At a glance
- Poorly managed family trusts can become toxic, costing millions in fees to resolve.
- Focusing only on tax minimisation ignores long-term risks from changing family structures.
- Trusts need active management, annual reviews, and specialist advice to mitigate risks.
A case that ended up in the hands of Equity Trustees highlights the risks of a poorly managed family trust.
A recently deceased couple had built a multi-million-dollar property portfolio through 12 interlinked family trusts and private companies. But because of poor record keeping and various tax issues, the entire structure turned toxic.
“We were appointed by the court to try to work it all out,” says Suzie Willis, senior estates and trusts solicitor at Equity Trustees, who remembers the case as one of the worst she has seen. “There were massive issues with unpaid tax, records that hadn’t been kept, capital gains that hadn’t been declared and general complexity.”
“There were multiple court applications and multiple applications to the ATO for private binding rulings, seeking permission to defer the payment of tax to be able to sell certain properties, etc.”
It took a decade and $8 million in trustee fees, legal fees and accounting fees to get it into a position where Equity Trustees could hand it back to the family.
The case study is a reminder that both family trusts and their associated family trust elections (FTEs) must be carefully planned and actively managed. This helps avoid not only a 47% family trust distributions tax, but also crippling professional fees.
Understanding the FTE
A family trust election (FTE) is not essential to the formation of a family trust. However, it can unlock specific tax concessions such as carry-forward losses, easier passing of franking credits, and smoother small business restructures.
“When an accountant is working on a family trust, the emphasis will typically be on tax reduction … That’s a potentially blinkered view.”
Jonathan Guthrie-Jones, National manager continuing trusts, Equity Trustees
As ATO guidance puts it: “The FTE entitles the trust to access certain tax concessions. The trade-off is that family trust distribution tax is imposed when distributions are made outside the family group.”
An FTE is designed to lock in a certain family group for distribution and tax consideration. In that specific family group, distributions can flow freely. But introduce someone else into the mix as a result of family change – perhaps because of a death or a marriage – and things can go pear-shaped very quickly.
Lionel Walsh, Partner at Walsh Accounting, says it’s rare that he would recommend making a FTE.
“Once it’s made, it’s forever,” he says. “We’ve inherited new clients where the FTE paperwork had been lost or forgotten, and that’s dangerous. If you distribute outside the elected family group, even accidentally, the whole distribution can be hit at 47%.”
“An FTE is not something you put in place without deep consideration. It serves a narrow purpose and outside that purpose, it mainly restricts you.”
Common traps for accountants
Jonathan Guthrie-Jones, Equity Trustees National Manager Continuing Trusts, says a focus on family trusts purely as a platform for tax minimisation is the main mistake to avoid.
“When an accountant is working on a family trust, the emphasis will typically be on tax reduction,” Guthrie-Jones says. “That’s a potentially blinkered view that can lead to them falling into traps. Our focus is on the protective element of a family trust.”
“A strong focus on tax minimisation, and trustees who go along with what the accountant says should be done, can lead to a position where the trust is in quite a difficult situation.”
Typically, at the time that a family trust is formed or when an FTE is made, risk is lower. But as time goes on, as families change shape through births, deaths, marriages or succession, risk increases. Distributions that once sat comfortably within the family group suddenly fall outside it.
Walsh agrees. “We are aware of a case where a daughter transferred just one share of 100 in the corporate trustee of a trust to her husband,” he says. “That small change altered the family group, and suddenly the whole distribution was exposed to family trust distribution tax.”
Early-warning signs in family trusts
As risks tend to emerge gradually in family trusts, early-warning signs to look out for include:
- changes in family structure through marriage, divorce, deaths and generational shifts;
- changes to the structure of the trust, including altering trustees, shareholdings or other parts of the structure;
- FTEs that have been lost or unconsidered; and
- overly complex structures that make it difficult to track compliance.
“Unhappy families are often where trustee companies step in,” Willis says. “Combine that with a poorly drafted deed or an FTE that’s not actively managed, and you’ve got a recipe for disaster.”
Best practice is not about avoiding family trusts and FTEs altogether. Instead, it’s about using them deliberately and managing them actively.
“The key is to not treat it as a passive vehicle,” Willis says. “At a minimum, you have to review the investments annually. You need to have evidence of that as well.”
Trustees should diarise tax deadlines, she says, and keep proper minutes. They must also understand that negligence makes them personally liable.
“If you’re uncertain, refer to a specialist – there’s no shame in saying this isn’t your area,” Willis adds. “A holistic approach, one that looks at family dynamics as well as tax mechanics, will protect clients and accountants alike from the very real risks trusts carry.”
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