Edited version of your written advice

Authorisation Number: 1012855395336

Date of advice: 6 August 2015

Ruling

Subject: Retrospective family trust election

Question 1

If the trustee of the Trust makes a retrospective family trust election (FTE) under subsection 272-80(4A) of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936), will it have the effect that a liability that has already arisen for the trustee of a different trust to pay Family Trust Distribution Tax under section 271-15 of Schedule 2F to the ITAA 1936 is retrospectively eliminated?

Answer:

Yes

Question 2

If the trustee of the Trust makes a retrospective family trust election (FTE) under subsection 272-80(4A) of Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936), will the beneficiaries of the trust become entitled to receive a franking credit tax offset, pursuant to former subsections 160APHL(7) and (10) of the ITAA 1936?

Answer:

Yes

This ruling applies for the following period(s)

Year ended 30 June 2015

Year ended 30 June 2016

The scheme commences on

1 July 2014

Relevant facts and circumstances

X Trust wishes to make a distribution of income to the A Trust, during the year ended 30 June 2016.

The trustee will resolve and pay the distribution on 30 June 2016.

X Trust is a family trust as it has made a family trust election (FTE).

A has not made an FTE.

A Trust has tax losses carried forward that were incurred during the year ended 30 June 2014.

The distribution will include franking credits of over $5,000 which will flow onto the ultimate beneficiaries of A Trust and for which the beneficiaries will be claiming a credit in their personal tax returns.

A Trust satisfies the family control test for the relevant period, being from when the trust was established up until such time as the FTE will be lodged.

A Trust intends to make an FTE, on the approved form, specifying the year ending 30 June 2014. The FTE will be lodged after the distribution by X Trust is made.

A Trust intends to specify the same test individual as specified in X Trust's FTE as the individual whose family group is to be taken into account in relation to the election.

A Trust satisfies all the conditions necessary to be eligible to make an FTE.

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 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.

Earlier year family trust elections

Subsection 272-80(4A) of Schedule 2F to the ITAA 1936 states:

The specified income year may be a year before the one in which the election is made if:

a) at all times in the period from the beginning of the specified income year until 30 June in the income year before the one during which the election is made, the trust passes the family control test (see section 272-87); and

b) either:

i. any conferrals of present entitlement to income or capital of the trust made by the trustee during that period have been made on; or

ii. any distributions of income or capital of the trust made by the trustee during that period have been made to;

the individual specified in the election or members of that individual's family group.

Availability of franking credits through a family trust

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.

These special rules are necessary because some interests in shares held through a trust are inherently risk-less (eg. a potential income beneficiary of a discretionary trust cannot be said to bear the risks of loss or opportunities for gain from shares held by the trust).

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.

Generally, in situations where a discretionary trust (that is not a family trust) has income beneficiaries receiving franked dividends from the trust that do not have a fixed 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 beneficiary will not be treated as a qualified person.

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 beneficiary would be a deemed long position under former subsection 160APHL(7) that is, the beneficiary will have a delta of +1. Accordingly, the franking credits can pass through the trust to the beneficiaries.

Application to your circumstances

A Trust satisfies the family control test for the relevant period, from establishment up until such time as the FTE will be lodged. A Trust satisfies all the conditions necessary to be eligible to make an FTE.

The trustee of the A Trust proposes to make an earlier year family trust election under subsection 272-80(4A) of Schedule 2F to the ITAA 1936. The election will be made some time after the distribution made by the X Trust on 30 June 2016. The election will specify that the A Trust was a family trust for the year ended 30 June 2014, commencing from when the trust was established. This means that the family trust election is in force from 2014.

The election will also specify that the individual whose family group is to be taken into account in relation to the election (subsection 272-80(3) of Schedule 2F to the ITAA 1936) is the same individual whose family group is taken into account for the X Trust. This means that the A Trust is a member of the "family group" of the specified individual in relation to the distribution made by the trustee of X Trust on 30 June 2016 (subsection 272-90(3A) of Schedule 2F to the ITAA 1936).

Where the trustee of a trust makes an earlier year family trust election under subsection 272-80(4A) of Schedule 2F to the ITAA 1936, it will have the effect that a liability that has already arisen for the trustee of a different trust to pay Family Trust Distribution Tax under section 271-15 of Schedule 2F to the ITAA 1936 is retrospectively eliminated.

Further, it is considered that other provisions of the income tax legislation that hinge on whether the trustee of a trust has made a family trust election (including a retrospective family trust election in respect of a previous income year) will be affected in the same way.

This means that the beneficiaries of the A Trust will become entitled to receive a franking credit tax offset (paragraph 207-150(1)(a) of the ITAA 1997), pursuant to former subsections 160APHL(7) and (10) of the ITAA 1936.