Family Trust Elections

The ATO recently conducted a webinar on Family Trust Elections (FTEs) to increase awareness of the reasons why a trustee may make an FTE, the implications of making FTEs and Family Trust Distributions Tax (FTDT). ATO officers have also raised FTEs in recent speeches, and the published findings of the Next 5000 program published in December 2024 identified distributions outside the family group as a key priority area, highlighting that family trusts and FTEs are on the ATO’s radar.

What is an FTE?

An FTE is an election voluntarily made by a trustee that a trust is to be a “family trust”. In doing so, it must identify the specified or “test” individual and the income year from which the election is to apply. The trust must satisfy the “family control test” which looks at who can control the application of the income and capital of the trust.

The family group to which these rules apply is determined in reference to the test individual, and includes the test individual and their spouse, along with their parents, grandparents, brothers, sisters, nieces and nephews and all lineal descendants and their spouses as well as entities that satisfy the family control test.

In addition, to allow distributions to non-individual entities within a group, interposed entity elections (IEEs) may also be required to include these other entities within the family group.

Once an election is made, if distributions are made outside the family group, then FTDT will apply at the top marginal rate plus Medicare levy, i.e. 47%. General interest charge (GIC) will also apply in addition to the FTDT.

Reasons to make an FTE

Having an FTE can be advantageous for numerous reasons. While FTEs were originally introduced as part of the trust loss provisions, having an FTE in place also provides concessional treatment in relation to:

• company loss tracing;
• the holding period rule;
• trustee beneficiary reporting; and
• small business restructure relief.

Each of these are briefly considered below.

Trust loss provisions

Trusts need to satisfy certain tests so that income losses can be carried forward to future years. Where an FTE has been made the trust only needs to satisfy a modified income injection test (other types of trusts must satisfy additional and more stringent tests). While the rules do not apply to capital losses, if there is a possibility that the trust may incur income losses, considering whether an FTE is required is especially important.

Company loss tracing

When determining the ability of a company to utilise carry forward losses, the company must pass the continuity of ownership test (COT). If it cannot satisfy the COT, it must satisfy the business continuity test, previously referred to as the same business test.

The COT requires the same persons to have had more than 50% of the voting power, 50% of rights to capital and 50% of rights to dividends from the beginning of the loss year to the end of the income year in which the loss is being utilised. When tracing through a company to determine which persons hold these rights, it is not possible to trace through discretionary trusts. This would mean the company could not satisfy the COT and would need to satisfy the business continuity test.

Section 165-207 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a family trust to be treated as a single notional shareholder, meaning the COT is capable of being satisfied.

Holding period rule

The holding period rule, or 45 day rule, requires a shareholder to hold shares “at risk” for at least 45 days to be entitled to franking credits on any dividends received. Discretionary trusts without an FTE cannot satisfy the “at risk” requirement due to there being no beneficial ownership of the shares.

If an FTE is made, the trust and the shareholders are taken to have a position in the shares meaning the holding period rule can be satisfied.

The small shareholder exemption can still apply if an FTE has not been made provided the total franking credits received by the trust and the beneficiary do not exceed $5,000.

Trustee beneficiary reporting

Trustees of closely held trusts need to provide certain information to the ATO regarding certain distributions to other trusts. That is, they need to make a correct Trustee Beneficiary (TB) statement for an income year if:

• a share of the trust’s net income is included in the assessable income of a trustee beneficiary and the share includes an untaxed part or
• a trustee beneficiary is presently entitled to a share of a tax-preferred amount, e.g. the discount component of any discount capital gains.

Trustee beneficiary reporting is not required where the closely held trust has made an FTE.

Small business restructure relief

Subdivision 328-G of the ITAA 1997 allows rollover relief for small businesses to restructure their businesses. One of the tests in Subdivision 328-G is that there must not be a material change in the individuals that have the ultimate economic ownership of the transferred assets. Where a transfer of assets involves a family trust, if individuals within the family group have all of the interests in the assets either before or after the transfer (as relevant), then a material change will not be taken to have occurred, and roll-over relief may therefore be available.

How to make an FTE

FTEs must be made in the approved form, that is, it is recorded on the trust’s income tax return as well as completing the form available on the ATO website.

The election must include the nomination of a test individual. There are not any restrictions relating to who can be a test individual, but they do need to be alive at the time of lodging the tax return for the year in which the FTE is to apply.

The FTE also needs to specify the income year from which the election is to apply. It can apply to earlier years, but it is necessary to ensure the family control test and conferrals of distributions comply with the provisions from the beginning of the year in which the FTE applies.

Issues with making an FTE

While making an FTE provides access to the concessions outlined above, due to the inflexibility of the rules there are issues that need to be considered before making one.

Distributions outside the family group

The family control test which determines which entities are included in the family group is complex, and it should not be assumed that all entities are eligible to be included. A detailed analysis needs to be undertaken to ensure that distributions are not inadvertently made to entities outside the family group.

FTDT applies if a distribution is made outside of the family group. For these purposes, distribution is defined broadly and includes payments by the trustee, transfers or the use of property, applying money or property for the benefit of a person, or the forgiveness of debts.

Crucially, there is no discretion available for the Commissioner to remit FTDT and there is also no limitation on the amendment period. Historical FTDT issues therefore remain a concern, particularly where the trust is subject to an ATO audit.

Futureproofing

There are several issues which arise when an FTE has been made which can impact the future structure of the group and its flexibility.

If for example a group company is sold in the future, and the entity has made an IEE to be part of the family group, it will not be able to make distributions to the new owners as FTDT will apply. It therefore means that there is less flexibility in being able to divest entities, as a purchaser would only want to acquire the business assets, not the entity itself.

As mentioned above, FTEs can only be made while the test individual is alive. Thought needs to be given as to what will happen once the test individual passes away if new group entities are required.

It is possible to revoke or vary an election but only in certain situations so the initial decision to make an election needs to be considered in detail.

Should we make an FTE?

It is not a requirement to have an FTE so each trust has a choice as to whether one should be made. This will depend on the trust’s particular circumstances and the need to access the concessional treatment applicable to family trusts. For example, where a discretionary trust will make losses or receive dividends, e.g. as a shareholder of a trading company, it is more likely an FTE will be required.

Other things to consider

You do not need necessarily need to lodge FTE and IEE forms with the ATO, however the ATO recommend doing so. Ticking the box on the income tax return that an FTE has been made may not convince the ATO of an FTE or IEE’s existence if a copy of the actual election cannot be provided.

Next steps

If you are looking to make FTEs or IEEs or you have previously made elections and want to better understand the implications, then please reach out to your MGIDC advisor.