Tax Tip 255: What is a Family Trust election?

A Family Trust Election is an election made by the trustee of a discretionary trust to make that trust into a ‘family trust’ for tax purposes. This has the effect of limiting the beneficiaries to who the trustee can distribute to (without penalty tax) to the immediate family members of a nominated ‘test individual’.

There are probably 4 reasons an FTE might be needed to be made:

a) To carry forward losses

b) To be able to distribute franking credits with franked dividends,

c) To distribute to another trust within the family group, and

d) For some small business CGT concessions

A trust that has as FTE in force the trust is an exempted trust which means it doesn’t have to meet certain rules designed to stop the trading of trust losses.


A FTE election of a test individual is generally irrevocable so great care must be taken before the trustee nominates a person. I will cover this in a future tip.

 

And since a FTE is irrevocable (excepting some limited circumstances that expire with time) it is generally best to defer a FTE until it is required.

I'm often asked about the merits of preserving a trust that may have some accumulated revenue or CGT losses. One of the limitations is ensuring that a FTE is made.

The other major one is franking credits. Without a FTE the holding period rules are failed by the trustee or a beneficiary meaning that the franking credits may be lost. However a FTE is not always required to meet this test. It may be an advantage to defer the FTE in these situations.

A FTE is a specific form and in practice comes with some traps
1. It is irrevocable except in limited instances
2. Later death can severely complicate a nominated test individual and the definition of "family"
3. Cannot be made prior to the end of the year (it may be invalid if it is)
4. Must be lodged with the ATO together with the trust tax return when made. Thereafter the FTE will be referred to within the return.

 

can also assist with allowing a company to pass the continuity of ownership test

 

and a little tip. did you know that uncles and aunties are not Family Members for the FTE Test Group

 

little scenario

- The ABC Discretionary Trust has made a FTE
- Paul is the test individual
- Paul owns 80% of the shares in Price Financial Pty Ltd and 20% is owned by his uncle
- The ABC Trust wants to distribute income to Price Financial Pty Ltd to absorb some losses

Should Price Financial Pty Ltd make an Interposed Entity Election ? Can it ?

 

Is Price Financial Pty Ltd part of the family group of Paul?
Yes because Paul has more than 50% of the shares in the company so has more than 50% fixed entitlements

There is no need for the company to make an IEE. It can make one because the family control test is passed.
Should it make one? Probably not unless it is needed.

 

Depends on control.. If the shareholders had an equivalent vote (1 each) then I may lack control. I would want to ensure voting was based on shares (ie 1 vote per share). I would agree with Terry. Dont make elections unless required. And do so before the due date. And dont amend a FTE

 

If a FTE is made, how does this affect distributing to a bucket company?

 

Complexly.
The company must be part of the family group and might need to make an interposed entity election.

 

A negatively geared property in any type of trust would have losses quarantined in the trust needing to carry forward to the next financial year. Does that mean from Year 1 of owning a negatively geared property any type of trust needs to make a FTE?

Does FTE effect all types of trusts, whether they are discretionary, unit, hybrid, etc.?

 

no

yes

 

In what circumstances can a trust distribute franking credits without an FTE?

My family trust holds ETFs which have franking credits attached in the distributions. The accountant has always claimed them but we don't have an FTE.

 

It cannot unless the recipient of the franking credits has less than $5,000 from all sources.

 

Yes the franking credits can be cancelled. Surprisingly, the ATO does have a field for the FTE date etc on the cover of a trust return making it a compliance issue that is obvious but they dont actually seem to have a process to cancel franking where there isnt a FTE. Or query it.

Failure to make a FTE can allow a late FTE to be lodged late well after a amendment period may have expired as the FTE is a seperate lodgement to the return itself. Its a complex issue for tax advice BUT usually wise to fix it. I suspect that may be the greater reason why the ATO dont chase it. Its like not including tax losses incl CGT losses in a past return. Its always able to be included in the present anyway.

 

A discretionary trust of which I am trustee has received substantial Capital Losses in its first year of operation. There are not enough capital gains to offset this to a net positive amount.
It seems that the best course of action for me would be to carry this loss forward to later years in which it might be available to offset any capital gain within the trust.
I have read both the post above, and the ATO and it seems that I do not need to do anything in this financial year (today is the last day of the financial year), but that I can create a Family Trust Election at any point in the subsequent year and file that with my tax return. Doing so would permit me to carry forward the Capital Losses for offset.
Question 1: is my understanding correct?

I do not expect the family group to modify other than perhaps new children of nominated reference individual. No new companies expected, and if they are they will be majority/wholly owned by the nominated reference individual.
Question 2: what disadvantages could there be of making a FTE in this circumstance?

 

Something the trustee will need specific legal advice on. See schedule 2F of the ITAA36

Being unable to distribute outside the family group without extra tax payable.

 

A family trust election is not required to carry losses forward. It is required to recoup or utilise the loss. A CGT loss isnt specifically covered by a FTE anyway. A net CGT loss isnt part of net trust income. BUT it may partially be if a small CGT gain is covered by a part of the loss. Instead it defers the CGT loss until it can be utilised when a future CGT event occurs.

I always recommend the need to make a FTE and nominate a test individual be deferred as long as possible. This avoids other complex issues if the test individual dies later. Income injection tests and so on. A FTE certainly should NOT be made now and should be considered at the time the return is being prepared. FTE are irrevokable (not quite) and mistakes complicate issues. If at that time deferral is suggested it then should be rechecked each year.

This is a good example of why having procifient tax advice to support a trust is essential.

 

Thanks Terry and Paul. I think I was confusing general losses (non-capital) and capital losses. The latter of which is the only ones I have, and Trust capital gains and losses seems to confirm that a FTE isn't required for this as Paul mentioned.

My circumstances suggest that I don't need a FTE right now and so I'll certainly be holding off until beneficial.

You're correct this is a complex area, and very easy to become confused.

 

Think in terms of estate planning long term. Your daughter could marry someone who is beneficiary of an existing trust that has already made a FTE to someone else in the other family. One of these trusts may have income and the other a loss. It might be hard for them to distribute to each other as they probably won't be in the same family group

 

Am I reading this correctly that the only point at which a FTE will be required for a discretionary trust is if the trustee wants to offset some of the capital gain in a future year (thereby reducing tax applied to capital gains of the trust)?

therefore, if a trust which is invested in shares (and which is therefore more likely to seek/achieve capital gains each year due to turnover) has profit in the subsequent year (year 2), then in order to reduce the Capital Gains Tax (CGT) they will have to have a FTE?

If this is the case, then if the discretionary trust achieves net positive capital gain in year 2 after a loss in year 1, but the trustee doesn't make a FTE then the year 2 gains are of course taxed without utilising the capital loss. But does this mean the capital loss account from year 1 can still be carried forward to year 3 (or any later year) to a time when the trustee sees it more worthwhile to make a FTE?