Understanding Family Trust Election in Australia

What is a Family Trust Election?

A family trust for tax purposes is a trust whose trustee has made a valid Family Trust Election (FTE). Simply including the words "family trust" in the trust's name is not enough to qualify as a family trust for tax purposes.

A trustee can only make a valid Family Trust Election (FTE) by meeting certain criteria and submitting an election in writing using the approved form. Once the election has been made, it cannot be changed or cancelled except in specific situations.

A Family Trust Election (FTE), is a decision made by the trustee of a trust to designate a specific individual as the reference point for determining the trust's 'family group' for tax purposes. The individual chosen must be alive at the time of the election and the trust must pass the 'family control test.'

The election, which must be made in an approved form by the Australian Taxation Office (ATO), generally takes effect from the start of the specified income year, and can only be made if the trust passes the family control test at the end of that year.

The election can be beneficial for trusts that receive franked dividends or have revenue losses, but the trustee must consider the risk of incurring Family Trust Distribution Tax (FTDT) if a distribution is made to a non-family member.

If a family trust receives franked dividends or has tax losses, the trustee may want to consider making a Family Trust Election (FTE) to access certain tax benefits. A Family Trust Election (FTE) allows the trustee to pass on franking credits to beneficiaries and offset prior year losses against the trust's taxable income.

However, just having a 'family trust' written in the trust's settlement deed is not enough for tax purposes, the ATO will only recognise a trust as a family trust if the trustee has made a Family Trust Election (FTE).

Keep in mind that if distributions are made to someone outside of the 'family group', the trustee will be subject to Family Trust Distribution Tax (FTDT) at a rate of 47%.

The family control test

A Family Trust Election (FTE) can only be made if the trust passes the family control test. The test is satisfied when some or all of the following entities control the trust: the test individual and/or members of the test individual's family; a professional legal or financial advisor of the family; the trustees of one or more family trusts, where the same test individual is specified in the Family Trust Election (FTE) and the individual together with family members have more than a 50% stake in the income or capital of the trust.

A group composed of these entities will be considered to have control of the trust when they have the power to control or obtain the beneficial enjoyment of the income or capital of the trust, or to remove or appoint the trustee.

The family group used for the control test is similar to the test individual's family group, but a former spouse of the test individual is not considered part of the family for this test.

Who should be the test individual?

The most important part of a Family Trust Election (FTE) is determining the 'test individual' whose family group will determine the range of beneficiaries to whom the trustee can distribute without incurring Family Trust Distribution Tax (FTDT).

Family of the specified individual

The family of the individual specified in the relevant Family Trust Election (FTE) consists of that person (the test individual) and all of the following (if applicable):

1. any parent, grandparent, brother or sister of the specified individual or the specified individual's spouse
2. any nephew, niece or child of the specified individual or the specified individual's spouse
3. any lineal descendant of a nephew, niece or child referred to in point 2
4. the spouse of the specified individual or of anyone who is a member of the specified individual's family because of points 1, 2 and 3.
5. former spouses of the test individual or a family member who is no longer considered a family member due to the breakdown of a marriage or relationship or death.

Any lineal descendant' includes any descendant of an individual in a direct line of relationship flowing downwards, including an individual's child, grandchild, great-grandchild, and so on.

They are not limited to descendants on either a patriarchal or matriarchal basis. A person does not cease to be a family member simply because of the death of another family member. If the specified individual in a Family Trust Election (FTE) is legally married but separated from their spouse, their spouse remains a member of the family.

However, if the specified individual divorces after being legally married, their former spouse will no longer be a member of the family, but will still be a member of the family group.

If the spouse of the deceased specified individual or a member of their family marries someone who is not a member of the deceased specified individual's family, the spouse will cease to be a member of the family and instead, the former spouse of the deceased specified individual or a member of their family will be considered a member of the deceased specified individual's family group.

This means that the former spouse of the deceased specified individual will not have access to the same concessionary treatment under the income injection test.

It is important to note that not all family members of the test individual will be part of the family group (such as aunts, uncles and cousins) to avoid any accidental exposure to FTDT.

Family group

For determining whether a conferral or distribution has been made, the following people and entities are generally considered as part of the family group of the individual specified in the Family Trust Election (FTE):

• The members of the specified individual's family
• Former members of the specified individual's family who are no longer members due to a breakdown in a marriage or relationship, or death (including former spouses, former widows/widowers, and former stepchildren)
• Family controlled or owned trusts, companies, or partnerships
• The family trust for which the Family Trust Election (FTE) has been made
• Other family trusts with the same individual specified in their Family Trust Election (FTE)
• Trusts, companies, or partnerships that have made an Interposed Entity Election (IEE) to become a member of the specified individual's family group
• Trusts, companies, or partnerships (other than non-fixed trusts) where certain members of the family group have fixed entitlements directly or indirectly, and for their own benefit, to all of the income and capital of the trust, company, or partnership
• Deductible gift recipients in Australia
• Bodies whose income is exempt from income tax.

Interposed Entity Elections

An Interposed Entity Election (IEE) can be made for two main reasons. The first is to include an entity as part of the family group of the individual specified in a Family Trust Election (FTE), allowing the trustee of the family trust to make distributions of income or capital to that entity without incurring Family Trust Distribution Tax (FTDT). The second reason is to exclude a trust from having to comply with the trustee beneficiary reporting rules in Division 6D of the Income Tax Assessment Act 1936.

An Interposed Entity Election (IEE) can be made for a trust that has a Family Trust Election (FTE) in force, and the election can start from an earlier income year, as long as the entity meets the conditions of passing the family control test and not making distributions or conferring present entitlement to anyone outside the family group during that time.

An Interposed Entity Election (IEE) is generally in effect at all times after the election commencement time, which is usually the beginning of the specified day in the Interposed Entity Election (IEE), but could be the earliest time from which the entity passes the family control test.

It's important to note that death of an individual specified in a Family Trust Election (FTE) does not prevent any other trust, company or partnership from making an Interposed Entity Election (IEE) to be included in the family group of that individual. Super funds may also make an Interposed Entity Election (IEE) if they pass the family control test.

Can I change my test individual?

Yes, it is possible to change the test individual in a Family Trust Election (FTE), but there are strict requirements that must be met. The change can only be made once, and it must be done before the end of the fourth income year after the year specified in the original election.

Family Trust Election (FTE) revocation

A Family Trust Election (FTE) can be revoked if the family trust is a fixed trust or if the Family Trust Election (FTE) was not needed for recouping tax losses, deducting bad debts, or accessing franking credits, under certain conditions.

Generally, revocations can be made until the end of the fourth income year after the income year that was specified in the original Family Trust Election (FTE). These revocations must be made in the trust's tax return for the income year from which the revocation is effective.

If the entity is not required to file a tax return for the income year, the revocation must be given to the Australian Taxation Office (ATO) within two months of the end of that income year, or a later date as allowed by the Commissioner of Taxation.

A Family Trust Election (FTE) cannot be made for a trust that has previously had a Family Trust Election (FTE) revoked. A tax return that has already been filed cannot be amended to include a Family Trust Election (FTE) revocation.

Family Trust Election (FTE) variation

The specified individual in a Family Trust Election (FTE) can be changed once, but only once and subject to certain conditions, such as that the new specified individual was a member of the original specified individual's family at the time of the original election, and that no distributions of income or capital have been made to parties outside the new specified individual's family group during the time the original election was in force.

Additionally, the specified individual can be changed if, due to a family law order, agreement or award arising from a marriage or relationship breakdown, the control of the trust passes to the new specified individual and/or members of their family.

The variation can be made until the end of the fourth income year after the income year that was specified in the original election and must be made in the trust's tax return for the income year from which the variation is effective.

If the entity is not required to file a tax return for the income year, the variation must be given to the Australian Taxation Office (ATO) within two months of the end of the income year or later date as allowed by the Commissioner.

A tax return that has already been filed cannot be amended to include a Family Trust Election (FTE) variation.

How to make, vary or revoke an FTE or IEE

A Family Trust Election (FTE) or Interposed Entity Election (IEE) must be made in writing and using the approved form. The government releases forms each year for making, changing, or canceling a Family Trust Election (FTE) or making or canceling an Interposed Entity Election (IEE). While using these standard forms is not mandatory, the election must be in writing and include all the information required on the form, including a written declaration.

It's important to note that a Family Trust Election (FTE) can only be made once for a trust, and the trustee of a family trust must include the income year specified in the Family Trust Election (FTE) on the trust tax return each year while the Family Trust Election (FTE) remains in effect. The same applies for companies, partnerships, and trusts with Interposed Entity Elections (IEEs).

When a trust receives franked dividends

When a trust receives franked dividends, a Family Trust Election (FTE) allows the beneficiaries to access the franking credits.

Typically, the beneficiaries of a discretionary trust can only access these credits if they do not receive more than $5,000 from all sources during the income year or if the trustee acquired the shares before December 31st, 1997.

If a beneficiary has total franking credit entitlements of $5,000 or more, the "holding period rule" must be met which requires the beneficiary to hold the shares for at least 45 days (90 days for preference shares).

However, this rule is difficult for discretionary trust beneficiaries to meet, but a trustee who makes a Family Trust Election (FTE) can personally satisfy this 45-day holding period test and pass the credits on to beneficiaries.

Trust has revenue losses

To claim deductions for prior year losses, trusts must pass several complex tests such as the income injection test, 50% stake test, pattern of distributions test and control test. These tests can be challenging to apply, especially for discretionary trusts.

However, by making a Family Trust Election (FTE), the trust only needs to pass a modified version of one of the tests, the income injection test, making it easier to claim the deductions.

2004 or earlier income years

For the income years 2004 or earlier, Family Trust Elections (FTEs) could only be backdated by following the guidelines in Practice Statement PS LA 2004/1 (GA) (Withdrawn).

Before that statement, Family Trust Elections (FTEs) could only be made for the earliest year for which a tax return had not been filed, subject to certain transitional rules.

Specifically, the election could not be made for the specified income year if it was made after the entity's tax return for that year had been filed.

Family Trust Distribution Tax

Family Trust Distribution Tax (FTDT) is a tax that is imposed on distributions or conferrals of income or capital made by a trustee of a trust that has made a Family Trust Election (FTE) or an IEE to entities that are not part of the family group specified in the Family Trust Election (FTE) or Interposed Entity Election (IEE).

It is calculated at the top marginal rate of tax plus the Medicare levy, currently 47%. This tax applies to distributions or conferrals made by the trustee after the Family Trust Election (FTE) or Interposed Entity Election (IEE) has become effective.

However, salary, wages, or other benefits provided to employees for work performed are not considered a distribution and will not trigger Family Trust Distribution Tax (FTDT) as long as they are commensurate with commercial rates for the type of work or services provided.

Avoiding Family Trust Distribution Tax (FTDT)

It is important for trustees and their agents to regularly review and be aware of the family trust elections they have in force. This includes considering whether the election is still needed, whether the specified individual is still the most suitable person, and being aware of the timeframes for revoking or varying the election.

Regularly reviewing these matters, at least annually, and not treating them as "set and forget" can help avoid potential Family Trust Distribution Tax (FTDT) liabilities.

It's also crucial to recognise who are the members of the specified individual's family group when making annual trustee resolutions, as distributions outside of the family group will result in Family Trust Distribution Tax (FTDT).

Examples showing how FTDT is applied

FTE variation invalid triggering FTDT liability

The trustee of Trust P, which has a Family Trust Election (FTE) designating Paul and the 2010 income year, made distributions to Trust S, which has an Family Trust Election (FTE) designating Sally, in the 2017, 2018, and 2019 income years. Although Paul and Sally are from the same family, their trusts are not considered part of the same family group.

In the 2017 income year, Trust P attempted to make a variation to its Family Trust Election (FTE) by changing the designated individual from Paul to Sally. However, the variation was found to be invalid as it was made outside of the legal timeframe.

Additionally, Trust S was not able to file an Interposed Entity Election (IEE) to be included in the same family group as Trust P because it had already filed an Interposed Entity Election (IEE) to join another family group.

As a result of these circumstances, a Family Trust Distribution Tax (FTDT) liability was triggered and assessed for the 2017, 2018, and 2019 income years for Trust P.

FTE variation and IEE revocation period lapsed triggering FTDT liability

The trustee of Trust J, which has a Family Trust Election (FTE) designating John, made distributions to Trust L, which has a Family Trust Election (FTE) designating Lionel and the 2014 income year, for the years 2016, 2017, and 2018. Although John and Lionel are from the same family, their trusts are not considered part of the same family group.

Trust L was unable to file a Family Trust Election (FTE) variation to change the designated individual from Lionel to John because the legal timeframe for doing so had expired.

Furthermore, another trust, Trust N, also has a Family Trust Election (FTE) in place that designates Lionel as the primary individual. Trust L had made an Interposed Entity Election (IEE) with Trust N, designating the 2014 income year. Trust L was unable to cancel this Interposed Entity Election (IEE) because the legal timeframe for doing so had expired.

As a result, Trust L was unable to vary the Family Trust Election (FTE) or make another Interposed Entity Election (IEE) to be included in the same family group as Trust J, which resulted in a Family Trust Distribution Tax (FTDT) liability being triggered and assessed for the years 2016, 2017, and 2018 for Trust J.

From these examples, it's important to note that if the client or their agent had carefully reviewed the elections they had in place each year before making distributions, they could have avoided triggering a Family Trust Distribution Tax (FTDT) liability by being mindful of the rules and timeframes for varying and/or canceling their elections. We encourage clients with elections in place and their agents to be mindful of this to avoid possible Family Trust Distribution Tax (FTDT) in future years.

Trustee beneficiary non-disclosure tax on circular trust distributions

As of July 1, 2019, the trustee of a family trust, a trust that has made an interposed entity election or a trust that is part of a family group will be subject to trustee beneficiary non-disclosure tax if:

• A portion of the net income of the trust is included in the taxable income of a trust beneficiary (as per section 97 of the ITAA 1936)
• The beneficiary becomes immediately entitled to an amount that is reasonably linked to the untaxed portion of that share, referred to as a 'round robin' or 'circular trust distribution'.

Next Steps

Making a Family Trust Election (FTE) is a decision that should be carefully considered, especially if the trust's main goal is to stream franking credits to beneficiaries or if the trust has revenue losses.

It is important to remember that making a Family Trust Election (FTE) does not necessarily mean that distributions can be made to every member of the family group; the trustee must refer to the trust deed to ensure that each person meets the definition of a beneficiary.

If a distribution is made to someone outside of the beneficiary class, the trustee may be subject to a 47% tax rate (including the Medicare Levy) on the amount of the distribution.

Other factors that may impact an effective distribution from a family trust include the trustee's power to determine income, the power to stream income and the trust's definition of beneficiaries.

If you have any questions regarding Family Trust Elections (FTEs) or the operation of your family trust, it is recommended you seek legal advice.

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Disclaimer

Any advice contained in this document is general advice only and does not take into consideration the reader’s personal circumstances. Any reference to the reader’s actual circumstances is coincidental. To avoid making a decision not appropriate to you, the content should not be relied upon or act as a substitute for receiving financial advice suitable to your circumstances.

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