What are the benefits of family trusts?
“Family trusts”. It’s a term that many of you will have heard of before. However, a family trust for tax purposes is essentially just a family discretionary trust where the trustee has made a valid family trust election for tax purposes. So why all the fuss? Well, family trusts are able to access a range of tax concessions that other non-fixed (i.e. discretionary) trusts can’t obtain which may ultimately be advantageous for the beneficiaries.
Although if you’re thinking of making a family trust election, there may be other factors you have to consider.
What is a family trust for tax purposes?
Many of you have heard of family trusts, but perhaps don’t know too much about their benefits and how they differ from the usual non-fixed discretionary trusts. Essentially, a family trust for tax purposes is a discretionary trust where the trustee has made a valid family trust election (FTE) for tax purposes. By becoming a family trust for tax purposes, the trust is able to access certain tax concessions which may be beneficial.
In order to make an FTE, the trust must pass the family control test at the end of the income year to which the election relates to. The family control test can generally be passed if the person that controls the trust is limited to the individual specified in the relevant family trust election, members of that person’s family, legal or financial advisers of either, or a combination of these persons.
An application to be a family trust must be made in the approved form and lodged with the ATO.
Once the election is made, it generally can’t be changed.
Tax concessions for family trusts
Once a valid FTE is made and the trust becomes a family trust for tax purposes, it will have concessional treatment in relation to trust losses.
For example, if a non-fixed trust has carried forward losses, it will need to satisfy all the trust loss recoupment tests related to ownership or control of the trust. However, a family trust is only subject to a concessional income injection test.
The second concession relates to company loss tracing. To utilise a loss, a company must satisfy ownership and control tests which require tracing the ownership or control of the company to specific individuals through trusts. In cases where the shareholder of a company with losses is a family trust, there is a tracing concession that applies so that a single person will be taken to own the interest in the company, thus removing the need to trace past the family trust.
The third concession for family trusts relates to the small business restructure rollover which allows small business entities to restructure their businesses by moving active assets into, or out of, a trust, a company, partnership, or a combination without adverse CGT consequences provided certain conditions are met. Non-fixed trusts that are family trusts may use an alternative economic ownership test to access this concession.
There is also a concession for family trusts in relation to administrative matters of the trust, specifically, the trustee beneficiary reporting rules. Generally, the rules require the trustee of a closely held trust to advise the ATO of certain details including beneficial entitlements. However, family trusts do not have to satisfy these reporting rules. In addition to this, trustees and beneficiaries of a family trust that receive franked dividends may benefit from a franking credit concession.
Now that you’ve heard about the benefits of making an FTE, it should be noted that there are also downsides to making a non-fixed trust a family trust for tax purposes.
Generally, once a valid FTE is made in writing in the approved form, it cannot be varied or revoked except in some limited circumstances.
Furthermore, if distributions are made outside the nominated family group, a special family trust distribution tax will be payable at the top individual marginal rate plus Medicare levy.
But for most family trusts, distributions outside the family group would be unusual, so this would not normally be an issue.
Thinking about setting up a family trust?
While there are many benefits to making an FTE, getting it wrong could mean significant tax consequences for the beneficiary or trustee.
Trusts and family trusts in particular is a complex area and care needs to be taken at the set up stage to ensure no one pays the price down the road.
Contact us today for expert advice about setting up your family discretionary trust and making an FTE or to review your current family trust arrangements.
You don’t want to get it wrong.