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Authorisation Number: 1012758290601

Ruling

Subject: Family trust election and franking credits

Question

Is the Trustee of the deceased estate eligible to make a family trust election allowing the beneficiaries to claim franking (imputation) credits?

Answer:

Yes

This ruling applies for the following period(s)

Year ended 30 June 2014

The scheme commences on

1 July 2013

Relevant facts and circumstances

The deceased passed away in the late 2000's.

The deceased's accountant and their solicitor were appointed executors.

Under the deceased's Will, the Executors were directed to divide the estate into two parts. One part of the estate included shares in ASX-listed companies which regularly paid franked dividends (which is the relevant part for this ruling).

Pursuant to the Will, the deceased bequeathed this part of their estate to the trustees to hold upon the following trusts;

a) Upon trust to pay the income therefrom to their children X and Y in equal shares

b) Upon trust to pay the capital therefrom following the death of X and Y to the children of X and Y in equal shares

Under the Will, the only persons who can obtain enjoyment of the income and capital of the Trust are the deceased's children and their children.

Subsequently, the trustees resigned as trustees and a special purpose company, Company A, was appointed as the replacement trustee. The directors and shareholders of the Trustee were, and remain, the original trustees.

The original trustees were, and continue to be, partners of the family's longstanding accountants.

The Trustee has carried on no activity other than to act as Trustee of the testamentary trust.

It is intended that one of the deceased's children will be specified as the individual (the test individual) whose family group is to be taken into account in relation to the family trust election to be lodged by the trustees of the Estate.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 272-75 of Schedule 2F

Income Tax Assessment Act 1936 Section 272-80 of Schedule 2F

Income Tax Assessment Act 1936 Section 272-90 of Schedule 2F

Income Tax Assessment Act 1936 Section 272-87 of Schedule 2F

Income Tax Assessment Act 1997 Section 207-145

Income Tax Assessment Act 1997 Section 207-150

Income Tax Assessment Act 1936 Former Division 1A Part IIIAA

Income Tax Assessment Act 1936 Former section 160APHO

Income Tax Assessment Act 1936 Former section 160APHM

Income Tax Assessment Act 1936 Former section 160APHL

Reasons for decision

Family Trust election

Section 272-75 of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936) provides that a trust is a family trust at any time when a family trust election in respect of the trust is in force. To qualify as a family trust, the trustee is required to make a family trust election under section 272-80.

An election will satisfy section 272-80 of Schedule 2F to the ITAA 1936 where:

a) there is a nominated test individual in relation to whom the family group is to be taken into account for the basis of the tests applicable to the trust;

b) the trust is able to pass the family control test; and

c) it is made in writing in the approved form.

Family group is defined in section 272-90 of Schedule 2F to the ITAA 1936 and can be divided into a number of categories:

a) family members of the specified individual;

b) certain former family members;

c) the family trust in respect of which the election is made;

d) another trust with the same test individual specified in its family trust election;

e) interposed entities that have made an interposed entity election where that election is still in force at the relevant time;

f) certain other 100% family-owned or controlled entities;

g) certain funds, charities, or other institutions covered by the gift deduction provisions or other tax-exempt bodies;

h) estates of the test individual or family members if all are dead; and

i) certain persons holding interests in small and medium enterprises (SMEs) that have made interposed entity elections.

Subsection 272-87(1) of Schedule 2F to the ITAA 1936 provides that a trust in respect of which a family trust election is proposed to be made passes the family control test if:

a) the requirement in any of the paragraphs of subsection (2) is satisfied in relation to a group consisting of:

i. the individual (the primary individual) who is to be specified in the family trust election or, in the case of an interposed entity election, who is specified in the family trust election to which the interposed entity election will relate; or

ii. one or more members of the primary individual's family; or

iii. the primary individual and one or more members of the primary individual's family; or

b) the requirement in any of paragraphs (a) to (e) of subsection (2) is satisfied in relation to a group consisting of a person or persons covered by subparagraph (a)(i), (ii) or (iii) of this subsection and one or more legal or financial advisers to the primary individual or to a member of the primary individual's family; or

c) the requirement in paragraph (f) of subsection (2) is satisfied in relation to a group consisting of:

i. the trustees of one or more family trusts, provided the primary individual is specified in the family trust election of each of those family trusts; or

ii. such trustees and a person or persons covered by subparagraph (a)(i), (ii) or (iii).

Subsection 272-87(2) of Schedule 2F to the ITAA 1936 explains that the requirement for the purposes of subsection (1) is that:

a) the group has the power, by means of the exercise of a power of appointment or revocation or otherwise, to obtain beneficial enjoyment (directly or indirectly) of the capital or income of the trust; or

b) the group is able (directly or indirectly) to control the application of the capital or income of the trust; or

c) the group is capable, under a scheme, of gaining the beneficial enjoyment in paragraph (a) or the control in paragraph (b); or

d) the trustee of the trust is accustomed, under an obligation or might reasonably be expected, to act in accordance with the directions, instructions or wishes of the group; or

e) the group is able to remove or appoint the trustee of the trust; or

f) the group has more than a 50% stake in the income or capital of the trust; or

g) persons in the group are the only persons who, under the terms of the trust, can obtain the beneficial enjoyment of the income and capital of the trust.

In this case, the only beneficiaries of the trust, and the only persons who can obtain the beneficial enjoyment of the income and capital of the trust, are the deceased's children and the children of those children (all members of the family group). Therefore, the trust would satisfy the family control test under section 272-87 of Schedule 2F to the ITAA 1936.

Accordingly, provided that the family trust election is made in writing on the approved form and, nominates one of the deceased's children as the test individual, the estate will be eligible to make a family trust election.

Franking credits

Section 207-145 and 207-150 of the Income Tax Assessment Act 1997 (ITAA1997) provide that if an entity to which a franked distribution is made is not a qualified person for the purposes of Division 1A of former Part IIIAA of the ITAA 1936, they are not entitled to gross up their income for the franking credit received, nor claim an offset equal to the franking credit.

While Part IIIAA of the ITAA 1936 ceased to apply from 1 July 2002, Taxation Determination TD 2007/11 confirms that it is necessary to have regard to the rules in Division 1A of former Part IIIAA of the ITAA 1936 in determining whether an entity is a qualified person for the purposes of paragraphs 207-145(1)(a) and 207-150(1)(a) of the ITAA 1997.

Essentially, a taxpayer who has held an interest in shares on which a dividend has been paid will be a qualified person in relation to the dividend if they have held the interest in the shares (not being preference shares) for a continuous period of not less than 45 days and, neither the taxpayer nor an associate has made, is under an obligation to make, or is likely to make, a related payment in respect of the dividend (former section 160APHO of the ITAA 1936).

To calculate the number of days in which a beneficiary of a trust is required to have continuously held their interest in the shares, days in which the beneficiary has materially diminished risks of losses of opportunities for gain in relation to the interest is excluded.

Former section 160APHM of the ITAA 1936 explains that there will be materially diminished risks of loss or opportunities for gain if the taxpayer's net position in relation to the interest is less than 30% of those risks and opportunities. A taxpayer's net position is worked out using the financial concept known as delta. If a delta is less than 0.3, there is a material diminution of risks of loss and opportunities for gain.

Former subsection 160APHL(7) of the ITAA 1936 provides that at a taxpayer's interest in a share is a long position with a delta of +1 in relation to itself.

Former subsection 160APHL(10) of the ITAA 1936 explains that if the if the trust to which the taxpayer is a beneficiary is not a family trust then the taxpayer will have an additional short position equal to the taxpayer's long position that arose under former subsection 160APHL(7) and, a long position equal to so much of the taxpayer's interest in the trust holding as is a fixed interest.

Former subsection 160APHL(11) of the ITAA 1936 provides that for the purposes of subsection (10), the taxpayer's interest in the trust holding is a fixed interest to the extent that the interest is constituted by a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding.

In this case, as the trust is currently not a family trust and the income beneficiaries receiving franked dividends from the trust do not have an interest in the corpus of the trust, the beneficiaries will be left with a nil net position, or a delta of zero. This will constitute a material diminution in the taxpayer's risks of loss or opportunities for gain and the beneficiaries will not be treated as qualified persons.

However, once an effective family trust election is in place, there will be no deemed short position under former subsection 160APHL(10) of the ITAA 1936, meaning that in the absence of any positions of the trustee that reduce risk, the only position of the beneficiaries would be a deemed long position under former subsection 160APHL(7) that is, the beneficiaries will have a delta of +1. Accordingly, the franking credits can pass through the trust to the beneficiaries.

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