Discretionary trusts continue to be a popular investment vehicle for the generation of family wealth, as they provide flexibility in the form of who income is distributed to, as well as for their asset protection qualities; however, the rules around discretionary trusts are complex.

Given the popularity of trusts, the Australian Taxation Office (ATO) continues to look closely at them and ensure that their trustees are meeting the relevant legislative requirements.

An area of increasing scrutiny from the ATO is around Family Trust Elections (FTE). Consideration should be given to making a Family Trust Election whenever a discretionary trust is established, and the existing structure of a family group, including trusts already in existence, should also be reviewed regularly to confirm any FTE’s in place remain valid.

What is a Family Trust Election (FTE)?

Making a Family Trust Election creates a ‘Family Group’ for tax purposes. The family group is formed around the person selected to be the Specified Individual. Once determined, the election locks in who is in the family group and, just as importantly, who isn’t. The election is irrevocable, so planning and consideration of the existing and future group structure is necessary to ensure the right specified individual is chosen.

Why make an FTE?

The main reasons to make an FTE are:

  • The ability to access any carried forward tax losses by the trust;
  • Beneficiaries receiving a franked distribution will be able to use the benefit of the attached franking credits;
  • Where a discretionary trust owns a company with losses, the Continuity of Ownership (COT) Test by the loss-making company will be passed;
  • Exclusion from having to meet the Trustee Beneficiary Reporting (TBR) rules;
  • The ultimate economic ownership of an asset is maintained when engaging in a Small Business Restructure Roll-Over, otherwise, a discretionary trust’s ability to access any of the above concessions is extremely difficult.

Consequences of getting a Family Trust Election wrong

Where an FTE is made and a discretionary trust proceeds to distribute outside of the ‘Family Group,’ Family Trust Distributions Tax (FTDT) is payable. FTDT is calculated on the invalid distribution made at 47%, which is the top marginal tax rate for individuals plus the Medicare Levy.

The tax consequences of getting it wrong are extremely high for a complicated area of legislation, and with the ATO looking more closely at FTE’s family groups need to be cognisant of the increased ATO activity and need to be reviewing their elections to ensure continued compliance.