By the Advisory Team at Quantum House | Chartered Accountants & Tax Advisers, Sydney
A family trust election, or FTE, is one of the most powerful — and most misunderstood — tools available to Australian trusts. Made correctly, it can unlock franking credits and preserve valuable tax losses that would otherwise be forfeited. Made without proper consideration, it permanently locks a trust into a defined family group and exposes any distribution outside that group to tax at 47%. This article explains what an FTE does, when a trust should consider making one, and the critical traps that catch trustees who do not take advice first.
What Is a Family Trust Election?
A family trust election is an irrevocable election made under Schedule 2F of the Income Tax Assessment Act 1936. By making the election, a trust nominates a single individual — the “test individual” — and agrees to restrict its distributions to that person’s defined “family group”. In exchange, the trust gains access to a range of tax concessions that would otherwise be unavailable to it.
An FTE is not mandatory, and it is not automatically beneficial. It is a deliberate trade-off: the trust accepts a permanent restriction on who can receive distributions, in return for access to concessions that depend on satisfying certain continuity tests. For many discretionary trusts, that trade-off is well worth making. For others, the restriction is too high a price. The right answer depends entirely on the trust’s circumstances — which is why this is a decision that should never be made without specialist advice.
When Should a Trust Consider Making an FTE?
A trust should consider making a family trust election when it wishes to do any of the following:
- Access franking credits where the trust would otherwise fail the pattern of distributions test
- Utilise tax losses carried forward from previous years
- Claim bad debt deductions under Division 165 or Division 175
- Pass trust losses to beneficiaries under Division 267
- Avoid family trust distribution tax when conferring present entitlement or making distributions outside the family group
The election is particularly relevant for discretionary trusts and unit trusts that wish to access these concessions or avoid punitive taxation. As we will see, discretionary trusts in particular often cannot satisfy the relevant continuity tests on their own — making the FTE the only practical pathway to preserving franking credits and tax losses.
The Family Group and Family Trust Distribution Tax
Once an FTE is made, distributions are restricted to the “family group” of the specified individual. The family group is broadly defined and includes the specified individual together with their spouse and former spouses; their parents, grandparents and those parents’ spouses; their children, grandchildren and those descendants’ spouses; their siblings, nephews and nieces and their spouses; and lineal descendants and their spouses. It also extends to certain entities, such as companies and trusts, where the relevant election conditions are met.
The consequence of stepping outside this group is significant. If a trust that has made an FTE subsequently makes a distribution outside the family group, family trust distribution tax — FTDT — applies to that distribution at 47%, being the top marginal rate plus the Medicare levy. This is a deliberate penalty designed to ensure the concessions accessed through the election remain within the family unit.
It is worth being clear about the alternative. A trust that has not made an FTE is not subject to FTDT, regardless of who receives its distributions. The trade-off is simply that it cannot access the concessions. In other words, the FTDT risk is the price of admission to the concessions — not a tax that exists independently of the election.
Franking Credits: What an FTE Does and Does Not Do
This is the area where trustees most often misunderstand the effect of an FTE. To pass franking credits through to beneficiaries, a trust must satisfy three separate rules — and a family trust election only assists with one of them.
The three-tier test for franking credits in trusts
| Rule | Must be satisfied? | FTE bypasses this rule? |
|---|---|---|
| Holding period rule (45 days at risk) | Yes | No — must still comply |
| Related payment rule (no dividend benefit passed to others) | Yes | No — must still comply |
| Pattern of distributions test (consistent distribution pattern) | Yes | Yes — this is the key benefit |
The holding period rule
To be entitled to a franking credit, the trust must hold the relevant shares “at risk” for a continuous period of at least 45 days for ordinary shares — or 90 days for preference shares — excluding the days of acquisition and disposal. “At risk” means the holding must be genuinely exposed to the risk of loss, with no hedging arrangements that substantially eliminate price risk and no obligation to dispose of the shares. Critically, an FTE does not bypass this rule. Even with an election in place, the trust must independently satisfy the 45-day holding period. A useful exception applies for small shareholders: where the trust receives less than $5,000 in franking credits in the income year, the holding period rule does not apply.
The related payment rule
The related payment rule denies franking credits where the trust, or a related party, makes a payment that passes the economic benefit of the dividend to someone else — typically through securities lending arrangements or dividend stripping. As with the holding period rule, an FTE does not bypass the related payment rule. If the trust enters into these arrangements, the franking credits will be denied regardless of whether an election is in place.
The pattern of distributions test
This is the test that an FTE is designed to solve. To satisfy it without an election, a trust must show that, across the income year and the three preceding years, the same individuals remained beneficiaries and the percentage distributed to each remained substantially the same — with the ATO generally accepting variations of up to 20 percentage points. Most discretionary trusts cannot meet this test, because the whole point of a discretionary trust is the flexibility to vary distributions year to year as circumstances and tax planning require. Once a valid FTE is made, the trust is automatically deemed to satisfy the pattern of distributions test — allowing distributions to be varied amongst family group members without losing franking credits, provided the other two rules are still met.
Trust Losses: Where an FTE Is Often Essential
Where a trust has prior-year tax losses it wishes to carry forward and use against future income, it must satisfy the trust loss tests in Division 267. There are two: the control test, which requires that the same persons control 50% or more of the income or capital of the trust at both the time the loss was incurred and the time it is used; and the income injection test, which denies losses where income has been injected into the trust under a scheme to take advantage of those losses and the benefit exceeds $100,000.
Discretionary trusts typically fail the control test, for a simple structural reason: their beneficiaries have no fixed entitlements to income or capital, control can shift between years as distribution decisions change, and there is no continuity of ownership in the traditional sense. This is why, for a discretionary trust carrying forward losses, an FTE is often essential — it is frequently the only way to preserve the ability to use those losses at all. Once a valid election is made, the trust is automatically deemed to satisfy both the control test and the income injection test. The same applies to unit trusts, where an FTE also satisfies the continuity of ownership test and the same business test.
Summary: What an FTE Does and Does Not Bypass
Bringing it together, the table below summarises which continuity tests a family trust election bypasses, and which the trust must continue to satisfy on its own.
| Test | When it applies | FTE bypasses? |
|---|---|---|
| Holding period rule (45 days) | Franking credits | No |
| Related payment rule | Franking credits | No |
| Pattern of distributions test | Franking credits | Yes |
| Control test | Trust losses | Yes |
| Income injection test | Trust losses | Yes |
| Continuity of ownership test | Unit trust losses | Yes |
| Same business test | Unit trust losses | Yes |
Worked Example: Divorce, Former Spouses and Companies
To see how the family group rules work in practice, consider a worked example. Andrew and Leah are a divorced couple. Both are discretionary beneficiaries of the Wilson Family Trust, and each owns one share in a company, Pasco Pty Ltd. In March 2024, the trustee of the trust made a family trust election specifying Andrew as the test individual. Two questions arise.
Does the divorce exclude Leah from Andrew’s family group?
Strictly, Leah is no longer a member of Andrew’s family. The definition of “spouse” includes a de facto spouse but not a former spouse, so once the couple divorced, Leah fell outside Andrew’s family. However — and this is the key point — the legislation specifically extends the family group to include former spouses. As Andrew’s ex-wife, Leah remains within his family group, and distributions to her are therefore exempt from family trust distribution tax. The divorce does not expose distributions to Leah to the 47% tax.
Can Pasco Pty Ltd be included in Andrew’s family group?
This is more complex. A company can be part of an individual’s family group without any further election only where the test individual, their family, or the trustees of one or more family trusts have fixed entitlements to all the income and capital of the company. Here, Leah owns one of the two shares in Pasco and therefore has an entitlement to a share of its income and capital. Because Leah is not a member of Andrew’s family — she is in his family group only by virtue of the former-spouse extension — Pasco cannot be a member of Andrew’s family group automatically. For Pasco to be included, the company must make an interposed entity election specifying that it is to be included in Andrew’s family group. It is also worth noting that if the underlying family trust election is ever revoked, any interposed entity election is automatically revoked with it.
Key Risks and Considerations Before You Elect
A family trust election is a powerful tool, but it carries real risks that every trustee should weigh carefully before electing:
- Irrevocability. The election continues indefinitely and, in practice, cannot be unwound. The restriction to the family group is a long-term commitment, so the decision must be made with the trust’s future in mind — not just the current year.
- The 47% FTDT exposure. Any distribution outside the family group is taxed at 47%. Trustees must understand precisely who is — and is not — within the group before distributing.
- Timing. The election must generally be made by the earlier of the due date for lodging the trust’s tax return for the relevant year, or the date the return is actually lodged. Missing the window can mean losing a year’s concessions.
- Interposed entities. Where companies or other trusts are beneficiaries, separate interposed entity elections may be needed to bring them within the family group without triggering FTDT.
- It is not a complete franking solution. An FTE only bypasses the pattern of distributions test. The trust must still satisfy the 45-day holding period rule and avoid related payment arrangements to access franking credits.
How Quantum House Can Help
Whether a family trust election is right for your trust depends on a careful analysis of your distribution history, your beneficiaries, any carried-forward losses, your share holdings, and your long-term family and succession plans. It is a decision with permanent consequences, and the cost of getting it wrong — whether by missing the election and forfeiting losses, or by electing and later triggering a 47% tax — is significant.
At Quantum House, our advisers work with trustees every day on exactly these questions. We assess whether an election would benefit your trust, prepare and lodge the election and any interposed entity elections correctly and on time, and put in place a distribution framework that keeps your trust within its family group. If your trust holds shares, carries forward losses, or distributes to a range of beneficiaries, we would welcome the opportunity to review your position.
Ready to talk?
If you would like to discuss whether a family trust election would benefit your trust, contact Quantum House today for a confidential consultation. Visit quantumhouse.com.au or call our Sydney office to speak with a senior adviser.
General information only. This article does not constitute personal tax, financial, or legal advice and should not be relied upon as such. Please seek advice tailored to your circumstances before acting.