Many Australian business owners use discretionary trusts to hold investments, operate a business or distribute income among family members. But calling a trust a “family trust” in everyday conversation is not the same as making a Family Trust Election for tax purposes.
A Family Trust Election, often called an FTE, can preserve access to important tax concessions in the right circumstances. It can also create a long-term restriction on who the trust can distribute income or capital to without triggering a separate tax. Before making one, trustees need to understand both sides of the decision.
What a Family Trust Election actually does
A Family Trust Election is a formal tax election made by the trustee in the approved form. It nominates one individual, known in practice as the specified individual, whose family group becomes the reference point for the trust. Once a valid election is in force, the trust is treated as a family trust for the relevant tax rules.
This is not a change to the legal ownership of trust assets. It does not rewrite the trust deed, replace trustee powers or automatically change who may be a beneficiary under the deed. Instead, it changes how certain tax rules apply to the trust and its distributions.
For many small business owners, the key attraction is access to concessional treatment under the trust loss rules. A valid election can also be relevant where a family trust owns shares in a company with tax losses, or where franked dividends flow through a discretionary trust to beneficiaries.
However, an FTE should never be treated as a standard EOFY formality. It is a structural tax decision. It narrows the range of people and entities that can receive trust distributions safely, and the consequences can remain relevant for many years.
Why business owners make an FTE
The main reasons for considering an FTE are practical, but they arise from specific integrity rules in the tax law. The election may be useful where the trust or a related company needs to rely on concessions that would otherwise be difficult to access.
Common reasons include the following.
Using trust tax losses or bad debt deductions: Trust loss rules can restrict the use of losses and certain deductions where there has been a change in ownership, control or participation. A family trust is an excepted trust for these purposes, although the income injection rules can still apply in a modified way.
Supporting company loss tracing: If a discretionary trust owns shares in a company, an FTE may assist the company in applying the company loss rules. Broadly, the rules can allow tracing to stop at the family trust rather than requiring an analysis of every potential discretionary beneficiary.
Accessing franking credit treatment: The holding-period rules for franking credits can be difficult for discretionary trusts because beneficiaries may not have fixed interests in trust-held shares. A valid FTE can be relevant to whether interests are treated as being held at risk for those rules.
Managing income injection concerns within a genuine family group: The income injection test is aimed at arrangements designed to transfer the benefit of trust deductions to outsiders. The law recognises that arrangements occurring wholly within the relevant family group may be treated differently.
An FTE does not create a deduction, make a loss automatically available or guarantee access to franking credits. The underlying conditions of each concession must still be met. It is better viewed as one important part of a broader tax analysis.
It also does not determine whether a trust qualifies for small business CGT concessions, whether a corporate beneficiary arrangement complies with Division 7A, or whether trust distributions have been validly made under the trust deed. Those issues need separate consideration.
Choosing the specified individual and understanding the family group
The most important strategic choice in an FTE is the specified individual. That person becomes the centre of the family group for tax purposes.
The legislation defines family more broadly than a simple household. It includes the specified individual, certain parents, grandparents, siblings, children, nephews and nieces of the individual or their spouse, lineal descendants of those children, nephews and nieces, and the spouses of relevant family members. The law also includes particular provisions for some former family members in defined circumstances.
That does not mean every person connected to the family can automatically receive a distribution. Trustees must distinguish between:
- an individual who is within the family group;
- a company, partnership or trust that is within the family group;
- an entity that needs an additional election before it can safely receive distributions; and
- an unrelated person or entity outside the group.
This distinction is especially important for business groups with multiple trusts and companies.
For example, a distribution to an adult child may be within the family group if the child falls within the statutory definition. But a distribution to a separate discretionary trust for that child may require closer analysis, because the recipient is the trustee of another trust, not the child personally. Similarly, a company used as a corporate beneficiary should not be assumed to be inside the family group merely because family members are directors or shareholders.
A company, partnership or trust can be included in the family group through an Interposed Entity Election. Certain wholly family-owned entities can also be included under the statutory family-group rules without needing that election. The ownership, control and distribution history of the entity should be checked before relying on either pathway.
The major risk: family trust distribution tax
The trade-off for the concessions is family trust distribution tax. This is the issue that makes an FTE a decision to plan carefully, rather than a box to tick.
Where an FTE is in force, the law can impose family trust distribution tax if the trust distributes income or capital, or confers a present entitlement, to someone outside the relevant family group. Similar rules can apply to a company, partnership or trust that has made an Interposed Entity Election.
The current legislation sets the primary family trust distribution tax at 47 per cent of the amount or value of the relevant income or capital. Where the trustee is a company, the company and directors at the relevant time may be jointly and severally liable, subject to limited statutory protections.
This risk is broader than a cash payment made at year end. It can arise from a present entitlement, an actual distribution of income or capital, and in some cases indirect dealings through another entity. That is why distribution resolutions, beneficiary records and corporate beneficiary arrangements need to be reviewed together.
There is another important point. The legislation states that the consequences can apply while the election is in force, including a time before the election was formally made. This matters where a trustee seeks to make an election for an earlier income year. A retrospective election can therefore bring earlier distributions into the family-group rules.
A practical example for a growing family business
Consider a discretionary trust that operates a successful consulting business. The trust has historically distributed income among the founder, their spouse and adult children. It also has a corporate beneficiary that retains funds for business expansion, and it holds shares in a separate operating company.
The group later discovers that the operating company has tax losses and that the family trust’s shareholding may need an FTE for the company loss tracing rules. Making the election may be appropriate, but it should not happen in isolation.
Before proceeding, the trustee should review:
- the trust deed and beneficiary classes;
- all distributions and present entitlements since the proposed election commencement period;
- whether the corporate beneficiary is wholly owned by the relevant family group or needs an Interposed Entity Election;
- whether any other trusts have received distributions;
- whether any unrelated investors, employees, business partners or charities have received trust income or capital; and
- whether prior distributions to companies have created separate Division 7A issues.
If an unrelated business partner has received a trust distribution in the relevant period, a retrospective election may create a serious problem. The better approach may be to investigate whether another pathway is available, rather than assuming an FTE can be made safely.
How to make the election without overlooking the bigger picture
A valid election must be made in writing and in the approved form. The trustee must nominate the specified individual and the trust must satisfy the family control test for the relevant income year. The law also permits an earlier income year to be specified only where additional continuity and distribution conditions are satisfied. (legislation.gov.au)
The trust’s tax return records the FTE status, and the relevant election documentation should be completed and lodged in accordance with current ATO requirements. The administrative process is important, but it is not a substitute for analysing the trust’s history and future plans.
Before making an FTE, a trustee should usually work through a structured review.
- Confirm the trust deed permits the intended distributions and identify the full beneficiary class.
- Map the family group around the proposed specified individual.
- Identify every related trust, company and partnership that may receive distributions or hold interests in the wider group.
- Review past distributions, present entitlements and capital appointments for the relevant period.
- Check whether any Interposed Entity Elections are needed.
- Consider future events, including new business partners, investor funding, succession planning, relationship breakdowns and a possible sale of the business.
- Document trustee decisions carefully, particularly annual distribution resolutions.
The choice of specified individual deserves particular attention. A person who seems the obvious choice today may not produce the most appropriate family group for future generations, a blended family, multiple family branches or a business expected to take on external investors.
Why changing course later can be difficult
A trustee can make only one FTE for a trust. The election is generally ongoing once it is in force, and the law permits variation or revocation only in limited circumstances and subject to detailed conditions.
This is why an FTE should not be made solely because a tax return software prompt appears or because the trust has “family” in its name. It may be entirely appropriate for a stable family-owned group, but it can be restrictive for a trust that expects to distribute outside the family group, bring in unrelated investors or support a broader commercial venture.
A review is particularly worthwhile before:
- admitting a new shareholder or investor;
- adding a business partner;
- establishing a new trust or corporate beneficiary;
- making a capital distribution;
- undertaking family law or estate-planning changes; or
- relying on tax losses, debt deductions or franking credits.
The key takeaway
A Family Trust Election can protect valuable trust tax benefits, particularly for family-owned businesses with trust losses, company shareholdings or franked investment income. In return, it places clear limits around the trust’s future distributions and can expose trustees to family trust distribution tax if those limits are breached.
The right answer depends on the trust deed, the group’s ownership structure, its past distributions and its plans for the future. Ample Finance can help review whether an FTE or Interposed Entity Election fits your business structure and the way you intend to use it.
This article is general information only and is not personal financial or tax advice. Before making or relying on a Family Trust Election, speak with a registered tax agent or accountant, such as Ample Finance, about your specific circumstances.