ATO Crackdown on Family Trust Election Compliance ; Family Trust Election Series (Part 1)

The ATO’s recent focus on compliance with the family trust election (FTE) rules has generated significant controversy and alarm. The crackdown has resulted in the ATO undertaking extensive audits of family trusts and historical distributions, and the issue of hefty Family Trust Distributions Tax (FTD Tax) assessments for noncompliance – being a 47% tax (plus Medicare levy) along with General Interest Charges (GIC) on any historical liabilities. The ATO’s approach has been criticised on the basis that its application has been harsh and inconsistent with underlying legislative intent, and that the rules are too complex, rigid and outdated.

It is a timely reminder for trustees and advisers to review existing FTE arrangements, and a message of caution to those who wish to implement them. Despite the recent alarm, the FTE provisions still provide numerous benefits to family groups if applied properly, including that such arrangements make it easier for trustees to pass franking credits through to beneficiaries, utilise carry forward trust losses and assist with accessing small business restructure CGT rollovers.

This article will outline what an FTE is and provide context on the recent critique of the ATO’s crackdown on family trusts. It will also provide some suggestions on what trustees and advisors should be doing in light of the ATO’s focus on FTEs, and will also outline some of the benefits and risks of making an FTE. This article will be followed next month by Part 2 in this series on FTE’s, covering recent examples and case studies of the ATO’s change in approach including cases currently on foot with high-net worth family trust arrangements.

What is an FTE?

Since they were introduced in 1995, the FTE rules have long been a useful tool for trustees and their advisors to support family members and manage family wealth of a family group.

An FTE is an election made to the ATO declaring a ‘family group’ determined by reference to a specified individual known as the ‘test individual’. While this structure allows certain tax benefits to be shared more easily between group members, those benefits are restricted to certain classes of persons and entities related to the test individual – this includes the test individual’s spouse, parents, siblings, grandparents and lineal descendants among others (as well as certain companies, partnerships and trusts).

Furthermore, the test individual must be carefully chosen as that individual must sufficiently control the trust in order for the FTE to be valid, and once an election is made it is generally irrevocable. If a distribution is made to a beneficiary not part of the family group, the trustee is hit with the FTD Tax on the value of that distribution – imposed at a rate of 47% tax plus Medicare levy, along with General Interest Charges (GIC) on any historical liabilities.

How has the ATO changed its administration of the FTE rules?

The recent ATO blitz on FTE compliance – the result of the ATO increasing its focus on privately owned and wealthy groups – has led to extensive audits of family trust groups and historical distributions, and the issue of hefty FTD Tax assessments.

The ATO’s crackdown has generated alarm among taxpayers and advisors. The rules, and the administration of those rules by the ATO, have been critiqued as:

• too complex, poorly drafted and difficult to navigate;
• being stringently and unreasonably interpreted by the ATO. The ATO’s view is that it does not have any discretion to issue FTD Tax assessments or make amendments to those assessments, which has been criticised as inconsistent with the original legislative intent behind the tax;
• giving rise to disproportionate penalties, as the consequences of the FDT Tax may far outweigh the degree of the mistake (which may be an advisor nominating the wrong test individual decades ago by mistake), with no room for discretion;
• giving the ATO an unlimited power of retrospective review, amplifying the consequences of any FTD Tax, making it riskier to make an FTE and generating uncertainty for trustees;
• not providing for effective succession planning or changes to the underlying needs of a family, given the election is generally irrevocable. For example, a family business may evolve over time but the test individual cannot be amended; and
• hindered by the ATO’s own systems, such as the tax agent portal which does not clearly record prior elections, meaning that issues can persist for years without being detected.

Alongside the critique of the ATO’s approach and the calls for reform, the ATO is continuing to focus resources on auditing FTE arrangements. The current highly publicised reviews of high net worth groups and issue of large FTD Tax bills are likely only the tip of the iceberg, and cases are already on foot in the Courts which may provide some clarity on whether the ATO is applying the rules correctly.

What should you do to safeguard your current FTE arrangements?

If you currently have an FTE in place, the ATO’s focus on FTE compliance provides a timely reminder to review your existing arrangements such as:

• the requirements to make a correct distribution under the FTE rules, and whether historical distributions have been in accordance with the election;
• whether the test individual is correct; and
• whether a voluntary disclosure to the ATO should be made (as such disclosure may result in the ATO remitting an amount of GIC).

It is also an important reminder that the trust deed also needs to be closely reviewed before making any distributions. While a person may be a member of a family group, they may not be an eligible beneficiary under the terms of the trust deed, meaning that any distribution would be invalid under the terms of the trust. In the contrary scenario, while a person may be an eligible beneficiary under the terms of a trust’s deed that beneficiary may not be part of the family group, meaning that any distribution would potentially trigger the FDT Tax.

If you do not have an FTE, should you consider making an election for your family?

Despite the recent alarm, the FTE provisions still provide numerous benefits to family groups, such as the ability to support family and manage wealth in a tax concessionary manner.

Three major benefits of having an FTE include that:

1. it is easier and simpler for trustees to pass franking credits onto beneficiaries;
2. it is easier and simpler for trustees to utilise a trust’s tax losses as the tests that apply to family trusts with an FTE are generally simpler to satisfy; and
3. it may make a CGT rollover for small business restructures more easily accessible. 

However, given the limitations of the family trust rules and the ATO’s current focus on compliance in the sector, trustees and advisors need to carefully consider whether making an FTE is worthwhile and would benefit the relevant family group. Given the recent critiques of the FTE regime, the inflexibility of the rules, the issues around succession planning and the risk of triggering the FTD Tax, you should seek legal advice on whether making an election is appropriate in your circumstances.

What are the Cleardocs products available?

Cleardocs offer the following relevant products:

• Family Trust Trustee bundle
• Discretionary (Family) Trust
• Discretionary Trust - Direct Lineal Relatives
• Discretionary Trust Distribution Minute

Please read the Product Benefits, Product Information and Frequently Asked Legal Questions carefully and consider if it is appropriate in your circumstances before purchasing any Cleardocs product.

More information from Maddocks

For more information, contact Maddocks on (03) 9288 0555 and ask to speak to a member of the Commercial team.

More Cleardocs information on related topics

• Discretionary Trust Deeds for Family Trusts - Aren't they all the same?
• Trust Issues: Learning to Read the Green, Red (and Beige) Flag
• Family Trusts and end-of-year distributions - Revisiting the benefits of the 'Bucket Company' structure
• 'Modernisation of Trust Administration Systems' (MTAS) comes into effect: new reporting requirements for trusts and beneficiaries