Family Trust Distribution Tax risks – Time to Act!

As an optimist, I hope and expect that many tax agents will already be reviewing client groups for trust elections (FTE) and interposed entity elections (IEEs) as part of their FY2026 return preparation process, and will have done so in relation to the 2025 year for some clients as well.

The limited and partial remission on interest charged on any family trust distribution tax (FTDT) was announced by the ATO in August last year, and runs to 31 December 2026. At the time of writing, easily more than half of that time has passed. Further, the ATO has mentioned this issue a number of times since the partial remission option was announced, with the theme of those announcements being that these rules cannot be ignored and that taxpayers should do the work whilst the reduced interest cost may be available.

In our view, it would be unwise to expect or assume that the ATO is doing nothing whilst this period runs. Recently there have been a number of tax commentators who have wondered aloud whether the ATO is undertaking pre-review and pre-audit work on taxpayer groups in preparation for likely contact with taxpayers and their agents after the limited remission period expires. If this is occurring, that work is likely to include reviewing any elections made and then considering any distributions or dividends paid to see if they have flowed within or outside of the relevant family group(s). That work is necessary to determine likely FTDT liabilities and would put the ATO in a position where it is ready to start reviews of taxpayers it identifies with a FTDT liability exposure.

As an aside, this raises a theoretical question should the above conjecture be accurate – should the ATO tell such taxpayers promptly after identifying possible issues and give them time to address? The ATO already tells taxpayers as part of its early engagement and commercial deals programs that it is aware of their side hustle which they expect to see in the tax return, and about the change of ownership of an asset for which they expect to see a capital gain declared. Why not this? Would any such delay provide grounds for further interest remission? An intentional delay by the ATO would appear to be a departure from its ‘compliance model’, wherein it engages with taxpayers when it becomes aware of tax issues – see QC 57034.

Going back to the elections themselves, if an issue is found – either by a taxpayer’s own review or by the ATO – then the two immediate questions which arise are (i) what is the quantum of FTDT likely to arise and (ii) can anything be done to reduce it?

In relation to the first query – FTDT is applied at 47% on the entity which made the distribution outside the family group.  This will usually be a trust or a company. However this is not necessarily the only tax liability which will arise. Where FTDT applies to a trust distribution made to a company then the trust has the FTDT liability whilst the company’s income is now NANE, so the company may well have a tax refund for prior year taxes paid, partially mitigating the FTDT impact. When that company pays a dividend funded by that NANE amount, the absence of company tax having been paid means that there may not be franking credits around to attach to the dividend. This lack of franking credits arising from the NANE nature of its profits means that the dividend will be unfranked – so another tax liability will arise for the shareholder of up to a further 47%.

As a simple example, where a trading trust with an FTE makes a profit of $1,000 and distributes that to a company outside its family group then the trust has a FTDT liability of $470. Assuming that the trust can take this out of the distribution it made, this leaves the company with a $530 profit. If the company uses this money to pay a dividend then it will likely be unfranked, as the company has paid no income tax and so may not have any franking credits. If that dividend is then taxed at 47% (subject to marginal rates) in the hands of an individual shareholder, that shareholder will pay $249 in tax, leaving $281 left from the original pre-tax $1,000 after all income taxes are paid. This is an effective tax rate of 71%. We have seen scenarios where the effective tax rate is even higher than this. One of these is in one of our earlier articles here.

As to the second issue, being whether anything can be done to prevent or mitigate such an outcome, to begin to answer that question you will need to know what elections were made, when they are made and who were the individuals either singly or collectively in control of each entity for the whole period of risk. Further, later distributions by any entity seeking to make an election with an earlier year start date need to be considered to see if making an election would cause a new FTDT liability to arise.  So if there was a distribution outside a family group in say 2015 which is subject to FTDT, then being able to advise your client as to whether an election can be made going back to cover it will depend on being able to know and prove who controlled the trust and the beneficiary at all times from 2015 to now, and also to have full information about every distribution made from 2015 onwards.

Death causes new issues to emerge

One area of the family trust rules which is not always fully appreciated is the impact of an individual’s death on FTDT exposures. An individual who is part of a family group can receive distributions (including dividends from companies in the family group) without FTDT being an issue. If that individual dies, their deceased estate is not them, and so is not in the family group. So a company paying out dividends as usual to family members might have a FTDT liability if some of its shares are owned by a deceased estate and those shares haven’t yet passed onto a beneficiary.

Of course, the deceased estate is a trust, and so can make an FTE to join or form a family group. When doing so, it can nominate the same test individual as other family entities have done, other than in situations where the individual who has died was the test individual of those other entities.  In this last situation, an IEE may (but will not always) assist.

These are merely some of the issues to consider in the trust election space – hopefully they help to show that these laws, intended originally to raise no revenue, are ones to be very careful with.  Of course, If you find that the matters discussed in this article resonate with you and your clients, we at Webb Martin Consulting are here to help.

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