House of Representatives

Explanatory Memorandum

Circulated by the authority of the Treasurer, the Hon Wayne Swan MP

Chapter 2 - Family trusts

Outline of chapter

2.1 Schedule 2 to this Bill amends Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936) (the trust loss measures) to change the definition of 'family' to limit lineal descendants to children or grandchildren of the test individual or of the test individual's spouse. These amendments also remove the ability for family trusts to make a variation to the test individual specified in a family trust election (other than specifically in relation to the 2007-08 income year or a marriage breakdown).

2.2 All legislative references in this chapter are made to Schedule 2F to the ITAA 1936 unless otherwise specified.

Context of amendments

2.3 As a pre-election commitment, the Government announced that it would reverse the family trust changes made by the previous government in the Tax Laws Amendment (2007 Measures No. 4) Act 2007 . However, as some of the amendments introduced in 2007 were largely technical improvements to the trust loss measures, the Government decided not to reverse all of the changes. Instead, only two of the changes will be reversed.

2.4 The trust loss measures protect the integrity of the income tax system by preventing the tax benefits arising from the recoupment of a trust's tax losses and bad debt deductions being transferred to persons who did not bear the economic loss or bad debt when it was incurred. In order to achieve this outcome the trust loss measures examine whether there has been a change in the underlying ownership or control of a trust or whether certain schemes have been entered into in order to take advantage of a trust's losses.

2.5 Family trusts are considered to be an 'excepted trust' for the purposes of the trust loss measures.

2.6 A trust becomes a family trust if it makes a family trust election in respect of an individual. By specifying the individual (the test individual), the 'family group' is established to which distributions can be made without penalty tax. Any distribution of, or conferral of present entitlement to, income or capital of the family trust or of an entity that has made an interposed entity election, to a person who is outside of the family group is subject to family trust distribution tax. This is currently imposed at the rate of 46.5 per cent.

2.7 Family trust distribution tax is imposed by the Family Trust Distribution Tax (Primary Liability) Act 1998 and the Family Trust Distribution Tax (Secondary Liability) Act 1998 .

2.8 The 2007 amendments expanded the definition of 'family' to include any lineal descendant of a nephew, niece or grandchild of the test individual or the test individual's spouse.

2.9 In 2007, amendments were also made to the trust loss measures to allow a one-off variation to the test individual specified in a family trust election. A variation was available where the new test individual was a member of the original test individual's family at the election commencement time. However, the variation was not available if there had been a conferral of present entitlement to, or distribution of, income or capital of the trust (or of an entity for which an interposed entity election had been made in relation to the trust) outside the new test individual's family group during the period in which the election had been in force.

Summary of new law

2.10 These amendments will change the definition of 'family' in the trust loss measures to limit lineal descendants to children or grandchildren of the test individual or of the test individual's spouse. This change will have effect from the 2008-09 income year. This definition is consistent with the definition of 'family' that applied prior to the 2007 amendments.

2.11 These amendments also prevent family trusts from making a one-off variation to the test individual specified in a family trust election (other than in relation to a marriage breakdown) from the 2008-09 income year. As a transitional measure effective from the 2007-08 income year, the amendments allow family trusts that meet the conditions specified in subsection 272-80(5A), to make a one-off variation valid for only the 2007-08 income year. A family trust that makes such a variation will revert back to the test individual specified in the original family trust election from the 2008-09 income year. Comparison of key features of new law and current law

Detailed explanation of new law

Definition of ' family'

2.12 Amendments are made to the definition of 'family' to limit lineal descendants to children or grandchildren of the test individual or of the test individual's spouse. This definition is consistent with the definition of 'family' that applied prior to the 2007 amendments. [ Schedule 2, item 5, subsections 272-95(1) and (3) ]

Variation of a test individual

2.13 Under these amendments, a test individual specified in a family trust election cannot be varied, other than specifically in relation to the 2007-08 income year or a marriage breakdown. [ Schedule 2, item 1, subsection 272-80(5A) ]

2.14 A variation made under subsection 272-80(5A) can only be made once and will only be valid for the 2007-08 income year. A family trust that has made a variation under subsection 272-80(5A) will revert back to the test individual specified in the original family trust election from the 2008-09 income year. [ Schedule 2, item 2, subsection 272-80(5B) ]

2.15 The current law allows a variation to be made in the trust's return for the income year from which the variation is to be effective. However, if the trustee is not required to lodge a return, the variation needs to be given to the Commissioner of Taxation by the end of two months after the end of the income year specified in the variation. These amendments will ensure that no variations can be made, other than specifically in relation to the 2007-08 income year or a marriage breakdown.

Example 2.1

The trustee of the Bennetts trust has made a family trust election pursuant to section 272-80 of the trust loss measures and has specified Peter as the test individual.

The trustee instead wanted to make the family trust election so that Aaron, Peter's child, was the test individual of the trust. The trustee of the Bennetts trust resolves to make a one-off variation to the family trust election to specify Aaron as the test individual for the 2007-08 income year and later income years. Under the old law, the trustee would have been able to make the variation in the Bennetts' trust return for the 2007-08 income year and later income years (assuming the conditions to do so were met).

As a variation of the test individual of a trust cannot now be made other than specifically in relation to the 2007-08 income year or a marriage breakdown, the trustee will only be able to make a one-off variation to specify Aaron as the test individual of the trust for the 2007-08 income year. Peter who was the original test individual specified by the trustee will become the test individual again for the 2008-09 income year and later income years.

2.16 The amendments alter the definition of 'specified individual' in section 272-140 of the trust loss measures. This provision deals with the situation when a test individual for a family trust is varied. A reference in the trust loss measures to a person specified in a family trust election is now a reference to:

•

if the family trust election has been varied under subsection 272-80(5A):

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in respect of the 2007-08 income year - the new individual specified in the variation; or

-

in respect of later income years - the individual originally specified in the election; or

•

if the family trust election has been varied under subsection 272-80(5C) (because of a marriage breakdown) - the person most recently specified under that subsection.

[ Schedule 2, item 3, paragraph 272-140(2)(b) ]

2.17 If an interposed entity election has been made or is made in relation to a family trust for the 2007-08 income year, the test individual for the purpose of the interposed entity election will be the new individual specified in the variation made under subsection 272-80(5A). For the 2008-09 income year and later income years the test individual for the purpose of the interposed entity election will revert back to the test individual specified in the original family trust election.

Application and transitional provisions

2.18 The amendments in Part 1 of Schedule 2 apply to the 2007-08 income year, and later years. [ Schedule 2, item 4 ]

2.19 The amendments in Part 2 of Schedule 2 apply to the 2008-09 income year, and later income years. [ Schedule 2, item 8 ]