA Tax Rates
So now we get to what Div 6AA is really all about. Division 6AA reduces the prescribed person’s tax-free threshold from $18,200 to $416. And then taxes their eligible income at 45% (apart from the 66% for the small branch between $417 to $1,307).
So eligible income is basically taxed at an adult’s top marginal tax rate without the $18,200 threshold, removing any incentive to shift income from an adult to a child.
Trust Distributions to Minor Beneficiaries.
Minor beneficiaires are children under the age of 18. They are beneficiaries under a legal disability. If a minor beneficiary has a present entitlement to a share of the net income of the trust, the trustee has to pay the tax under s98 on their behalf at the beneficiary’s marginal rates. And the beneficiary’s marginal rates are Div 6AA rates unless one of the exceptions applies.
If the minor beneficiary has other income, the trust distribution goes into their assessable income. And a credit applies for the tax the trustee paid (see s100).
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