Australian trust loss rules are complex, poorly understood and onerous to apply. As a result, business or investment trusts risk claiming losses incorrectly, a situation that can result in a significant tax liability.
By making a family trust election (FTE), small to medium sized privately-held businesses operating as a trust can satisfy the trust loss rules much more easily.
Trust loss rules are designed to ensure that only those who funded loss-making activities can benefit from the use of those losses. Legislated in 1995, trust loss rules are complex and widely misunderstood. As a consequence, a trust can inadvertently claim losses it is not entitled to. This can result in having to repay any taxes saved from claiming the losses plus interest and penalties, the size of which is dependent on the facts of the case.
Trust loss tests
The trust loss rules are made up of 4 main tests.
- 50% Stake Test
- Control Test
- Pattern of Distribution Test
- Income Injection Test
Like corporate loss tests covered previously, the tests revolve around maintaining control and ownership of the trust. Which of the 4 tests apply to a trust with losses depends on the type of trust being used. Most small to medium sized privately-held businesses operating in a trust or investment activities conducted in a trust use either a *fixed unit trust or a *non-fixed discretionary trust.
In a *fixed unit trust, the unit holders receive a proportion of the generated income which is ‘fixed’ (or determined) by the number and type of units they hold. Fixed unit trusts tend to be used by small to medium entreprises being conducted by unrelated people, that is business associates who are not members of the same family. A fixed unit trust has the effect of tying down equity interests so that entitlements to income are in accordance with the ownership of units.
In a *non-fixed discretionary trust, the trustee can ordinarily distribute income generated to the known beneficiaries in whatever proportions it wants to, and can vary that from year to year.
How a family trust election (FTE) can help
Both fixed unit trusts and non-fixed discretionary trusts can remove much of the hassle of satisfying the four trust loss tests by making a written family trust election (FTE).
A FTE effectively declares to the tax commissioner that the trust has nominated a ‘test individual’ in relation to whom family members (‘family group’) are then formally defined. The rules then permit the family group of the test individual to, where possible, inject income into the trust or benefits from the trust without breaching the Income Injection Test and in the process putting at risk the use of the available trust loss. This is a broad definition of ‘family group’ and includes the test individual’s spouse, children, grandchildren, parents, grandparents, brothers, sisters, nephews and nieces; their spouses and lineal descendants.
Advantages of a family trust election (FTE)
There are several advantages of a FTE, the most significant being a reduction in the number of tests that need to be satisfied and a modification to the Income Injection Test, making it easier to satisfy. However, a FTE must be lodged in the year when the trust is intending to utilise the losses.
It is possible to back-date a FTE to as far back as 2005. Those who don’t make a FTE risk failing the trust loss tests and being denied the use of trust losses and exposure to tax liabilities, interest and possible penalties. In spite of this, some trusts nevertheless claim losses, an error than has the consequences outlined above. Should the ATO audit you they will likely check whether or not you satisfy the tests. When you don’t, they will deny the loss, and issue a new assessment which may include a significant tax liability.
Certain additional circumstances to do with consistency in the control and management of the trust must be satisfied, but aside from this, back-dating can happen relatively safely, particularly if you seek quality professional advice.
Disadvantage of a family trust election (FTE)
There is one significant disadvantage of being a family trust. If, in a year when it is making profit, a family trust makes a distribution of income or provides a benefit to a person who is outside the family group according to the legislation, Family Trust Distribution Tax (FTDT) of 46.5% is payable, regardless of the personal tax situation of the recipient.
It is also worth noting that the concept of a family group includes companies and trusts controlled by its members. These rules have enabled corporate entities and trust entities of the broader family group to also be part of the family group. Such entities either qualify automatically or via the making of an interposed entity election (IEE) where permissible.
More information? To find out more, give us a call on 1300 023 782 or email firstname.lastname@example.org.
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