November 2024 Round Up - Family Trust Elections in the spotlight

Why do we need a refresher on family trust elections? The ATO refocuses its guidance on FTEs and IEEs.

Plus, the finalised guidance on section 99B, primarily impacting benefits from non-resident trusts, that offers a low compliance approach in certain scenarios.

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Inside this month, Michael Carruthers (Tax Director), Ann Dai (Tax Adviser) and Lisa Armstrong (MD) bring you:

Section 99B - benefits from non-resident trusts

Reference: 

• TD 2024/9
• PCG 2024/3

The ATO has finalised its guidance on the operation of section 99B of the ITAA 1936.

Section 99B basically ensures that payments made to a beneficiary who has been a resident of Australia at any time during the relevant income year are taxed in Australia, unless a specific exception applies. While the legislation isn’t specifically limited to non-resident trusts, in practical terms the risk of section 99B applying is much higher if the trust has been a non-resident at some stage since it was established.

Section 99B(2) reduces the amount assessed under section 99B(1) to the extent that the distribution is sourced from the corpus of the trust, unless this relates to income or gains made by the trust that haven’t been taxed in Australia but would have been taxed had they been derived by an Australian resident (i.e., a hypothetical resident taxpayer).

In TD 2024/9, the ATO discusses the hypothetical resident taxpayer aspect of the rules and provides some practical examples explaining how the ATO would apply the rules in some reasonably common scenarios. Under the hypothetical resident taxpayer tests, the only characteristic of the hypothetical taxpayer is that they are an Australian resident. Therefore, the ATO confirms that the CGT discount is not available to the hypothetical taxpayer. 

For example, the ATO indicates that section 99B would not apply if a foreign trust sells a pre-CGT asset and distributes the capital gain to a resident taxpayer, since it would be reduced in full under section 99B(2).

PCG 2024/3 explains how the ATO will approach section 99B in a number of common scenarios, although the guidance is high-level and focuses more on whether the taxpayer would need to consider section 99B in more detail. The PCG makes it clear that section 99B can potentially apply in a wide range of circumstances, including situations involving loans, forgiven debts, amounts received from deceased estates and when beneficiaries use assets owned by a trust. 

However, the PCG sets out the ATO’s compliance approach for two common scenarios which are considered low risk, and the record-keeping expected to substantiate this.

The two common scenarios covered in the PCG relate to deceased estates and where trust property is provided on commercial terms.

For deceased estates, an arrangement will be considered low risk if:

• The deceased individual was a non-resident just before they died; 
• The trust property (including cash or proceeds from the sale of trust assets) is distributed to the resident beneficiary within 24 months of the date of death; 
• The total value of trust property received by the beneficiary doesn’t exceed $2m; 
• The distribution is not made from a testamentary trust; 
• The beneficiary obtains appropriate documentation to prove that the conditions are met; 
• There aren’t any elements of a contrived nature; and 
• The arrangement wasn’t entered into for the purpose of enabling the beneficiary to provide a benefit to another resident beneficiary of the trust. 

For the second scenario, an arrangement will be considered low risk if:

• The borrowing, hire or use of the trust property is subject to an agreement, whether written or verbal;
• The agreement is made on commercial terms; and
• The resident beneficiary makes a physical payment to the trustee equal to the interest, hire or use per the commercial terms.

It is accepted that an agreement is on commercial terms where the rate applied and terms of the agreement are consistent with market rates in the same or similar circumstances. There is also a safe harbour for loans if the interest rate and term aligns with Division 7A loans.

If the arrangement satisfies the conditions to be considered low risk, then the ATO will not dedicate compliance resources to consider the application of section 99B, apart from confirming the low risk features are met. However, it is important to remember that even if section 99B doesn’t apply, this doesn’t necessarily mean that the arrangement wouldn’t trigger other taxing provisions.

The onus is on the beneficiary to provide appropriate information and documentation when seeking to rely on the reductions in section 99B(2)(a) or (b). For example, beneficiaries would be expected to obtain:

• Signed and executed trust deeds or the will of the deceased individual
• Signed trustee minutes, resolutions or distribution statements confirming an amount was paid or applied for the benefit of a beneficiary from the trust's corpus;
• Copies of the trust's financial accounts for the relevant years, prepared in accordance with the accounting principles of the relevant country;
• Further documents on a case-by-case basis (e.g. records of the payments or transfer of property, working papers, bank statements, trustee minutes or resolutions, correspondence and advice, etc).

Where the onus is not discharged, the ATO will administer section 99B on the basis that the full amount should be included in the beneficiary's assessable income.

Reminder on Family trust elections and concessions

Reference:

• Family trust elections - what you need to know
• Family trusts concessions

The ATO has issued a reminder of the key issues to consider when making family trust elections (FTE) and interposed entity elections (IEE).

Where a trustee makes a valid FTE, the trust becomes a ‘family trust’ for tax purposes. The trust needs to pass the family control test before it can make an FTE.

An FTE must specify a person as the test individual. The ‘family group’ is defined with reference to this individual and the family control test is applied with reference to this individual. Each trust can only have one specified individual, who must be alive at the time of the election.

In many cases, it is difficult for discretionary or non-fixed trusts to pass certain tests in the tax rules. Making a valid FTE provides access to certain tax concessions, including:

• Trust loss measures – family trusts are only required to pass the modified income injection test and don’t need to pass the other trust loss tests.
• 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, where the relevant interests in a company are held by the trustee of a family trust, a single notional entity that is a person is taken to own the interests.
• Holding period rules for franking credits – the trustee and beneficiaries of a family trust that receives a franked dividend to benefit from a franking credit concession as a ‘qualified person’.
• Trustee beneficiary reporting (TBR) rules – trusts that have made an FTE or an IEE (among others) are excluded from having to comply with the TBR rules.
• Small business restructure rollover – special rules apply for family trusts in the context of assessing whether there has been any material change in ultimate ownership.

However, once the election is in effect, family trust distribution tax (FTDT) at 47% can arise on distributions that are made outside the ‘family group’ of the specified individual. The trustee of a family trust will also be liable to pay trustee beneficiary non-disclosure tax if it makes a circular trust distribution.

Trusts, companies and partnerships which don’t automatically form part of the family group can potentially make an IEE to be included in the family group if they are able to pass the family control test. This means that these entities can received distributions from the relevant family trust without triggering FTDT. However, if an entity that has made an IEE makes a distribution outside the family group of the relevant individual this will trigger FTDT for the interposed entity.

Experience tells us that applying these rules can be a complex exercise, especially when dealing with multi-generational family groups or groups that contain a range of trusts and other entities. Practitioners and clients who fail to apply the rules carefully can inadvertently trigger significant FTDT liabilities.

The ATO has flagged that it has seen a number of instances where FTDT liabilities could have been avoided by clients and their agents being more vigilant with respect to making elections.

The Senate’s 'freight train' final sitting of the year

The Senate pushed through 32 Bills on the last sitting day of the calendar year clearing the way for an election.

The Government secured the passage of 32 Bills on the last sitting day of the calendar year with the support of The Greens. For their support, The Greens secured electrification upgrades to 50,000 social homes, and removed support for coal, oil and gas under Future Made in Australia and commercial investments and programs of Export Finance Australia.

Not on the Senate Bill freight train was Div 296 - the $3m tax on earnings in a superannuation fund that was announced to commence from 1 July 2025. A Bill that is unlikely to see the light of day pre-election.

And, the extension of $20,000 instant asset write-off by 12 months until 30 June 2025 was removed at the last minute.

Among the Bills passed were a number relevant to accountants and advisers:

• Objective of superannuation enshrined
• Foreign resident capital gains withholding, change in tax amendment periods for SMEs, and ATO able to retain refunds
• Anti-money laundering Bill draws in professional services
• Aged care Bill changes funding structure
• Build to rent incentives
• Restructuring the Reserve Bank of Australia

Read the full overview of the Bills passed by the Senate on our blog.