FTE Questions

When you work with private clients the question of a Family Trust Election almost always comes up. But you need to be careful. A family trust election can be dangerous and cost you a lot of tax, ie. Family Trust Distribution Tax. Unlike normal income tax, the amendment periods don’t apply to Family Trust Distribution Tax, so the ATO can still hit your client decades later with FTDT. Hence, it is really important to get Family Trust Elections right.

In this episode, Jonathan Ortner of Arnold Bloch Leibler will answer the following 10 FTE questions

Here is what we learned, but please listen as Jonathan explains all this much better than we ever could.

Access the episode through a free podcast app on your mobile phone to listen while you drive, walk, or work.

1 – How the Trust Loss Provisions Killed Trust Loss Trading

Trust loss trading is a thing of the past. It used to be very common in the 1980s and early to mid-1990s, but then the trust loss provisions came in and ended the party.

Before 1995, a trust could freely offset carry-forward tax losses, while companies had to battle continuity of ownership and business tests. This made trusts very popular and companies very less so.

It also led to the trading of trust losses. In other words, you could sell trust losses back then.

How Trust Loss Trading Used To Work

Imagine you had a trust with an accumulated loss and no profit in sight. Unless you use this loss to offset income, the loss is wasted.

You wonder how to use this wasted loss to your advantage. You have four options: You

1 – get an outsider to inject income into the trust. For example, a third-party trust distributes income to your loss trust. Or you bring an outsider into the trust to generate a profit within the trust.

2 – distribute to a different entity now, for example the entity that injected income into your loss trust

3 – sell the trust by transferring the units of a unit trust.

4 – transfer the shares in the corporate trustee to an outsider or change the individual trustee of a discretionary trust.

These are all good ideas. People did all that before May 1995, resulting in significant tax leakage. As we all know, legislators and the ATO don’t like tax leakage, so they set out to plug the hole. They did it through the trust loss provisions on 16 April 1998, effective 8 May 1995.

How the Trust Loss Provisions Killed Trust Loss Trading

The purpose of the trust loss provisions is to stop you from recouping losses you didn’t incur. To stop you from trading trust losses.

You are not meant to get a tax deduction for a trust loss when you didn’t bear the economic loss of this trust loss. The trust loss provisions look for changes in a trust’s underlying ownership or control to spot the trading of trust losses.

Schedule F

From May 1995 onwards, Schedule 2F blocked every one of the four options you had to use up trust losses:

1 – The income injection test in Div 270 stops an outsider from injecting income into the trust.

2 – The pattern of distribution test in Div 267 stops you from distributing to an outsider

3 – The 50% stake test stops the sale of units in a unit trust.

4 – The control test stops the change of trustees in a discretionary trust.

With these four tests, trust losses face similar restrictions to other entities.

All Entities Got Loss Provisions

You might think that the trust loss provisions are something special that other entities don’t have. However, all entities have loss provisions in some shape or form. No entity comes off scotch-free—with one exception: individuals with passive income.

Sole traders and partnerships got the non-commercial loss rules in Div 35. They can only offset a loss with other income if they pass these rules.

Companies got the continuity of ownership and continuity of business tests in Div 165 before they can offset a loss.

And trusts got the trust loss provisions in Schedule 2F.

So, all entities must pass a test before claiming a loss – with one exception: Individuals earning passive income. As an individual, you can claim a loss from passive income (rent, dividends, interest, royalties) against other income without any restrictions.

2 – How the Trust Loss Provisions Created Family Trusts

The trust loss provisions badly affected trusts held by families. The income injection and the pattern of distribution tests cut deep. A family needs flexibility in allocating funds.

So, to cushion the blow, the legislator introduced the concept of the ‘Family Trust’ and the Family Trust Election (‘FTE’) to become one.

Once you have made an FTE, the trust only needs to pass a modified form of the income injection test. The modified income injection test allows income injections into the trust from within the family but not from outsiders.

But look out for s100A. Whenever you consider the modified income injection test, also consider s100A about reimbursement agreements.

3 – How to Analyse a Family Trust

When you receive a new client with a family trust, you must ask eight questions to analyse your client’s tax position.

a—Is there a valid Family Trust Election?

If there is no valid FTE, then there is no Family Trust.

b—Was there a valid revocation or change of the FTE?

An FTE is designed to be made once. And that’s it—no more changes. However, mistakes happen. And so you have a tiny door to fix a mistake. You can revoke or change an FTE as long as you haven’t relied on the FTE and are within the four-year time window.

c—Has the Test Individual changed?

When the Family Trust came into existence thanks to a valid FTE, it must have had a living Test individual. The two go hand in hand.

But you can change the Test Individual. Just once ever. But you can. So, who is the Test Individual now?

d—Is there a valid Interposed Entity Election?

Some entities are part of the family group by default. For example, another trust with the same test individual. Any other entity needs to make an interposed entity election (‘IEE’) to become part of the family group, assuming they pass the family control test.

e—Has the Interposed Entity Election been revoked?

You can’t change an IEE, but you can revoke it.

f—Who is within the Family Group?

A Family Trust is meant to only distribute to members of its Family Groups. Hece, who is inside or outside of a Family Group is crucial. The definition of a Family Group can get very complicated when blended families go up and down the family tree.

g—Was there a distribution outside the Family Group?

When a distribution is a cash payment, the answer is a clear yes or no. But when the distribution is in-specie or the use of an asset, the answer gets a lot more complicated.

A distribution outside the Family Group attracts Family Trust Distribution Tax.

h—Is there Family Trust Distribution Tax to pay?

An FTE is a promise. The promise is that the trust will only ever distribute income or capital within the Family Group. When a trust breaks this promise, there is a penalty—a family trust distribution tax. Think top marginal tax rate plus Medicare.

So, ask these eight questions every time you deal with a trust.

4 – Why Not Every ‘Family Trust’ is a Family Trust

Before we discuss the four conditions for a valid Family Trust Election, please let us state the obvious: To create a Family Trust, you must make a Family Trust Election.

We explicitly say this since clients often think that just calling an entity a ‘family trust’ makes it one. Others believe that if the deed only lists family members, it automatically becomes a Family Trust.

So, to make it perfectly clear, a trust with no FTE isn’t a family trust for tax purposes. You need a valid FTE. To have a valid FTE, you need to meet the following four conditions.

5 – How to Make a Valid Family Trust Election

There are four requirements for making a valid FTE per s272-80 ITAA 1997. You must

1 – identify the ‘test individual’

2 – be in writing in the approved form

3 – list the specified income year from which the FTE is to apply

4 – confirm that the trust passed the family control test at the end of the specified income year.

A Family Trust Election fails when you don’t tick every one of these four conditions.

6 – How To Choose the Right Test Individual

There is just one type of Test Individual that will kill an FTE: a dead one.

The only condition the Test Individual must meet for a valid FTE is to be alive. If the Test Individual is already deceased by the time the FTE is made, there is no FTE (per ATO ID 2014/3). That is the only mistake you can make around the Test Individual that will lead to the FTE failing.

Everything else will not lead to a failed FTE. The Test Individual could be a non-resident, have capacity issues, be an FBI fugitive or hermit, or die after the FTE was put in place. Nothing will get the Test Individual to break the FTE apart from being dead at the time of the election.

However, what might happen is that you select the wrong Test Individual. When you do that, you end up with a family group you didn’t intend. You still have a family trust, but it isn’t the one you wanted. In that scenario, you can change the Test Individual once.

7 – What is ‘in Writing, in the Approved Form’

To make a valid FTE, you must make the election in writing and in the “approved form” (per s272-80 (2) Sch 2F ITAA36). But what does ‘approved form’ mean?

For an answer, you are sent from section to section (from s272-80 (2) to s6 ITAA 1936) and, in the end, get an essay in s388-50 Schedule 1 Tax Administration Act 1953 (the TAA) what ‘in the approved form’ might look like.

8 – What Dates are Important for an FTE

There are four important dates for an FTE:

a – Specified Income Year

Question 6 in the FTE schedule asks: “Where making a family trust election, select the income year specified… for the family trust election.”

b – Election Commencement Date

Question 7 in the FTE schedule asks you for ‘the election commencement date for the family trust election’.

The election commencement date is the first day your FTE is to apply. That is usually the start of your specified income year, ie. 1 July, but it doesn’t have to be. It could be any day within that specified income year.

Let’s say you want your Family Trust Election to start in the 2020 financial year. So, your specified income year is 2020, and your election commencement date would be 1 July 2019.

The election commencement date is essential for two reasons: From here onwards, the trust must:
a – pass the family control test and
b – avoid any distributions to Family Group outsiders.

c – End of Previous Financial Year

Take the trust tax return year. And then take the last day of the previous financial year.

Let’s say you make the Family Trust Election in the 2026 Trust Tax Return. So, the end of the previous financial year is 30 June 2025.

Why is this date important? The trust must pass the Family Control Test from the election commencement date to the end of the Previous Financial year.

d – Date the Trustee Makes the FTE

Why is this important? The Test Individual must be alive on this date.

10 – How to Pass the Family Control Test

Your trust can only make an FTE, if it passes the family control test. And to pass the family control test, your Group (family plus advisers) must – either directly or indirectly – be able to:

a – obtain beneficial enjoyment of the trust’s capital or income

Your Group can somehow get all the trust’s capital and income, either directly or indirectly.

b – get control over who gets the trust capital or income

Your Group can somehow control who gets all the trust’s capital and income, directly or indirectly.

c – create a scheme to get beneficial enjoyment or control

The group can create a scheme that will give it either the beneficial enjoyment in point (a) or the control in point (b);

d – have the trustee do as told by the group

The trustee usually follows the instructions of the Group, either because they must or they can reasonably be expected to.

e – remove or appoint the trustee of the trust

The group can remove or appoint the trustee of the trust;

f – hold more than 50% of the income or capital

The group has more than a 50% stake in the income or capital of the trust.

g – have per trust deed exclusive beneficial enjoyment of income or capital

The trust deed only allows distributions of capital and income to people within the Group.

If you don’t pass the family control test in the specified year, you don’t make a valid FTE and, hence, don’t create a family trust.

Assessment of the Trustee

s99B Carve Outs

Div 6E Income

Disclaimer: Tax Talks does not provide financial or tax advice. All information on Tax Talks is of a general nature only and might no longer be up to date or correct. You should seek professional accredited tax and financial advice when considering whether the information is suitable to your or your client’s circumstances.

Last Updated on 11 November 2024

Tax Talks spoke to Jonathan Ortner - Partner at Arnold Bloch Leibler - for more details.