Does your family trust receive franked dividends or have tax losses? In this case, for accessing specific tax concessions, the trustees could consider the option of making an FTE or a family trust election.
Making a family trust election can help you simplify the rules to a great extent. However, it comes with the risk of reduced flexibility and huge penalties if the election is breached.
This article aims to simplify what the family trust election is, how it is beneficial and what the consequences are.
What is a family trust election?
A family trust election or an FTE is the choice made by the trustee to specify a certain individual (or the test individual) around whom the family group will be formed.
Simply put, the test individual is the reference point used to define the ‘family group’ for election purposes. The specified individual must be alive when the election is made, and the trust also needs to pass the ‘family control test’ (which is discussed later in the article).
When the family trust election (FTE) is in force, the trust will constitute a family trust.
The election has to be made in the Australian Taxation Office (ATO) approved form, and it will usually take effect from the commencement of the specified income year in the election. Keep in mind that before the family trust election is made, the income year (specified) must have ended.
The reason behind this is that the FTE can only be made when the trust passes the family control test at the end of the year.
Making a family trust election is extremely beneficial for the trusts receiving franked credits or having revenue losses. The trustee needs to be aware that although with FTE, you may obtain concessional tax treatment but with it comes the risk of family trust distribution tax (FTDT) when any distribution is made to a beneficiary who is outside of the family group.
It is the reason why family trust election is not appropriate for everybody.
Trust receiving franked dividends
With the help of a family trust election or an FTE, the beneficiaries of a trust can access franking credits once the trust receives franked credits.
Usually, beneficiaries of a discretionary trust can be passed franking credits if they don’t receive more than $5,000 in franking credit in an income year (from all the sources) or if the shares were acquired before 31 December 1997.
If the total franking credit entitlements of a beneficiary is $5,000 or more, the ‘holding period rule’ has to be satisfied. This rule requires the beneficiary to hold the shares at risk for 45 days minimum, and when it comes to preference shares, the duration of the holding period doubles, i.e. 90 days.
Any beneficiary of a discretionary trust that can’t satisfy this holding period rule will not be given the benefit of franking credits.
Now this is where a family trust election (FTE) can help. A trustee who made an FTE can satisfy this 45-day holding period rule personally and then pass the franking credits to beneficiaries.
Trust having revenue losses
For deducting losses from previous income years, trusts have to satisfy a couple of complex tests known as the 50% stake test, control test, pattern of distribution test and income injection test.
The tests are complicated when it comes to their application, especially when applied to discretionary trusts.
However, if the trust makes a family trust election (FTE), it will only have to satisfy the modified version of one of those trust loss tests, the income injection test.
Test individual – who can be the test individual?
One of the most important aspects of a family trust election (FTE) is identifying the ‘test individual’. The election must be made in writing, for which a form published by the Australian Taxation Office (ATO) is used.
The ‘family group’ surrounding the test individual will then be able to set the range of beneficiaries to whom the distributions can be made without triggering the family trust distribution tax (FTDT).
The family group of a test individual mostly includes:
- The test individual themselves, along with their spouse;
- The sibling, parents and grandparent of that test individual or their spouse;
- Child, niece or nephew of the test individual (or their spouse) and other lineal descendants of these people;
- Spouses of the individuals mentioned above;
- Former spouse(s) of the test individual or any family member who is no longer a family member (because of the breakdown of a relationship or marriage, or the demise of the test individual or their family member).
Not every family member of the test individual forms part of the family group, for example, cousins, uncles or aunts, and you must keep this information in mind to avoid any accidental exposure to family trust distribution tax (FTDT).
Is it possible to change my test individual?
Simply put, yes, the identity of the test individual can only be changed once (but must satisfy strict requirements). Also, remember that such variations can be made until the end of the 4th year from the specified year in the original election.
Family control test
A trust has to satisfy the family control test to make a family trust election (FTE). For this test, some or all of the people are needed to control the trust:
- The test individual;
- The family members of the test individual;
- The professional legal or financial adviser of the family;
- The trustees of one or more than one family trust, where individuals who specify in the family trust election (FTE) and the individual, along with family members, have more than 50% stake in the capital or income of the trust.
A group with all the people mentioned above is considered to have control of the trust. This group basically has the power to obtain or control the beneficial enjoyment of the capital or income of the trust or can even appoint or remove the trustees.
Are there any consequences of making a family trust election?
Although it is extremely beneficial to make a family trust election (FTE), there is one thing you must be aware of. The distribution from the entity cannot to made to a person outside of the family group of the test individual without FTDT (family trust distribution tax).
When such distributions are made, you may be subject to 48.5% on the distribution value (*current family trust distribution tax rate).
Hopefully, this guide was able to help you understand what family trust election is and whether it is the right choice for you.
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