Dealing with Family Trust Elections and Interposed Entity Elections when they close the loop too tightly
Discretionary Trusts offer a great structure for clients to tax effectively flow income and capital throughout their family group. There may be a number of factors which require a trust to make a Family Trust Election.
These include:
- The trust loss measures;
- The company loss tracing measures;
- The franking credit trading measures;
- The trustee beneficiary reporting rules; and
- The Small Business Restructure Rollover.
Whilst making a Family Trust Election does enable a trust to navigate the above measures more effectively, it does significantly restrict the way in which capital can flow outside of the family group as defined by reference to the chosen “Test Individual”, usually one of the parents.
Where an entity is not automatically included within the Family Group, then an Interposed Entity Election can be made, which is an election to make an entity (company, partnership or trust) a member of the family group of the test individual specified in a family trust election.
Family Trust Distributions Tax is a tax imposed on a family trust (or an entity that has made an IEE) where a present entitlement or distribution is made to a person or entity that is outside of the test individual’s family group.
This can cause major headaches for families especially where FTE’s or IEE’s have been incorrectly made in the past and thus caused entities which may have been in the same family group to now sit outside the family group. This may cause unexpected tax consequences for loans and distributions where they would not have been subject to tax had they been made to the individuals that control those entities.
Where clients have many different trusts in their group, the first step is to identify all FTE’s and IEE’s and determine whether these create multiple Family Groups within the same Family for FTE purposes. If this has occurred it is really important to ensure that the movement of funds does not inadvertently trigger a distribution between these family groups. The best way to ensure this does not occur is to ensure that any transfers of capital between the two family groups are made via the individual beneficiaries who would form part of both family groups.
For example, Jack and Arnold are brothers who each have family trusts where they have nominated themselves as the test individual. Any transfers directly between Jack’s Trust and Arnold’s trust will potentially be subject to FTDT. However a transfer from Jack’s Trust to Arnold (who is a member of Jack’s family group) and then from Arnold into his trust (also in his family group) would not be subject to FTDT as the transfers in both entities are effectively via an individual within both of their family groups.
It is therefore important to ensure that clients are aware if multiple family groups exist within their family structures and if so, how to manage capital flows between them. Having problematic family trust or interposed entity elections does not on their own cause unexpected tax liabilities, rather they can seek to place unexpected tax liabilities on the flow of funds between these entities.
If you have any questions in relations to Family Trust Elections or Interposed Entity Elections, please contact Chris Schoeman.