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Unforgiving tax law unleashed on family trust arrangements.
FTDT: The sleeping giant awakes
10 July 2025
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13 minute read
The 30-year old tax law surrounding family trusts and family trust distribution tax (FTDT) is outdated, difficult to navigate, and terribly unforgiving. The complex nature of these provisions and insufficient ATO guidance continues to create confusion, resulting in tax practitioners hitting roadblocks and clients facing significant unforeseen tax liabilities.
While the provisions have been in effect since 9 May 1995, a lack of understanding of the complex provisions, and a lack of attention from the ATO and the courts over the decades, has resulted in a lack of regard for these rules, poor compliance and honest mistakes.
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But the sleeping giant has awoken. Practitioners across the country are reporting an emerging issue; the application of the FTDT provisions to both historical and current arrangements, giving rise to significant, unexpected tax bills.
What is FTDT and when does it apply?
Historical note
The family trust provisions were enacted by the Howard Government in April 1998, but were retrospectively applied from 9 May 1995, their date of announcement by the then Treasurer in the Keating Government, Ralph Willis, as part of the Federal Budget 1995–96. Improvements were made to the operation of the provisions by the Howard Government in 2005 and 2007.
The enabling legislation (amending Act) inserted the trust loss provisions into Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936). The accompanying explanatory memorandum (EM) explains that the rules were introduced to prevent trafficking in trust losses that provided benefits to a person who did not bear the economic loss at the time the losses were incurred by a trust. Under the rules, trusts must satisfy certain tests before a deduction is allowed for prior year and current year losses and certain debt deductions. While the amending Act was repealed on 10 March 2016 as part of a legislative cleanup, the provisions in Schedule 2F continue to operate.
The EM goes on to explain that:
The definition of family trust is crucial to the operation of the provisions. Family trusts (as defined) that distribute only to members of the family group will normally not be affected by the proposed amendments.
Notably, the EM adds:
… if such trusts and entities abide by the election they have made, the provisions will never have any application.
Unsurprisingly, the revenue estimates from these provisions forecasted only $90 million in the 1995–96 financial year, with most of its intended effect being the prevention of leakage of revenue that was occurring through the tax benefit of trust losses.
What is a family trust?
A family trust is defined in section 272-75 of Schedule 2F to mean a trust that has a family trust election (FTE) in force. An FTE can be made only if the family control test is satisfied at the end of a specified income year. When making an FTE, the trustee of the trust specifies the income year from which the election applies, and the specified individual whose family group is to be considered. Selecting the individual specified in the FTE (known as the test individual, primary individual or specified individual) is important because, once the election is in effect, FTDT is imposed at the rate of 47% when distributions are made outside the family group of the specified individual.
FTEs can be revoked and the specified individual can be varied in only very limited circumstances. Such revocations and variations are subject to a four-year limitation period. FTEs specifying an earlier income year can be made (where the FTE specifies the 2004–05 or a later income year) if certain conditions are met.
A crucial condition of making an FTE is that the specified individual must be alive at the time the election is made. However, an FTE is not affected by the death of the specified individual — the members of their family group continue to be determined by reference to that individual.
Over the years, many practitioners advised clients to make FTEs, unnecessarily. Due to their restrictive nature, the decision to make an FTE should be taken with caution and fully informed of the long-term implications. Consider whether there is a compelling reason to make the election, not just by default.
What is an interposed entity election?
An entity (trust, company or partnership) can make an interposed entity election (IEE) which allows the trustee of a family trust to confer a present entitlement to, or make distributions of, income or capital of the family trust on or to the entity that made the IEE without the trustee becoming liable for FTDT.
Importantly, an IEE does not specify an individual. Rather, it is a mechanism for the entity to elect to be part of the family group of the individual specified in the FTE made by the family trust.
What is FTDT?
Where an FTE has been made by a trust, or an IEE has been made by an entity, the trustee of the family trust and/or the directors, trustee, or partners of the interposed entity, are liable for FTDT if they confer a present entitlement, or distribute income or capital, to a person (including an entity) outside the family group.
Meaning of distribution
The meaning of distribution for this purpose is broad — much broader than the general meaning of distributing trust income or capital. It also includes payments, credits, loans, transfers of property, use of property, and the extinguishment, forgiveness, release or waiver of a debt, to the extent that the transaction exceeds the consideration given by the recipient in return. For example, the free use by ‘Aunt Sally’ of a holiday house owned by a family trust will attract FTDT, as aunts are outside the family group. It does not matter whether Aunt Sally is a beneficiary of the trust.
It extends to transactions involving recipients who are not a beneficiary, shareholder or partner of the family trust or interposed entity. Guidance on the types of transactions that may be treated as distributions is set out in TD 2017/20.
Payment of FTDT
FTDT is generally due and payable 21 days after the date on which the distribution occurs, regardless of when the distribution is identified as being subject to FTDT. Late payment of FTDT attracts the general interest charge (GIC) (which, from 1 July 2025, is no longer deductible) from 60 days after the FTDT became due and payable. FTDT is payable by the trustee, director, or partner on the amount or value of the distribution. The circumstances where an obligation to pay FTDT arises, and on whom that liability falls, are set out in Division 271 of Schedule 2F.
Each payment of FTDT must be accompanied by an FTDT payment advice.
FTDT as a penalty rate of tax
FTDT is not imposed as a form of double taxation; rather, it applies as a penalty rate of tax. Amounts subject to FTDT are not classified as assessable income. To the extent that FTDT has been paid on an amount, it is non-assessable non-exempt income in the hands of the beneficiary.
Unlimited amendment period
Section 170 of the ITAA 1936 provides that a beneficiary’s return assessment may be amended at any time to give effect to an FTDT assessment on the trustee. This allows the Commissioner to raise an FTDT assessment at any time, regardless of how much time has elapsed. Further, the Commissioner has no discretion to ignore the application of FTDT, nor a power to extend the time to revoke or vary elections. Accordingly, the ATO appears to be hamstrung from limiting its administrative approach to four years, the standard amendment period.
This makes the law unforgiving in its operation. Not only can an FTDT liability arise many, many years after a distribution was made outside the family group, but GIC applies from day 81 after the distribution was made, so this can also stem back an awfully long time. The recent change to deny deductibility for GIC will only compound the situation.
FTDT issues
Reform of the legislation is needed
The measures were never intended to raise revenue; they were deterrent provisions to prevent the trafficking of trust losses. The trust loss provisions were drafted in a different era and, 30 years on, are now archaic, inflexible, unfit for purpose, and do not reflect contemporary arrangements.
The past year has seen an increase in the number of FTDT issues raised by the ATO, primarily due to the complexity of the law, genuine misunderstandings by taxpayers and practitioners, and greater scrutiny by the ATO of trust arrangements. This is leading to increased tax disputes, and more bona fide arrangements that do not involve any mischief are being caught in the wake of this revival of these integrity provisions.
The sleeping giant has finally awoken, and it’s not pretty.
What we’re seeing
The ATO has sharpened its focus on FTEs, and is more firmly applying the law. Succession planning, and the passing of family members including the specified individual, is revealing a range of issues, including:
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the making of inconsistent elections;
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incorrectly identifying members of the family group;
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inability to distribute to certain entities as they fall outside the family group and an IEE cannot be made;
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inability to make a valid FTE specifying an individual who is deceased;
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inability of a company with different classes of shares to be wholly controlled by the family group (which would otherwise remove the need to make an IEE);
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ATO online services suddenly showing FTDT debts accruing over decades from when the liability was triggered; and
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ATO online services not providing sufficient or accurate and timely information on the making of legacy elections.
The ATO’s warnings of FTDT issues in the lead up to this year’s tax time have improved, but have been sorely lacking over the years. We continue to see unforeseen tax liabilities arising from inadvertent distributions outside the family group. Disproportionate tax outcomes are resulting from honest mistakes or administrative confusion about the status of elections.
At the time the FTE rules were introduced, the government believed the rules would improve the efficiency and equity of the taxation system. The current operation of these draconian rules extends far beyond the original policy intent. FTDT was never designed with the objective of generating the amount of revenue that is now potentially able to be raised by the ATO.
Legislative reform is clearly warranted.
About the Author
Robyn Jacobson is the Senior Advocate at The Tax Institute.
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