FocusOn - Family Trusts

What is a Family Trust?

A trust becomes a family trust if it makes a family trust election.  In order to be eligible to be a family trust, a trust must first pass a control test.  In effect, where only one family uses the trust, the trust will satisfy this test.  However, a unit trust in which two separate family groups hold units cannot be a family trust.

When the control test is passed, a trust can become a family trust by the trustee simply making an election.  The election must state who the “test individual” is.  The test individual is then used to determine the “family group”.  Distributions or benefits provided outside the family group will be subject to family trust distributions tax, being tax at the top marginal rate plus Medicare.

Accordingly, a family trust is restricted to distributing to the family group.  The family group comprises the test individual and the following:

	a spouse or former spouse
	lineal descendants including children, grandchildren and great-grandchildren
	a parent, grandparent, brother, sister, nephew or niece of the test individual or their spouse
	a spouse or widow of any individual covered above
	the family trust itself
	any trust, company or partnership that has made an interposed entity election
	any fixed trust, company or partnership in which an individual above has a fixed entitlement and
	certain tax exempt and deductible gift bodies, including most churches

The following diagram shows the family group:

It should be remembered that benefits, as well as distributions, provided outside the family group are subject to the family trust distributions tax.  For example, if a rental property owned by the family trust is provided free of charge to friends outside the family group.

Family trust elections can be revoked or varied in limited circumstances.

Why be a Family Trust?

A trust might elect to be a family trust for two main reasons.

Firstly, a discretionary trust that acquires shares after 31 December 1997 cannot distribute the franking credits arising from those shares, unless it is a family trust or unless the beneficiaries are eligible to use the “small shareholders’ exemption”.

Secondly, many trusts will only be able to utilise their tax losses if they are a family trust.  Unless certain tests are met, the losses cannot be used.

Losses include not only carried forward income losses, but also losses in one area used to offset profits from another area.  For example, the laws can prevent the offsetting of a negatively geared rental loss against business profits.

Trusts which are not family trusts must satisfy various onerous tests in order to utilise income losses.  However, a family trust need only satisfy the income injection test.  It will pass the test in any year unless:

	Someone outside the family group provides a benefit to the trust and receives a benefit in return; and
	it is reasonable to conclude that the flow of benefits is under a scheme which took place wholly or partly, but not merely incidentally, because the deduction would be allowed

For example, if you are the test individual and your uncle provides a loan to the trust and receives interest on the loan, both the trust and the uncle have received a benefit.  If the reason for the arrangement was even partly motivated by the fact that the trust would obtain the tax deduction, the income injection test is failed.

Clients may consider restructuring their affairs to avoid the need to make a family trust election.  Alternatively, it may be advantageous to use different trusts or other entities for different types of transactions.  For example, consideration could be given to establishing a separate trust to make any new share purchases.  Only the new trust makes the election, allowing distributions outside the family group to be made from the old trust.

Choosing the Test Individual

To make a family trust election, the trustee must specify the test individual.  The test individual is used to determine the family group and therefore the family members that can receive distributions or benefits from the trust.  Usually the test individual will be the husband or wife.  For example, if the husband is the test individual, the family group will cover most near relatives of both husband and wife, but excludes aunts and uncles.

The test individual must be alive at the time the election is made.  Accordingly, deceased individuals and unborn children cannot be test individuals.  However, where the test individual later dies, that person is still used to determine the family group.  A new test individual can be appointed if desired, but only once.

In summary, care should be taken in choosing a test individual.  The decision can only be changed once and can have major implications in future years.

Published : July 2009