Family Trust Elections & FTDT: The Tax Issue Back in Focus (Part 1)

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You're listening to Explain That by Velocity Legal, the podcast that keeps business owners and professional advisers ahead of the curve in an ever-changing legal landscape.

Family trust elections are one of the most misunderstood areas of tax.

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In this series, we'll examine why family trust elections exist, when you need to make them, and how they can go very, very wrong.

This is a very topical area as the ATO has been looking at this in a high degree of detail in recent years, and there's a lot of discussion about this area.

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In this first episode, we'll unpack what a family trust election is and what it does.

To do that, I'm joined by Ani Tuna, who's a special counsel in Velocity Legal's Tax team.

Welcome to the show, Ani.

Thanks, Andrew. It's a pleasure to be here.

As you say, it's a very topical discussion we're probably likely to have.

0:56
So I think the timing's good. I'm glad to be able to sit here with you to talk about it.

Yeah. I think with tax, I sort of think that every year, every second year or third year, there's sort of like a flavour to the year or second year.

And definitely I think the flavour at the moment is family trust elections and family trust distribution tax.

1:16
Would you agree?

Yeah, absolutely. Yeah. It's in the media and it's definitely a focus area.

So something that really needs to be brought to light and understood, I think at this particular point as well.

And as an adviser, would you say that this is an area that, while it's now being brought into focus, historically, perhaps there really wasn't much attention paid to this area?

1:37
Yeah, I do think so.

And I think the attention that was paid was probably simplified.

It's one of those things where we sort of put the rubber stamp of family trust election on something, or we might assume something has been made as a family trust election, and then not much thought occurs thereafter.

1:54
And I mean, the history of the family trust elections, we can talk about what they are, but they date back to I think the 90s, or at least the mid to late 90s, and it's evolved quite a lot since then.

So I think what's happened is that some of the focus around the more complex parts has kind of gotten lost.

2:12
And now that it's in focus by the ATO, we're seeing some of those assumptions or simplified thoughts coming to light, and things that we thought might not have been a problem perhaps now being a problem.

So definitely one that's perhaps a little bit more complex than we might have originally thought.

2:31
Definitely agree with that.

Well, let's go back to the history a little bit because, as you said, these have been around since the mid 90s as a concept. So it's 30 years old, give or take.

Now, what is a family trust election, firstly? And why was this concept created and what is it used for?

2:48
Yeah, I can happily say that the concept of the family trust election predates my time in tax.

So yeah, like I said, it sort of goes back to the late 90s.

And the reason why family trust elections were introduced was that at the time, what they were really intended for was to combat what was happening around trust loss trafficking.

3:12
And what that effectively means was that trust losses, so losses that had been accumulated in trusts, were being traded.

And the reason for doing so was so that the benefit of being able to utilise those losses, so being able to offset them against other income, say, and pay less tax.

3:31
What was happening is those losses were being traded.

And so the economic, the persons, or the trust I should say, that bore the economic loss, it wasn't the same trust that was getting the benefit or the same person.

So these rules were introduced almost as an integrity measure as a result of that trust loss trafficking.

3:52
So a concept called family trust elections, or a family trust, was created.

And the reason for that was that the idea is that, well, look, if the trust and all the people around the trust are all within the same family, then the fact that you might have a trust that had losses and somebody else sort of reaps the benefit of those losses, that's cool, as long as it's all within the same family group.

4:16
So this idea of family trusts and making an election to be a family trust was all around that idea of trust loss trafficking.

Yeah, because you could have, I guess, you're an adviser, you've got two clients on your book.

4:33
Client one has a discretionary trust that's got some big losses, and they're not going to do anything further economically. They're never going to recoup them.

And then client two's got some income from something, and you'd say, wouldn't it be great if client two could use client one's losses, and we'll compensate them somehow for that too.

4:56
But yeah, I mean, that was the problem, right?

That is, yeah, that's exactly it.

And there are other areas of the tax legislation that deal with mischief like that. You know, there is Part IVA, which is a general anti-avoidance provision that's designed really broadly to capture anti-avoidance.

5:13
But sometimes we need very specific rules in the legislation to combat that.

And so that's where this whole evolved from. And like I said, that was in the 90s.

So the reason, if we go back to your original question, why do we have family trust elections?

5:29
It was for trust losses.

Yeah, make an election and then you don't have to worry about proving losses or anything to do with that. That was the gist, right?

Yeah, that's exactly right.

And we can talk about why, because there are now many other reasons in addition to losses why you might want to make a family trust election.

5:46
Yeah, and we can talk about them as well in a moment if you like.

Yeah. Well, let's go to, I guess, the form of them first, and then perhaps we'll go back to those other ones.

But okay, so this regime is introduced and says, right, we've got this concept of a family trust election.

6:03
I mean, what is that? It's a piece of paper that you fill in, right?

Yeah, it is. Like I said, it's a piece of paper that you fill in, and then from thereafter you probably don't look at it very often.

So a family trust election is an election. So it's a choice made by a trust, or a trustee more technically, and it's effectively just a choice that they make to say we want to be treated as a family trust.

6:27
We want to get the benefits.

Let's say the loss benefits.

That's all the benefits. Yeah, that's right.

And when you make that election, you have to do a couple of things.

So that election requires the trust to make some choices in addition to making the family trust election.

So, you know, you need to choose who is the individual in the family that the group is going to be centred around.

6:48
And we usually call that the test individual or the specified individual.

So, you know, you make a choice, put your hand up. I want this trust to be treated as a family trust, and I want the group that you're going to determine the family around to be around this particular person.

And then the other thing you need to specify is, well, look, I'm making a family trust election, but I'm making it as of a particular date.

7:10
So really a family trust election is saying it's a family around a particular individual, and it starts from this particular date and continues thereafter.

Yeah. And it's a tax fiction for deeming purposes. It doesn't do anything else beyond that.

7:26
Yeah. And that's some of the complexity that I talked about.

It sounds so simple to say it's a choice for tax purposes, but there is an interaction between this choice just for tax purposes and then the trust itself.

So as I said, you're forming a family group around this particular individual.

7:46
But at the end of the day, the trust is still governed by the document, the trust deed, and the trust deed will always still determine who that trust can give benefits to.

So it's almost like you need to think of those two things side by side because, as you say, it is just a tax fiction.

8:06
And the other interesting thing is that the choice is made for tax purposes, but you'll see a lot of trusts called the Smith Family Trust or it might be the Tuna Family Trust or the Henshaw Family Trust.

That doesn't actually mean anything for tax purposes.

8:23
It just means that it's probably the trust for your family.

That's right. But without actually having made that tax election, you're not actually a family trust for tax purposes.

In the next episode, we'll talk about family trust distribution tax, which requires a whole episode for itself.

8:40
Probably multiple episodes if we're being honest.

But I wanted to go to, I guess, the evolution of the concept and how it's sort of rolled into things over time.

So okay, we started with loss trafficking, but what else?

8:55
What else are we covering now by this mythical election?

Yeah, that's right.

So losses, as we started with, are one of the reasons why you would make a family trust election.

So as we said, it's easier to utilise your trust losses if you've made this election.

9:12
On the topic of losses, and again, this is sort of side to the trust, if your trust is a shareholder of a company and that company has losses.

So we're not talking now about the trust with the losses. We're now talking about a company.

If you're a shareholder of a company and you're a trust, and that company has losses, you might need to make a family trust election in the trust for the company to be able to utilise those losses.

9:40
So that's another reason why.

Essentially it's treating the trust shareholders as sort of a bit of a block and not having to look any further beyond that.

Yeah, that's right. I mean, and again, we could have another discussion and almost another podcast as to why that's necessary.

9:55
But yeah, that's exactly right. That's exactly what it does.

So losses. So if you've got a trust with losses or a company with losses and the trust is a shareholder of those, they're another reason why.

And then again with companies, if your trust has shares in a company and it's a discretionary trust, there will generally be a requirement if those shares have been acquired after a certain date.

10:19
And the magical date is 31 December 1997, which in most cases that's what we see now.

So if you've got relatively recent shares that have been acquired by the trust and you're receiving, as the trust, franking credits on the dividends from those shares.

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And you want to give those franking credits, or the benefit of those credits, to your beneficiaries, in order for those beneficiaries to utilise those franking credits, in most cases the trust itself will need to make a family trust election.

So I know that's a lot of words there.

10:52
But the key point is if you've got a trust and it's got shares in a company, then it's likely you will need a family trust election to make use of those franking credits.

Yeah, yeah. Otherwise you're denied, essentially, I think if it's over $5,000 worth of franking credits. You're denied the franking credits.

11:09
Yeah, that's absolutely devastating if you were denied those.

Yeah, absolutely.

So it's not uncommon as soon as the trust purchases shares, you might make a family trust election just so you have that security of being able to provide those franking credits.

And as you know, it's the franking credits that prevent the double taxation in the hands of the ultimate beneficiary.

11:28
So definitely want a family trust election there if needed.

Yeah. So we've got trust losses, we've got company losses owned by trusts and franking credits, and there's been some more evolution since then.

Essentially, this is the concept that just keeps getting tacked onto, isn't it?

11:44
Yeah. So another reason why you might want to have a family trust election is if you've got assets and you want to transfer some of those assets, particularly if they've been used in a business.

You want to transfer them either to or from a trust. One of the ways you can do that and get some really great concessions is by utilising something called the small business restructure rollover.

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And in order to use that and to transfer those assets from or to a discretionary trust, you'll need a family trust election.

So again, that's another one. So if you're looking to restructure some assets and to utilise that, you might need it.

And then there's a couple of other reasons that have to do with reporting.

12:24
So certain trusts that have made family trust elections are not required to report. So there's some trustee beneficiary reporting requirements.

So having made a family trust election alleviates that. So that's a great compliance reduction in your costs and your work.

12:42
And then the other one, which kind of goes to why you make a family trust election or who is part of the family, is that you might actually need a family trust election because you already have one trust that's made a family trust election and you have another trust part of the same family group.

12:58
And that trust, in order for those two to be in the same family group, you'll actually need to make a family trust election for that trust as well.

So it's kind of like dominoes. Once one falls in, all of them need to be done.

That's exactly right.

13:21
So yeah, like I said, there are just so many reasons why you might need a family trust election that it's gone way beyond what we started with in the late 90s.

Which is why, as you say earlier, family trust elections are really well known because advisers who work with private groups, they're well across family trust elections.

They've been made for quite some time and they're often needed a lot.

13:42
Perhaps what's lesser known is understanding who's in the group, for example, or how to validly make that family trust election.

And that's maybe where the rubber hits the road sometimes.

What I've seen sometimes is you get an accountant who's taken over a group, or perhaps had it as a long-term client, and they don't have any elections at all and it's clear that they have needed them.

13:59
The question often gets asked, can we backdate the trust elections?

Yeah, that's right.

We don't generally love the word backdate.

Effective date.

But yeah, actually, as it turns out, with family trust elections, in certain circumstances you can make them retrospectively.

14:19
So the good news is if, let's say the trust bought the shares in the company and you did nothing because you weren't expecting any dividends for a really long time, and so you never made a family trust election, and then maybe you did need a family trust election and you didn't make one.

14:36
In some cases you can actually make one retrospectively. So you can go back in time.

Now, in terms of things that can go wrong, it's not just, oh yeah, just go back in time, pretend like nothing happened.

You do still need to meet the right rules.

14:57
So really you are effectively going back in time, which means that what's happened since that retrospective date.

So let's say we're sitting in today's shoes and we're like, oh no, we really needed that trust election back in, say, 2017.

We could potentially make it, but we need to look at what's happened between now and back in 2017.

15:19
And we need to satisfy the rules to make sure that, yeah, we can make it retrospectively, but have we satisfied the rules that allow us to do so?

And that sometimes is where the problems can arise.

Yeah, it can get complicated.

And sometimes the problems can arise because you might have done some things in that time that prevent you from being able to make it retrospectively.

15:39
One question I get asked, and I'm sure you get asked this too, is that if you've got that situation, okay, I've got this group and there's all these trusts.

Should I just make elections for everything, or should I just leave it and work it out?

Like one day if I need it, maybe I'll make it at that point and I can make it retrospectively, so I don't need to worry about this.

15:55
Yeah, I know it's going to depend on the situation, but do you see that? And do you have any thoughts on it?

Yeah. It used to be back in my tax training days, one of my favourite questions to ask, because as you went around to all the different accounting firms of different sizes and different philosophies, everybody would have a view on it.

I suspect some of it has changed a little bit.

16:27
I feel like when the elections were first in place, and I won't go into some of the changes that happened in the early 2000s, but I do feel like really early on, the philosophy was in fact, you've got a discretionary trust, absolutely make your family trust election immediately.

16:49
And I suspect that a lot of that was around the fact that there was this uncertainty around retrospective elections.

I hear now that perhaps sometimes it's lesser done. From what I hear that's happening with advisers is some will say, well, look, I won't make one until I know I need to make one because it does limit your ability.

17:07
I think for me, it's always about proactivity or being proactive.

You know, why your clients are setting up a trust, or at least at a particular point in time, you have some idea of what they're intending to do.

And if you kind of go through that list of reasons why you might make a family trust election, there are some times where it's just not necessary.

17:35
There's never going to be any losses. It's not the sort of trust that's going to be investing in assets. It's not part of a large family group. It's probably not important and maybe not necessary.

So you don't want to limit it.

One thing that a lot of people don't realise, or perhaps make the mistake of, is that if you want to introduce other parties, which is not really common in the context of a discretionary trust, generally a trust is set up for your own family.

17:55
But I have seen situations where a family trust election, or the sister to the family trust election, the interposed entity election, has been made and then that's really capped things.

That has capped things.

So one of the reasons why you might want to think more broadly is, well, what does the future look of this group look like?

18:16
So, you know, it depends on the situation really.

I wanted to ask one more question about family trust elections.

This regime's been around for 30 years. Tax agents get new clients all the time.

It's to do with how do you know if an election is being made and what does it say?

18:31
I know this is a whole mess of an issue, and I know that the portal has some information, but what are your thoughts on this?

I have spent, yeah, I've had many discussions on this. I think it's probably the $1 million question.

18:55
And we'll talk about this in the next episode. I think if you could answer that question, you could be making or saving people a lot of money.

A lot of the genuine mistakes that happen are generally because the information's not there.

So as you say, clients change accountants, and it's a form, it's a piece of paper that could have been made 15 years earlier.

19:18
Now what we do have is the ATO portal. It has a report that accountants are able to access.

And that report will say, for every single client they have, it'll tell the accountant for each one of those trusts or entities, this entity has made a trust election for this commencement date and this test individual.

19:35
What that report doesn't do is it doesn't tell you when those elections were made.

And one thing we haven't quite covered is that you can only ever make one election. You might be able to vary it in limited circumstances, but once you've made a valid election, you can't really make another one.

19:52
And so that report, sometimes I've seen it be like one entity. So it might say the Henshaw Family Trust and there's a commencement date for an election in 2009 with Andrew as a test individual, and there's another one in 2011 with Andrew's wife as the individual, and it goes on.

20:10
Now that report doesn't tell us anything other than to say, well, someone attempted to make an election.

It doesn't say an election is valid or not.

No, it doesn't say whether tests have been satisfied.

It doesn't even tell us which one, assuming that the others are invalid, doesn't tell us which one was the very first one and therefore which one we should be relying on.

20:34
And also the report's not often updated. The ATO will actually openly say, oh, if the report doesn't include it and you think that an election has been made, let us know.

So there might be an election made you don't know of.

And also there was a Federal Court case not that long ago in 2023 where they actually said that an election doesn't necessarily need to be notified or you don't need to actually necessarily lodge it with the ATO.

21:01
Now the ATO's preference is that they have a form and they like it to be lodged, but it doesn't actually need to be lodged.

As far as the court is concerned, it can be inferred with the way in which you prepare your tax return.

So in addition to the portal, which is kind of not reliable in the sense that it doesn't confirm the validity, there is the possibility that there's actually one in the drawer somewhere, particularly one really long ago that predates the portal that doesn't even appear.

21:18
So as you say, it's really hard to know, and without the right information, you can go ahead and make choices and go ahead and act in a way that's inconsistent.

Yeah, I think that's an excellent summary of the history of family trust elections and some of the difficulties, because it is a regime that's been around for quite some time.

What I'm really looking forward to is getting stuck into Part 2 where the consequences of this all come home to roost in family trust distribution tax.

Thanks once again for being part of this episode, Ani.

Thanks, Andrew.