Family Trust Election

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Contents

  • How a FTE works
  • Reasons for making a family trust election
  • Eligibility – the family control test
  • What does ‘control’ mean?
  • The family group
  • Effect of death on a family trust and a family group
  • Applying a FTE retrospectively
  • Revoking a FTE
  • Varying a FTE
  • Interposed entity election

A trustee of a trust can make a family trust election (FTE) in respect of that trust. The FTE provides the trust with a number of benefits (explained more fully below) including:

  • less stringent testing in order for losses of the family trust to be utilised as a deduction.
  • concessional treatment in respect of the application of the holding period rule that enables the beneficiaries of the family trust to utilise franking credits on dividends distributed to them.
  • concessions regarding the satisfaction of the continuity of ownership test for a company in which the family trust holds shares.
  • expanded eligibility for the family trust to access the small business re-structure rollover.

Conversely, if a FTE is made, there is a risk of family trust distributions tax for distributions made to persons or entities outside the ‘family group’.

It is certainly the case that a family trust election will not be appropriate for every trust and a case-by-case assessment of suitability is recommended.

See our Trust Tax article for more general details on trust taxation.

How a FTE works

The family trust election requires a living individual to be nominated as the ‘test individual’, also known as a ‘specified individual’ or ‘primary individual’. The election must be made in writing and in an approved form. The ambit of the family group is defined by reference to the test individual. The test individual must be living at the time of election, but the subsequent death of that individual will not upset the standing of the election.

The trust is permitted to distribute income or capital of the trust to persons within the family group (see heading below regarding definition of family group). However, it is first necessary to determine that the trust is eligible to make a family trust election by having satisfied the family control test.

Two pairs of shoes and flip flops lines up on the beach sand.

Reasons for making a family trust election

The trust has losses or bad debts, and the trust loss rules would prevent the trust from carrying the losses forward or claiming the bad debt. Making a family trust election in relation to a trust makes it an “excepted trust”. The rules regarding the denial of tax losses and bad debts under the trust loss provisions do not apply to excepted trusts. The income injection test, which is part of the trust loss rules, will still apply to a family trust.

If a non fixed trust holds equities on which frank distributions are received, the beneficiaries will be entitled to claim a tax offset for the imputation credits attached to the dividends, if they are franked. In the absence of the family trust election, the recipient of the dividend would not be able to satisfy the holding period rule. There is an exception if the beneficiary of the trust is an individual and has franking credit entitlements in an income year of $5,000 or less.

With regard to the $5,000 level of franking credits, this represents a reasonably large Australian share portfolio. Particularly if the dividends distributions are split between more than one individual, trustees should think carefully as to whether a family trust election is really needed to enable the beneficiaries to make use of franking credit tax offsets.

If a company has losses, which is owned by a non-fixed trust, the company cannot satisfy the continuity of ownership test unless the trust is a family trust. To satisfy the continuity of ownership test, the same persons must beneficially own more than 50% of exactly the same shares in the company from the beginning of the loss year until the end of the year in which the losses are recouped.

Where at least 50% of the shares in a company are held by a non-fixed trust, it is not possible for the company to satisfy the continuity of ownership test because 50% or more of the shares do not have a beneficial owner. (The trustee is the legal and not the beneficial owner).

Nevertheless, if the trustee makes a family trust election from at least the beginning of the loss year, the shares are taken to be beneficially owned by the family trust from that time which means the company can satisfy the continuity of ownership test.

If a transferor non-fixed trust or transferee non-fixed trust wishes to gain the benefit of the rollover on assets under the small business restructure rollover (Subdivision 328-G ITAA 1997), it is necessary that they are family trusts and the same family groups are the “ultimate economic owners” of the assets.

If there is another trust where it is desired to bring that second trust within the family group, a method of doing this is to make a family trust election for the second trust and nominate the same test individual as for the trust that has already made a family trust election.

Eligibility – the family control test

A family trust election is only available for a trust if the family control test is passed. The test requires that the trust is ‘controlled’ by a controlling group consisting of some or all of the following persons:

  • The test individual and / or any members of the family group; or
  • Any of the above persons and an expert adviser to the family; or
  • The trustee of one or more family trusts. This is provided that the test individual is the same person in respect of both trusts and the family group has greater than a 50% stake in the income or capital of the trust.

What does ‘control’ mean?

Broadly, the group will be taken to control the trust if either of the following powers exists:

  • The group has power to obtain the benefit (including indirectly, if relevant) of the income or capital of the trust; or
  • The group has power to control (including indirectly, if relevant) the distribution of income or capital of the trust; or
  • The trustee generally acts in accordance with the directions or wishes of the group; or
  • The group has power to remove or appoint the trustee; or
  • The group has greater than a 50% stake in the income or capital of the trust; or
  • Persons in the group are the only persons who can benefit from the income and capital of the trust.

Note that some of these above control tests will not be satisfied where the relevant power is being exercised by an expert adviser described in point 2 above.

The family group

The ‘family group’ consists of the following:

Individuals that can be included in the family group:

  • The test individual, their child, parent, grandparent, brother, sister, nephew, niece. Note that a ‘child’ includes an adopted child, stepchild, ex-nuptial child, child of a spouse, or child within the meaning of the Family Law Act.
  • The spouse of any of these above-listed persons. This includes an ex-spouse and an individual with whom the individual is in a relationship and lives with on a genuine domestic basis.
  • The lineal descendants of a nephew, niece or child of the test individual or the test individual’s spouse. Note that lineal descendants is defined to include adopted children, step-children or ex-nuptial child.
  • An individual who was a spouse of the test individual or the spouse of a family member before a relationship breakdown in a marriage or relationship.
  • An individual who was member of the family group immediately before the death of the test individual or another family member and who becomes the spouse of a person who is not a member of the family group.
  • An individual who was a child of the spouse of the test individual or group family member before a breakdown of the marriage or relationship.

Entities that can be included in the family group:

  • The family trust itself.
  • An alternative trust with the same test individual specified in its family trust election.
  • A company, trust or partnership which has made a valid interposed entity election to be a part of the family group.
  • A company, trust or partnership whereby members of the family group (and / or their relevant family trusts) have fixed entitlements to all of the income and capital of that entity.
  • Certain interests in small enterprises, certain funds and certain tax-exempt bodies.

Note that the above-listed persons do not cease being part of the family group merely because of the death of the test individual or another family member.

Effect of death on a family trust and a family group

Death of a family member

Section 272-95(2) states: “A person does not cease to be a family member merely because of the death of any other family member”.

The important word in this provision is “merely”. This appears to mean “solely”. That is, if there is another reason, in addition to the death of someone in the family that makes an individual no longer in the family, 272-95(2) has no application and the person concerned will no longer be a member of the family. They may still be a member of the family group.

As a simple example, assume the test individual dies. This means the (former) spouse of the test individual is no longer the spouse of the test individual and, without more, the spouse would cease to be a member of the family and the family group. However, due to the operation of 272-95(2), the spouse remains a member of the family and the family group.

New relationship following death

As stated above, an individual will not cease to be a member of the family group if they were the spouse of a deceased member, and the living former spouse becomes the spouse of another person who is not a member of the primary individual’s family. However, that person is very likely to cease being a member of the family.

For example, assume that Mark is married to Jennifer. Jennifer is a sibling of the test individual of a family trust. This makes both Jennifer and Mark members of the family. Jennifer dies. This means that Mark is no longer the spouse of a sibling of the test individual. If nothing more occurred, Mark would remain in the family due to the operation of 272-95(2).

However, Mark meets Jane and they marry. Jane is not a member of the test individual’s family. Due to this, Mark will cease to be a member of the family because the death of Jennifer is not “merely” what is causing Mark not to be a member of the family. Mark is now the spouse of a person outside the family, and this means that there is another reason, other than the death of Jennifer, that takes him outside the family.

In this instance, 272-90(2A)(b) will have operation to include Mark (not Jane) in the family group of the test individual. However, Mark (nor Jane) will be in the family of the test individual. This means that distributions can be made to Mark by the family trust without incurring FTDT. Distributions to Jane would attract FTDT. If the family control test is being considered for an entity, Mark’s influence over that entity would not be taken into consideration because he is not a member of the test individual’s family.

If Mark and Jennifer had children, these children would be either nephews or nieces of the test individual and the children would remain members of the family.

Step-children

Assume Gary, a nephew of the test individual is married to Rita. This is a second marriage for Rita, and she has child from her first marriage. The child’s name is Charles. All three individuals are members of the test individual’s family because Gary is a nephew of the test individual and Rita is a spouse of Gary. Further, Charles is in the family because he is a step-child of Gary.

Gary dies. If nothing more happens, Rita and Charles will remain members of the test individual’s family because a person does not cease to be a family member merely because of the death of any other family member.

However, Rita meets Usain, and they start living together as a couple. This makes Rita the spouse of Usain. Accordingly, Rita ceases to be a member of the test individuals’ family because the death of Gary is not the only reason Rita is no longer a member of the family. However, Rita remains a member of the family group due to the operation of 272-90(2A)(b).

Charles ceases to be both a member of the family and the family group. He is no longer the step-child of Gary and Charles’ mother’s relationship to Usain means that he cannot rely on the “mere death” inclusion to keep him in the family. Further, there is no provision in section 272-90 that will include him in the family group.

Variation of the test individual

The ATO will not permit a test individual to be changed to another test individual if the first test individual has died.

However, if the conditions are satisfied, a test individual can be varied to another test individual. These provisions are available whether or not the test individual has died. The conditions that must be met are:

  • The new test individual must have been a member of the family since the original family trust election commenced; and
  • Any distributions since the original election was made have been to the new test individual or anyone included in the new test individual’s family group; and
  • There must not have been any previous change of the test individual; and
  • The variation of test individual must happen in the period between the start of the income year specified in the original election and ending 5 years after that time.

Applying an FTE retrospectively

The family trust election can be instituted retrospectively and be deemed to commence from as far back as the 2004/05 income year. However, this retrospective commencement time is only possible where at all times from that earlier income year:

  • the trust satisfied the family control test; and
  • only the test individual or members of the family group have been made presently entitled to capital or income from the trust or received distributions of capital or income.

Revoking an FTE

The family trust election may not be revoked other than in limited circumstances. Specifically, revocation is permitted where within 4 years after the income year specified in the original family trust election:

  • The trust which has the election in place is a fixed trust; or
  • Concessions available under the election have not been utilised by the trust. For example, tax losses must not have not been recouped by the trust or another entity where those losses could not have been recouped without an election in place. Similarly, bad debt deductions or franking credits must not have been claimed if the claim was only available because an election was in place.

Once revoked, the trust is not permitted to have a further family trust election instituted.

Varying an FTE

The test individual may be varied on only one occasion within 4 years after the income year specified in the original family trust election. This is provided that:

  • The new test individual was a member of the original test individual’s family group when the election commenced; and
  • Since the election commenced, no person outside of the new test individual’s family group has been made presently entitled to capital or income of the trust or received distributions of capital or income.

The test individual may also be varied pursuant to family court orders where there is a marriage breakdown.

Two pairs of big and small boots.

Interposed entity election

The members of the family group include those natural persons who are family members of the test individual. However, it is possible for a company, trust or partnership to make an interposed entity election to also be included in the family group. This election must be made in writing and in an approved form.

Note that an interposed entity election is not necessarily required where members of the test individual’s family have fixed entitlements to all of capital and income of the entity. In such circumstances, the entity will automatically be a member of the family group.

For an entity to be eligible to make an interposed entity election, the interposed entity must itself pass a modified version of the family control test at the end of the income year of the proposed commencement of the election. To pass the modified test, the controlling group must beneficially hold (including indirectly, if relevant) fixed entitlements to greater than 50% of the capital or income in that interposed entity.

The interposed entity election may be elected to commence in an income year later than the income year in which a family trust election commenced and as far back as the 2004/05 income year. However, this retrospective commencement is only possible where at all times from that earlier income year:

  • the company, trust or partnership satisfied the family control test; and
  • only the test individual or members of the family group have been made presently entitled to capital or income from the trust or received distributions of capital or income.

The interposed entity election may only be revoked in limited circumstances. For example, where the entity is a member of the family group i.e. where only members of the family group hold fixed entitlements to 100% of the capital and income of the trust. The interposed entity election will automatically be revoked where the underlying family trust revokes its family trust election.

Note that an interposed entity election can be made in respect of two or more family trusts where the test individual in each of these family trusts is identical. This enables different family trusts to distribute to the same interposed entity without any family trust distributions tax consequence.

This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.