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Summary only:
Technical Update for Small Practitioners
Trust Losses and Family Trust Elections
Paper prepared for and sponsored by
The Australian Society of CPA’s
26 February 1999
by Brett Davies Lawyers
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PROVISIONS OPERATE TO LIMIT
DEDUCTIONS
All trusts (except Excepted Trusts) must pass certain tests before
claiming:
- prior year and current year losses from 9 May 1995 and
- debt deductions from 20 August 1996
- bad debt deduction (s51 or s64 ITAA 1936) or
- debt/equity swap deduction (s63E ITAA 1936 or s8-1 or s23-35 ITAA
1997)
But does not apply to capital losses.
Schedule 2F ITAA 1936 (Royal Assent on 17 April 1998)
POLICY OBJECTIVE
To prevent the transfer of trust losses to parties other
than those who have economically suffered the loss (i.e. only the person who
economically suffers a loss to which a tax deduction relates should be able
to have the tax benefit of that deduction)
The new provisions achieve this objective by limiting the deductibility
of losses or outgoings incurred by a trust in two circumstances :
(i) Acquisition of a loss trust
Deductions are limited where there is a change in ownership or
control of the trust (i.e. when a person acquires beneficial interests
in the trust or control of the trustee) followed by the new
owner/controller of the loss trust deriving assessable income so that
the income is sheltered by the trust loss.
The provisions covers this situation by providing 4 different tests
which must be satisfied (depending on the type of trust) before a loss
can be allowed.
(ii) Transfer of income into a loss trust
Deductions are limited where the trust is involved in a scheme to
take advantage of a tax loss or other deductions.
This is done by transferring income into a loss trust under an
arrangement whereby the owners/controllers of the trust effectively
receive a fee for the use of the losses from the transferor of the
income (i.e. the trust receives a benefit for allowing the transferor to
use the trust losses to shelter income from tax.)
The provisions covers this situation by providing for an income
injection test to be satisfied before trust losses can be allowed as a
deduction.
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| STEPS IN APPLYING PROVISIONS (1) Identify the type of trust
Type of trust |
Description |
| Fixed trust |
Persons have fixed entitlements to all the income and
capital of the trust |
| Widely held unit trust |
A fixed trust that is a unit trust 20
or less individuals between them do not beneficially hold, directly or
indirectly, 75% or more of the fixed entitlements to income or capital
of the trust |
| Unlisted widely held trust(1) |
A widely held unit trust The units are
not listed on an approved stock exchange |
| Listed widely held trust |
A widely held unit trust The units are
listed on an approved stock exchange |
| Unlisted very widely held trust(1) |
An unlisted widely held trust with at
least 1,000 unit holders Compliance with other conditions as
s272-120 |
| Wholesale widely held trust(1) |
An unlisted widely held trust where 75%
or more of the units in the trust are held by certain bodies and the
initial amount subscribed for units in the trust by each particular
unit holder in the trust is at least $500,000 Compliance with other
conditions as specified in s272-125 |
| Non-fixed trust |
A trust that is not a fixed trust |
| Family trust |
A trust that has made the election to be a family trust for
the purposes of the trust loss measures |
| Excepted trust |
A family trust A complying
superannuation fund, complying approved deposit fund or pooled
superannuation trust
A unit trust where tax exempt bodies have fixed entitlements,
directly or indirectly, to all the income and capital of the trust
Certain deceased estates within 5 years administration period (but
testamentary trusts not restricted to this period) |
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| (1) Note that the classification of a trust that meets
the definition of unlisted widely held trust, unlisted very widely held trust or wholesale
widely held trust may be affected by the nature of its parent (s272-127) (2) Apply all applicable tests before deduction is
allowable
Type of trust |
50% stake test |
Same business test |
Pattern of
distribution test |
Control test |
Income injection test |
| Fixed trust other than a widely held unit trust |
*(1) |
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* |
| Unlisted widely held trust |
* |
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* |
| Listed widely held trust |
* |
*(2) |
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* |
| Unlisted very widely held trust |
* |
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* |
| Wholesale widely held trust |
* |
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* |
| Non-fixed trust |
* |
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*(3) |
* |
* |
| Family trust |
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*(4) |
| Excepted trust (other than a family trust) |
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(1) An alternate test is also available
in certain cases where non-fixed trusts directly or indirectly hold fixed
entitlements in the fixed trust
(2) This test can be applied if the 50% stake test is failed by a listed
widely held trust
(3) This test does not apply for current year loss purposes
(4) The income injection test does not apply where entities and
individuals within a family group inject income into a family trust with
losses |
Tests that apply to limit deductibility of
losses and debt deductions
| What is the 50% stake test for fixed trusts? Applies
to all fixed trusts other than excepted trusts |
The same individuals have fixed entitlements,
directly or indirectly, to more than 50% of the income of the trust at
the relevant times (1) and
The same individuals (not necessarily the same as those that hold
fixed entitlements to income) have fixed entitlements, directly
indirectly, to more than 50% of the capital of the trust at the
relevant times (1).
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| What is the 50% stake test for non-fixed trusts? Applies
to non-fixed trusts other than excepted trusts |
If individuals have fixed entitlements to more than
50% of the income of the trust at any time in the test period, then at
all times in the period from that time, the same individuals must hold
more than a 50% stake in the income of the trust(2) and
If individuals have fixed entitlements to more than 50% of the
capital of the trust at any time in the test period, then at all times
in the period from that time, the same individuals (not necessarily
the same as those that hold fixed entitlements to income) must hold
more than a 50% stake in the capital of the trust(2)
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| What is the alternate test for fixed trusts? Applies
to fixed trusts (other than excepted trusts) that are not widely held
unit trusts if:
* at all times in the test period, 50% or more of the fixed
entitlements to income or capital of the trust or a holding entity of
the trust are directly held by a non-fixed trust(s) (other than a
family trust)(3) and
* individuals do not have more than a 50% stake in the income
or capital of the trust at the start of the test period
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There is no change in the persons directly holding
fixed entitlements to shares of the income or capital of the trust or
holding entity nor the percentage of their shares and
Every non-fixed trust (that is not a family trust or other excepted
trust) that holds fixed entitlements in the fixed trust, directly or
indirectly, would satisfy the relevant tests that apply to non-fixed
trusts if they stood in place of the loss trust
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| What is the same business test? Applies
to listed widely held trusts other than excepted trusts |
All the following are met:
the trust carried on the same business as it carried on before a
particular time(4)
the trust did not derive income in the income year from:
a business of a kind that it did not carry on before a particular
time(4) or
a transaction of a kind that it did not enter into in the course
of its business operations before a particular time(4)
the trust did not do things for the purpose, or for purposes
including the purpose, of being taken to have carried on the same
business as it carried on before a particular time(4). The things
are:
start to carry on a business of a kind it did not carry on before
the particular time or
enter into a transaction of a kind that it had not entered into
in the course of its business operations before the particular time
the trust does not incur expenditure in carrying on a business of
a kind that it did not carry on before a particular time(4)(5)
the trust did not incur expenditure in entering into a
transaction of a kind that it had not entered into in the course of
its business operations before the particular time(4)(5)
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| What is the pattern of distributions test? Applies
to non-fixed trusts other than excepted trusts |
More than 50% of the relevant distributions of the
relevant income years (as specified in Subdivision 269-D) are
distributed (directly or indirectly) to the same individuals(6)(7)
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| What is the control test? Applies
to non-fixed trusts other than excepted trusts |
A group must not begin to control the trust, directly or
indirectly, during the test period(8) |
| What is the income injection test? Applies
to all fixed trusts (including widely held unit trusts) and non-fixed
trusts
Does not apply to excepted trusts other than family trusts |
The trust has a prior year loss deduction
or a current year deduction and:
under a scheme, assessable income is derived by the trust, an
outsider provides the trustee or a beneficiary (or an associate) with
a benefit and the trustee, a beneficiary (or an associate) provide a
benefit to the outsider or an associate of the outsider(9) and
the assessable income has been derived, or any of the benefits have
been provided, wholly or partly, but not merely incidentally, because
of the loss or other deduction in the trust
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(1) If a trust is a widely held unit
trust it is taken to pass the 50% stake test if it is reasonable for the
Commissioner to assume that the test is passed
(2) Under ss 267-40(3) and 267-70(3) the Commissioner may treat this test
as not having been failed if he or she considers it fair and reasonable to
do so having regard to certain matters
(3) A 'holding entity' is a trust or company that holds all of the fixed
entitlements to income and capital of the trust (whether directly or
indirectly)
(4) A particular time is a reference to the time immediately before the
first abnormal trading in units of the trust and on testing at that time the
trust fails the 50% stake test
(5) This test applies for current year loss purposes only
(6) The smallest percentage of any distribution to an individual is taken
into account in determining whether this test has been satisfied. The
combined smallest percentages for all beneficiaries must be greater than 50%
(7) This test only applies for prior year loss purposes
(8) The terms 'control' and 'group' are defined in section 269-95
(9) An associate of an outsider effectively does not include a member of
the family group where the trust is a family trust (see s270-10(1)(b)(iii)) |
Case Study - 50% Stake test
Vanguard Trust, a fixed trust, has a prior year loss from
Year 1.
In Year 2, the Trust seeks to deduct that loss.
Throughout Year 1 and part of Year 2, the following persons hold the
fixed entitlements set out :
JACK : 50% fixed entitlement to income & 30% to capital on
winding up
JILL : 50% fixed entitlement to income & 30% to capital on
winding up
MARY : 20% fixed entitlement to capital on winding up
BILL : 20% fixed entitlement to capital on winding up
During Year 2, both JACK & JILL sell half of their fixed entitlements
in Trust A to James.
As a result, from the time of sale, the new entitlements are as follows
:
JACK : 25% fixed entitlement to income & 15% to capital on
winding up
JILL : 25% fixed entitlement to income & 15% to capital on
winding up
MARY : 20% fixed entitlement to capital on winding up
BILL : 20% fixed entitlement to capital on winding up
JAMES : 50% fixed entitlement to income & 30% to capital on
winding up
Is the stake test failed?
Before the sale, JACK, JILL, MARY & BILL have 100% of the fixed
entitlements to both income and capital of Vanguard Trust.
After the sale, however, they only have between them a fixed entitlement
to income of 50% and a fixed entitlement to capital of 70%.
The residue is held by James.
Vanguard Trust fails the 50% stake test.
WHY?
There has been a 50% change in the natural persons who hold fixed
entitlements to income of the trust for their own benefit.
That is, the original owners of the fixed entitlements no longer hold
more than 50% of the fixed entitlements to income of Vanguard Trust.
Case Study - Pattern of distributions test
A trust incurs losses in Year 6. Year 7 is the current
income year.
The trust has made one distribution of income in Years 1, 2, 3 and 4 and
two distributions in Year 7.
However, no distributions of capital have been made in Year 7. (This
means it isn't possible to apply the test for any distributions of capital
by the trust.)
In accordance with the pattern of distributions test, the end year is
Year 7 (i.e. the current income year) and the start year is Year 4 (because
it has a distribution made BEFORE the loss year that is CLOSEST to that loss
year).
To work out the test year distribution for each year, you total each
distribution of income made to each beneficiary.
The percentage of the total received by each beneficiary is that
beneficiary's share of the test year distribution.
The test year distributions made by the trust are as follows: |
Beneficiary |
Percentage of income
received in Year 4 test year distribution |
Percentage of income
received in Year 7 test year distribution |
Percentage taken to
be received for every test year distribution |
Jack |
50% |
10% |
10% |
Jill |
40% |
10% |
10% |
Mary |
10% |
10% |
10% |
Bill |
0% |
70% |
0% |
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| In this example, the trust does not
satisfy the pattern of distributions condition. WHY?
Because only 30% of each test year distribution has been received by the
same persons, having regard to the fact that each beneficiary is taken to
receive the smallest distribution for each test year distribution.
In essence, if the total worked out by adding the smallest distribution
of each person is more than 50%, the test is passed (in the above example,
the smallest distributions are those in the far right column).
NOTE : The test would still be failed, even if the same persons continued
to receive the income, albeit in different proportions, eg. if Bill received
5% of the income in Year 4, the test will be failed. |
| (3) Calculate the net
income/loss in a special way if required In
some circumstances, the trust must work out its net income/loss for the
income year in a special way.
1. The trust's income year must be divided into periods on the
basis of when a specified event occurs.
As a general rule, the beginning of the first period will be the
start of the income year and the end of the last period will be the end
of the income year.
Other periods will end and begin at the time when one
of the relevant disqualifying events occur during the period.
Once the trust fails a test in a year, even if it re-commences to
satisfy the tests in a future year, it cannot claim a deduction
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Type of Trust |
Disqualifying events
which result in the end of a period (1) |
| Fixed trust other than widely held unit trust |
Failure of 50% stake test Failure of
alternate condition |
| Unlisted widely held trust |
Failure of 50% stake test (50% stake
tested on abnormal trading) |
| Listed widely held trust |
Failure of 50% stake test (unless the
same business test is satisfied) (50% stake tested on abnormal
trading) |
| Unlisted very widely held trust |
Failure of 50% stake test (50% stake
tested on abnormal trading) |
| Wholesale widely held trust |
Failure of 50% stake test (50% stake
tested on abnormal trading) |
| Non-fixed trust |
Failure of 50% stake test Failure of
continuity of control test |
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(1) A period will always end at the end of the
year of income
2. Assessable income and deductions are
allocated, where possible, to particular periods and a notional net
income or notional loss is calculated for each period as if it were an
income year.
If there is no notional loss in any of the periods, the net
income of the trust is calculated in the normal way.
A notional loss incurred in the last period of an income year may be
carried forward to a later year.
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| 3. The net income (if any) and tax loss for the year
must be worked out, taking into account the notional net income and notional loss for each
period, as well as any income or deductions that cannot be allocated to specific periods. The
formula for working out net income for the income year is as follows :
Sum of the notional net incomes for relevant
periods
ADD Full year amounts included in assessable income
LESS Full year deductions for bad debts &
prepaid expenditure
LESS If any amount remains, subtract any other full
year deductions
The formula to calculate domestic losses
is :
Sum of the notional losses for relevant periods
ADD Full year deductions for bad debts or prepaid
expenditure
LESS Notional net incomes for relevant periods
LESS Full year amounts included in assessable
income
LESS Net exempt income as per s79E(12) derived by
the trust
What is the effect of these provisions?
A deduction for prior year losses is not allowable once
the "disqualifying event" occurs in the income year. Nor can the
loss be claimed in future years.
Note if there are both notional incomes & losses for periods during a
year there is a separate calculation of the trust's net income and loss for
the year. |
| Family Trusts Overview of the Family Trust provisions
Family trusts are subject to concessional treatment and most of
the trust loss provisions do not apply to them.
Only the rules dealing with income injection schemes apply to family
trusts and only where persons outside the family group inject income (can
inject income within the family trust or family group)
A trust becomes a family trust for the purposes of the measures if it
makes a family
trust election.
A consequence of making the election is that a special tax (family trust
distribution tax) is payable where a family trust gives income or
capital to persons who are not members of the family group.
This tax is levied at the top marginal rate applying to individuals, plus
Medicare levy.
The family group for the purposes of the family trust rules includes
companies, partnerships and trusts that have made an interposed entity election.
A consequence of making an interposed entity election is that family
trust distribution tax is payable where the interposed entity gives income
or capital to persons who are not members of the family group.
In the case of a family trust that is a fixed trust the family trust
election can be revoked provided that certain conditions are met.
Otherwise, a family trust and interposed entity election cannot be
revoked.
Must be a Family Trust at all relevant times |
| type of deduction |
relevant times =
test period |
| Prior year loss |
The period from the beginning of the loss year to
the end of the income year in which the loss is to be recouped
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| Current year loss |
The income year
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| Debt deduction |
If the debt is incurred in an income year before the
deduction arises - the period from the time the debt is incurred until
the end of the income year
If the debt is incurred in the income year in which the deduction
arises - the income year
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A Family Trust only by election
A trust will be a family trust where the trustee of the trust
has made an election that the trust be a family trust and the election is
in effect.
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Mechanics of Family Trust
election
Must specify an income year from which it is to take effect
Made by the trustee in the trust's return for the specified income year
If the trust is not required to lodge a return, the trustee must make
the election in writing to the Commissioner - given either within 2 months
after the end of the income year or such later time as the Commissioner
allows
The family trust election must specify a test individual
Note ATO Election Form does not require beneficiary details other
than the test individual.
The Family Control test?
A trust cannot make a family trust election unless it is controlled by
the relevant family from the time the election comes into effect.
ie. it must pass the "family control test" at least at the
end of the income year.
A trust will satisfy the test if it is controlled at that
time by a controlling group consisting of some or all of the following:
the test individual
family members, as defined, to include persons related in specified
degrees to the test individual
legal or financial advisors to the test individual or a
member of his or her family
A group constituted in this way will have the requisite control if
(broadly speaking) it has the power, directly or indirectly, to control or
obtain the beneficial enjoyment of the capital or income of the trust or to
remove or appoint the trustee of the trust.
Members of the Test Individual's Family?
This definition is relevant to establish family control as
a pre-requisite to making the Family Trust election as well as establishing
the family group that is afforded the concessional treatment:
(a) any parent, grandparent, brother, sister, nephew, niece, child,
or child of a child, of:
(i) the test individual or
(ii) the test individual's spouse
(b) the spouse of the test individual or of anyone who is a member of
the test individual's family because of
(2 generations up and down within the same generation)
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Note Extended Definition up to 13 May 1997
The test individual's family also includes former spouses,
great-grandparents, aunts and uncles, their spouses or former spouses, and
any child of a relative of the test individual who, under the trust, is
capable of benefiting on the death of the test individual.
Notable Exceptions to Current Definition
Test individual’s great-grandchildren (important as trusts may have a
life of 80 years and may well extend into the 4th generation)
Former spouses (divorced or separated de-factos)
Children of a former spouse
Same-sex partners
Cousins
Aunts and uncles of the test individual
Financial dependants.
The Family Group?
The making of a family trust election in essence involves
specifying an individual, coupled with an implicit undertaking that
distributions and the conferral of entitlements will be limited to the
''family group'' established by reference to that individual. |
Potential Members of
the family group |
Comments
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| A member of the family of the individual specified in the
family trust election |
The person must be such a member at the time of the
distribution. A person will be a family member if, in relation to the
test individual, that person is one of the persons listed in s272-95.
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| Certain family controlled or owned trusts |
These are:
* the family trust in relation to which the family trust election
has been made
* any trust that has made an interposed entity election in
accordance with s272-85 and the election is effective at the time of
the distribution
* any fixed trust if, at the time of the distribution, some
or all of the individuals specified in the family trust election,
the family members of that individual and family trusts of the same
individual have fixed entitlements, directly or indirectly, and for
their own benefit, to all the income and capital of the fixed trust.
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| Certain family controlled or owned companies |
These are:
* any company that has made an interposed entity election
in accordance with s272-85 and the election is effective at the time
of the distribution
* any company if, at the time of the distribution, some or
all of the individuals specified in the family trust election, the
family members of that individual and family trusts of the same
individual have fixed entitlements, directly or indirectly, and for
their own benefit, to all the income and capital of the company.
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Potential Members of
the family group |
Comments
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| Certain family controlled or owned partnerships |
These are:
* any partnership that has made an interposed entity election
in accordance with s272-85 and the election is effective at the time
of the distribution
* any partnership if, at the time of the
distribution, some or all of the individuals specified in the family
trust election, the family members of that individual and family
trusts of the same individual have fixed entitlements, directly or
indirectly, and for their own benefit, to all the income and capital
of the partnership.
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| Some financial institutions and their subsidiaries |
These are such institutions or
subsidiaries to whom distributions are made by certain companies that
are small or medium enterprises and that have made an interposed
entity election in relation to a family trust
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| Certain persons or bodies when the individual specified in
the family trust election and all the members of his or her family are dead at the time of
the distribution |
These are:
* the estate of the individual specified in
the family trust election or the estate of a member of his or her
family
* any religious, scientific, charitable or
public educational institution that, at the time of the
distribution, is exempt from income tax (the exemption will be under
s23(e), or item 1.1, 1.2, 1.3 or 1.4 of the table in s50-5 of the
ITAA 1997)
* certain funds, authorities or institutions
in Australia to whom tax deductible gifts can be made (these are
those listed in the tables in s78(4), covered by s78(5)(a) or
mentioned under items 1 or 2 of the table in s30-15 of the ITAA
1997.
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| Certain funds, authorities or institutions in Australia to
whom tax deductible gifts may be made |
These are those listed in the tables in s78(4) or
covered by s78(5)(a) or mentioned under items 1 or 2 of the table in
section 30-15 of the ITAA 1997. However, they will only be in the
family group where s78A would not apply to deny a deduction if one
were allowable under section 78, or Division 30 of the ITAA 1997, for
the distribution. s78 and Division 30 of the ITAA 1997 provide for the
deductibility of gifts.
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| Certain bodies all of whose income is exempt from income
tax |
These are:
* some religious, scientific, charitable and public
educational institutions (s 23(e), and section 50-5 of the ITAA
1997)
* some public hospitals and non-profit hospitals (s 23(ea),
and items 6.1 and 6.2 of the table in s50-30 of the ITAA 1997)
* the Thalidomide Foundation (s 23(ec))
* some non-profit cultural, sporting, community service and
friendly societies (s 23(g), and ss 50-5, 50-10, 50-20 and items 9.1
and 9.2 of the table in s50-45 of the ITAA 1997) and
* some funds established for public charitable purposes and
purposes of enabling scientific research to be conducted by or with
a public university or public hospital (s 23(j), and s50-5 of the
ITAA 1997).
However, they will only be in the family group where s78A would not
apply to deny a deduction if one were allowable under s78, or Division
30 of the ITAA 1997, for the distribution.
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A family trust election is
irrevocable unless the trust is a fixed trust
Only if some or all of the interests in the trust are disposed of to
non-family members or if any of the persons holding them cease to be
family members.
Notification of the revocation will need to be included in the trust's
return of income for the income year in which the family ceases to so hold
fixed entitlements to all the income and capital of the trust.
If the trust is not required to lodge a return in that year, the
trustee must notify the revocation in writing to the Commissioner in an
approved form.
In this case, the revocation must be given either within 2 months after
the end of the income year or such later time as the Commissioner allows.
INTERPOSED ENTITY ELECTIONS
Members of the family of the test individual can receive distributions
of income and capital from the family trust through interposed companies,
trusts and partnerships.
Where family members (including another family trust of the same test
individual) do not have fixed entitlements, directly or indirectly, and
for their own benefit, to all the income and capital of the interposed
entity, it will be necessary for the interposed entity to make an election
before it can be included as part of the family group.
How is the interposed entity election made?
In the return of income of the interposed company, trust or
partnership.
Can by made after year in which the family trust election was made.
If a partnership, company or trustee is not required to furnish a
return for an income year the interposed entity election must be lodged
with the Commissioner in writing within 2 months after the end of the year
of income or such later time as the Commissioner allows
Specify a date in the income year from which the election takes effect
Specify the family trust to which the election relates, the individual
specified for the purposes of that trust and such other information that
the Commissioner may require (See ATO Election Form)
The interposed entity must be controlled by
the family
Ie. from the time the election comes into effect.
The entity must pass the 'family control test' at least at the end of
the income year.
When does a
company or partnership pass the family control test?
When certain persons beneficially hold between them, directly or
indirectly, fixed entitlements to more than 50% of the income or capital
of the company or partnership.
Because the control test for companies and partnerships only looks at
who beneficially owns interests in the entity, any control influenced by a
professional legal or financial adviser to a family is not relevant to
determining whether the family controls the entity.
An interposed entity election is irrevocable
Note that there is no need to provide for the revocation of an
interposed entity election for a fixed interest entity wholly owned by a
family.
Such entities can be members of a family group without the need to make
an interposed entity election.
Can more than one interposed entity election
be made by an entity?
An interposed entity may want to make more than one election because,
for example, two family trusts of the same test individual will want to
make distributions to the same interposed entity.
It can do so if the 2 family trust have the same test individual.
FAMILY TRUST DISTRIBUTION TAX
This is the consequence if a family trust or interposed
family entity makes a distribution or confers a present entitlement
outside of the family group
The tax is payable at the top marginal rate applying to individuals,
plus Medicare levy, on the amount or value of the income or capital.
What is a
distribution of income or capital?
Normal meaning of distribution
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Entity |
Income |
Capital |
| Trust |
paid or credited to a person as money or is
transferred as property
reinvested or dealt with on behalf of the person or as the person
directs
otherwise applied for the benefit of a person
made to the person in their capacity as a beneficiary of the trust
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paid or credited to a person as money or is
transferred as property
reinvested or dealt with on behalf of the person or as the person
directs
otherwise applied for the benefit of a person
made to the person in their capacity as a beneficiary of the trust
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| Company |
A payment of a dividend - includes formal and informal
distributions made upon winding up of a company (s47(1) and (2A)) as well as deemed
dividends (e.g. sections 108 or 109). |
A payment or crediting of money or the
transfer of property to a person that is not a dividend and
represents:
(i) a repayment of money paid up on a share or
(ii) results in a debit entry to a share premium account of the
company.
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| Partnership |
paid or credited to a person as money or is
transferred as property
reinvested or dealt with on behalf of the person or as the person
directs
otherwise applied for the benefit of a person
made to the person in their capacity as a partner in the
partnership
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paid or credited to a person as money or is
transferred as property
reinvested or dealt with on behalf of the person or as the person
directs
otherwise applied for the benefit of a person
made to the person in their capacity as a partner in the
partnership
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Extended meaning of distribution
the payment (including by way of a loan) or crediting of money of the
entity to a person or the reinvesting of such money for that person or
the transfer of property of the entity to a person or allowing the
use of such property by a person or
the application of money or property of the entity for the benefit of
a person including where the money or property is dealt with for or on
behalf of the person or as the person directs (e.g. where the entity
pays-off a debt owed by the person to a third party) or
the extinguishment, forgiveness, release or waiver of a debt or other
liability owed by a person to the entity.
If the distribution takes the form of property or some other benefit,
it will be necessary to obtain a monetary equivalent of the property or
other benefit provided.
The amount or value of the thing must exceed the consideration given in
return for it to qualify as a distribution.
Example
A trustee provides an interest free loan to a beneficiary of $1,000
which is repayable in 5 years time.
To obtain a comparable loan from a financial institution the
beneficiary would have to repay the principal of the loan in equal
instalments over a 5 year period and incur an interest rate of 10%.
If the annual interest rate on a comparable loan is 10% the present
value of $1,000 repayable in 5 years time is $620
The benefit provided to the beneficiary is $1,000-$620, i.e. $380.
For the purposes of this provision $380 will be taken to be a
distribution of income.
When is a person presently entitled to
income or capital?
A person is presently entitled to a distribution when the person has a
present legal right to demand and receive the distribution.
Eg. in the case of a partnership, a partner would be presently
entitled to a distribution of income or capital when the profits of the
partnership are divided among the partners or when the partner becomes
entitled to withdraw capital from the partnership.
Also, an electing entity can confer a present entitlement without there
necessarily being a decision to that effect.
Eg. where a person becomes presently entitled to a distribution under
the terms of a trust deed, the trust confers a present entitlement on
that person even though the trustee has not made any decision.
Who is liable to pay the family trust
distribution tax? |
Electing entity
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Who has the
liability for the tax? |
| Trust |
If the trustee is an individual - the
trustee If trustee is company - the trustee together with the
directors of the company
(jointly and severally liable) |
| Partnership |
The partners If a partner is company -
the directors of the company
(All jointly and severally liable) |
| Company |
The company and directors of the company (jointly
and severally liable) |
|
Exclusion of directors from liability to pay
tax:
if the director did not take part in any way in any decision to make
the conferral or distribution
if the director was aware of the proposal to make a decision or knew
that it had been made, he or she had taken reasonable steps to prevent the
making of the decision or its implementation
if the director voted against or otherwise disagreed with a decision to
make the conferral or distribution and took reasonable steps to prevent
the distribution being made
No Double Taxation Where FTDT Paid
Amounts on which family trust distribution tax is paid are exempt from
income tax and non-resident withholding tax.
However, any expenditure incurred in deriving the distributed amounts
will not be deductible.
For superannuation contributions surcharge and Medicare levy purposes,
an adjusted taxable income is used which includes the amount exempted due
to FTDT.
INCOME INJECTION TEST
Family trusts only have to follow this test (but potentially applies to
all trusts, except for excepted trusts).
Primarily an anti-avoidance provision, designed to deal with
schemes whereby a trust has a prior year loss deduction or a current year
deduction under which assessable income is injected into the trust to
shelter it from tax.
In the case of family trusts, members of the family or other entities
in the family group can inject income into the family trust to take
advantage of its losses.
The income injection test will only apply where an outsider to
the loss trust seeks to take advantage of the deduction under a scheme.
In general terms, the outsider must provide a benefit to the
trust and a return benefit must be given to the outsider.
Either of the benefits, or the income injected under the scheme, must
have been provided or derived wholly or partly, but not merely
incidentally, because of the deduction.
Test operates objectively and does not have a tax avoidance
motive.
What are the consequences if the test is
failed?
The assessable income derived under the scheme will be
included in the net income of the trust estate, taking no account of tax
losses and deductions that might otherwise have been allowable.
The net income of the trust will be increased so that it equals the scheme
assessable income (even if net income calculated in normal way is
less or nil !).
However, the losses are ''quarantined' and will continue to be
available for offset against non-scheme income in later years.
Example (where income injection test has failed)
A trust has a current year deduction of $120,000 - not related to the
derivation of the scheme assessable income.
Scheme assessable income of the trust is $100,000 and the non-scheme
assessable income is $20,000.
In the absence of the income injection test, the net income of the
trust would be $0 ($120,000 assessable income less the $120,000
deduction).
On failing the income injection test, the net income of the trust is
increased to $100,000 (the amount of the scheme assessable income)
However, the trust has a carry forward loss of $100,000 ($20,000
non-scheme assessable income less the $120,000 deduction).
If the $120,000 deduction mentioned above had instead been a prior year
loss, $100,000 of that loss would have been available for carry forward to
future years.
Flowchart of Income Injection Test |
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| SHOULD YOU MAKE A FAMILY TRUST
ELECTION? Things to Consider
(1) Start with the position that the trust will not elect to be a
Family Trust
Consider the implications, if any, of not making the election:
will the trust have loss or bad debt deductions?
will the losses be recouped internally?
will the losses require an income rejection by outsiders?
Consider whether the tests applicable for your type of trust can be
satisfied easily - if yes, there is no point making the election
Consider each of the applicable tests carefully because they may not
apply to some situations:
income injection test - there must be a scheme (same meaning as
Part IVA)
pattern of distribution test - there must be a distribution
(5) Consider also the Trust Deed to see if there are deemed
distributions to primary beneficiaries if the Trustee fails to
distribute net income or an automatic vesting of entitlements to income
to unitholders
(6) Consider the Trust Deed to see if the Trustee will be in breach
if it favours beneficiaries belonging to a family group over other
beneficiaries that are considered outsiders - especially if the objects
of the trust include both family group and non-group members (to
overcome conflict, may need separate trusts)
(7) Choice of test individual is crucial as it locks in the class of
family members that comprise the family group forever.
Drawbacks
(1) Distribution or conferring present entitlement to outsiders attract
FTDT
(2) Long term implications given the locking in of the family members
of the test individual:
Subject to the transitional measures, the notion of family membership
extends upwards and downwards 2 generations of the test individual
If the family patriarch or matriarch (a member of the oldest
generation in the family) were to be chosen as the primary individual,
family trust status would cease upon the death of the grandchildren of
the oldest generation
If one of the ''middle generation'' were chosen, this would serve to
perpetuate family trust status for a further generation, but it would
(subject to the transitional provisions) be achieved at the expense of
excluding brothers and sisters of the patriarch or matriarch (uncles or
aunts of the test individual) from qualification as ''family members''
(3) Dilemma between choosing the husband or wife as the test
individual:
if they separate (in case of de-facto) or divorce, the ex-spouse
falls outside the family group
a distribution under an order of the Family Court to the test
individual’s ex-spouse would be subject to the FTDT
if shares retained in private company and distributions received
from the family trust, FTDT is payable
Advisers should highlight drawbacks to the one not chosen as the test
individual.
Income injection test will capture "freebies" given to family
members who are not recognised as being part of the family group"
Exceptions to definition of family member:
Great-grandchildren
Former spouses
Children of a former spouse
Same-sex partners
Cousins
Aunts and uncles of the test individual
Financial dependants
Benefits conferred to such non-family members:
free accommodation provided in properties (eg. Farm homestead or
holiday house) owned by family trust (even to foster children or
exchange students)
interest on loan forgone.
(5) Many small business and farms are owned by family trusts or
interposed entities. However, such assets cannot be handed down more than
2 generations (say, to the great-grandchildren) after the test individual
without attracting FTDT
(6) Interests in interposed entities which carry on a small business
may be difficult to sell because a distribution to the purchaser, after
the sale, would be subject to FTDT - will need to sell the underlying
asset and dissolve the interposed entity
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