Just because your family trust includes the words “Family Trust” in its name, doesn’t mean your family trust is a family trust for income tax purposes.
To be seen as a Family Trust by the ATO the trust needs to make a Family Trust Election.
What is a Family Trust Election?
A Family Trust Election (FTE) is a choice by the trustee of the trust to specify a particular individual around whom the family group is formed. This individual is called the test individual. The family group is then restricted to a maximum group compared to all of the potential beneficiaries possible in the trust deed.
The family group is limited to:
- The test individual and their spouse
- Any parent, grandparent, brother or sister of the test individual (or the test individual’s spouse)
- Any nephew, niece or child of the test individual or their spouse and any lineal descendent of these individuals
- The spouse of anyone mentioned above
- A company, trust or partnership where anyone mentioned above has an entitlement to all of the capital and income of the entity (or an appropriate FTE or interposed entity election has been made)
This is also subject to the above mentioned also being an eligible beneficiary in the trust deed.
Why should I make a Family Trust Election?
A trustee should consider making a FTE in the following circumstances:
- The trust receives franked dividends
- The trust has losses
- The trust owns shares in a company with losses
- To bring the trust within the family group of another trust, or
- Where the trust is involved in a restructure under the new small business restructure roll over relief
Where a trust receives franked dividends, the franking credits (the tax credits for tax paid by the company) can only be passed onto the beneficiaries if one of the following is satisfied:
- The shares were acquired pre 31 December, 1997 or
- The beneficiary is an individual who does not receive more than $5,000 in franking credits from all sources during the year (the small shareholder exemption)
- where a trust has made a FTE.
In order for a trust to offset prior year’s tax losses against future taxable income the trust needs to be able to pass all of the following tests:
- The income injection test
- The control test
- The 50% state test and
- The pattern of distributions test
However, where a FTE has been made the only test that needs to be satisfied is a modified income injection test (which is easier to satisfy than the standard income injection test)
In order for the company to offset prior year’s tax losses against future taxable income the company needs to be able to pass one of the following tests:
- The continuity of ownership test (COT) or
- The same business test (SBT)
In order to pass the COT, 50% or more of the shares in the company must be beneficially owned by the same people at all times during the test period (from the start of the loss year to the end of the income year).
Where the shares are owned by a trust, the company may not be able to pass the COT as it is very difficult to work out which individuals own which % of the shares.
However, where a FTE has been made the trust is treated as an individual for the purposes of assessing whether the COT is passed.
To bring a trust within the family group of another trust.
A trust with profits that has made an FTE, can possibly distribute to another trust if it has also made a FTE choosing the same test individual.
Small business restructure roll-over relief
Beyond the scope of this article. If we have identified your trust as a candidate for restructure, we will discuss FTE’s with you.
If your trust receives franked dividends, has losses, or own shares in a company with losses, the trustee should seriously consider whether it needs to make a FTE.
The FTE is made in the trust’s income tax return. Please discuss this with us prior to making any FTE.