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Family trusts – concessions

A family trust for tax purposes is one whose trustee has made a valid family trust election (FTE). It is not sufficient to simply include the words ‘family trust’ in your trust’s name.

A trustee only makes a valid FTE where they have satisfied the relevant tests, and made an election in writing in the approved form. Once the election has been made, it cannot be varied or revoked except in limited circumstances.

The FTE entitles the trust to access certain tax concessions. The trade-off is that family trust distribution tax (FTDT) is imposed when distributions are made outside the family group.

There are five main reasons to become a family trust:

  • The trust loss measures – a non-fixed trust has a carried forward tax loss, or certain debt deductions, but the trust could not satisfy the required trust loss tests to recoup the loss. By becoming a family trust, the trust is subject to concessional treatment and only one of the trust loss tests – the income injection test – applies, and only in a modified way.
  • A company loss tracing concession – the company loss provisions allow a company that has a non-fixed trust as a shareholder to benefit from a tracing concession where that non-fixed trust is a family trust. Broadly, the tracing concession applies so that where the relevant interests in a company are held by the trustee of a family trust, a single notional entity that is a person will be taken to own the interests. This means that there is no need to trace past the family trust.
  • The holding period rules regulating access to franking credits – the holding period rules allow the trustee and beneficiaries of a family trust that receives a franked dividend or franked non-share dividend to benefit from a franking credit concession. Broadly, unless the trustee of a non-fixed trust has elected for it to be a family trust, a beneficiary of the trust who does not have a vested and indefeasible interest in so much of the capital of the trust as is comprised by the shares giving rise to the dividends will not be a ‘qualified person’ for the purposes of the holding period rule. Someone who is not a ‘qualified person’ is denied the benefit of the franking credits attached to dividends paid on shares, or interests in shares, acquired by trusts (other than widely held public share-trading trusts).
  • Trustee beneficiary reporting (TBR) rules – generally, these rules require the trustee of a closely held trust to advise the ATO of certain details. These are details about each trustee beneficiary that is presently entitled to a share of a tax preferred amount of the trust, or has included in its assessable income a share of the net income of the trust comprising an ‘untaxed part’. This advice must be provided by the due date for lodgment of the closely held trust’s tax return. Trusts that have made an FTE or an interposed entity election (IEE) (among others) are excluded from having to comply with the TBR rules.
  • Small business restructure roll-over – from 1 July 2016 small business entities can restructure their business by moving active assets into, or out of, a trust, company, partnership, or a combination, without adverse capital gains tax consequences. There are requirements that must be met in order to access the rollover. One of these is that there is no material change in the ultimate economic ownership of an asset. Special rules apply in this context to discretionary trusts that have made FTEs.

While any kind of trust can elect to be a family trust, the need to pass the family control test restricts the choice to a trust that is not widely held and where a specific family effectively controls the trust.

FTDT at the top marginal rate is payable where a distribution is made to a party that is not a member of the family group of the specified individual named in the FTE.

The trustee of a family trust will also be liable to pay trustee beneficiary non-disclosure tax if it makes a circular trust distribution.

Find out about:

Family trust elections

A trust is a family trust at any time when a family trust election (FTE) for the trust is in force. Generally, an FTE is in force from the beginning of the income year specified in the FTE (the election commencement time). The FTE must also specify an individual who forms the point of reference for defining the family group that is taken into account in relation to the election.

The income year specified in the FTE must have ended before the FTE is made. This is because an FTE can only be made if the trust passes the family control test at the end of the specified income year. The FTE can specify an earlier income year from when the election is to commence, provided that from the beginning of the specified income year until 30 June of the income year immediately preceding that in which the election is made:

  • the trust passes the family control test, and
  • any conferrals of present entitlement to income or capital during the period, or actual distributions of such amounts, have been made to the specified individual or members of their family group.

Generally, an FTE is in force at all times after the ‘election commencement time’.

The election commencement time is usually the beginning of the income year specified in the FTE. However, if the family control test (FCT) is not passed for the whole of the specified income year, the election commencement time is the time from which the trust passes the FCT continuously for the rest of the income year.

These rules apply to FTEs specifying the 2004–05 and later income years.

The ability to make a FTE specifying an earlier year of income can impact on an FTDT liability that would otherwise arise but for that election.

See FTDT examples: FTE reversing FTDT liability.

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    10 things you should consider before buying a property

    Are you considering buying a property? Do you know you could miss opportunities to save thousands, or tens of thousands of dollars if you don’t plan well before the purchase?

    Below are a few key considerations:

    1. How should you set up your loan structure? If you don’t have a loan offset account for a rental property, after you make extra payments directly to the loan account, you can only claim interest deduction on the remaining balance of the loan. For tax purposes, this deductible balance can’t be changed even if you redraw the overpaid amount later. A good loan structure could also help you to stabilize interest rate and speed up loan repayment by combining a standard variable loan (with an offset account) and a fix rates account.

    2. Timing of renovation. You might want to do a renovation right after you have bought the rental property. But do you know for any genuine repair & maintenance included in the renovation, you can claim an outright deduction against the rental income when the property is available for rental? If the work is done before the date when the property is available for rental, you can only claim the deduction against future capital gain when the property is sold. Depend on when you are going to sell, it could take years or up to decades before you can claim the deduction.

    3. How should you split ownership? You might want to share the property ownership with a family member. For tax purposes, the percentage of ownership is based on the legal title, regardless of who is paying more on the mortgage. If the property will give you a tax profit, you might want to allocate more
    ownership to the low-income earner to utilize the lower marginal tax rate. If it is giving you a tax loss, you might want to allocate more ownership to the high-income earner to utilize the loss. The goal is for the family to pay minimum tax together.

    4. Should you use a family trust to purchase the property? There are many pros and cons related to a family trust. The advantages include tax savings on rental profit or capital gain, asset protection and succession planning on family wealth. However, family trust can’t distribute losses. All losses are trapped in the trust to be used to offset future trust profit. Therefore, you can’t utilize any rental loss in a trust to offset other income such as salary & wages. Family trusts also attract high accounting fees on initial setup and annual fees on financial statements and tax returns. State governments also charge much higher land tax on family trusts.

    5. Will the income level change in future years for different owners? You might want to forecast the possible income for different owners to understand total tax payment / savings related to the property. This could also impact on your decision making on point 3 and 4 above.

    6. Understand when you can treat your property as main residence to receive an exemption on capital gains tax. When eligible, even if you have received rental income, you could still treat your rental property as main residence and receive the exemption. To be eligible, you will need to treat it as your main residence at the beginning. Please check out this ATO link: Treating former home as main residence.

    7. Decide whether you need to purchase a depreciation report. Most taxpayers don’t know that the depreciation on the building will need to be added back to calculate capital gains tax when the property is sold. When the property is held for more than 12 months, after applying the capital gains tax discount of 50%, it will effectively cut the tax rate by half at the time of sales. This makes depreciation deductions desirable for high income earners. However, for low-income earners it might not be ideal to claim depreciation as a rental deduction since they could be paying more on capital gains tax in the future. It could get more complicated if the property is under joint ownership between high and low income earners.

    8. You might want to consider Centrelink payments for future or existing owners. Most Centrelink payments are income and asset tested. Before attaching a rental property to a family member who is receiving, or plan to receive government benefits, you might want to check the testing thresholds first to see if the Centrelink payment will be impacted. This is also applicable when you are making distributions from a family trust to different family members.

    9. Have you considered using your SMSF (selfmanaged super fund) to make the purchase of a rental property? There are a lot of tax saving opportunities with a SMSF since the income tax rate is only 15%. And the capital gains tax rate is effectively only 10% after factoring in the 1/3 discount. The major downside with a SMSF is normally you can’t get the money out until you retire or on compassionate grounds (SMSF does have more flexibilities compared to normal retail super fund. But the choices are still very limited). It could be expensive to set up and operate a SMSF too. There are also strict legal requirements on the trustees. Penalties on incompliance could be severe. Tax law around SMSF is very complicated too. You will need to find a good tax accountant specialized in SMSF to help you to understand the structure, also do a cost-benefit analysis before setting it up.

    10. Consider internal ownership changes. For your existing rental properties, you can also consider whether you should transfer the ownership between family members, or between different business structures (this is not applicable for SMSF). You might want to do this when the income level changes with family members, or rental property changes between tax profit and loss. Before the change, you need to consider the cost of transfer including capital gains tax, stamp duty, conveyancer fees, etc. Again, a cost-benefit analysis is a must before the change.

    Last but not the least, did you combine all the above strategies and compare your choices? If you haven’t yet, how would you know that you have picked the best strategy to minimize your taxes? We can help you to factor in all considerations, compare different scenarios, also present you with a Property Prepurchase Report with all our findings to help you to make a decision. Contact us today to book in a consultation with an experienced tax accountant!

    IMPORTANT INFORMATION
    This is general advice only and does not consider your financial circumstances, needs and objectives. Before making any decision based on this document, you should assess your own circumstances or seek advice from your financial adviser and seek tax advice from your accountant.

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