Preventing Family Trust Distribution Tax in property settlements

New entities are often established as part of implementing property settlements. 

However, this could overlook one current focus area of the ATO – whether or not Family Trust Distribution Tax (FTDT) is payable due to distributions having been made by Family Trusts outside their ‘family group’.  

FTDT is applied at a flat 47 per cent on any distribution or payment made outside the designated family group. The Commissioner has no discretion to waive FTDT. More detailed information is contained in this recent article.

The issue might create complexity if certain tax elections have been made by existing entities in a family group: Family Trust Elections (FTE) and Interposed Entity Elections (IEE). While making these elections can unlock valuable tax concessions, they also bring strict compliance obligations including in the context of relationship marriage breakdowns, where large transfers of wealth and complex asset divisions are common.

The rigid wording of the tax provisions and the tight timeframes involved can create significant risk or severely limit the structuring options of either party if insufficient prior planning occurs.

Not getting this right may lead to:

Example

Consider the situation of the parties to a former marriage or other relationship protected by law looking to make a property settlement. The parties are referred to below as Angelina and Brad and could represent any spouses or former spouses.

If a new trust is to be involved in a property settlement, FTDT must be considered as this can significantly reduce the size of the asset pool. This example highlights how timing is critical:

• The asset pool is held within the Brangelina Trust. For tax purposes, an FTE was made in a prior year specifying Angelina as the test individual meaning that distributions can only be made within their ‘family group’.
• $1m of the trust’s assets are to be allocated to Brad and they want these distributed to their own discretionary trust.
• Brad makes an FTE specifying their former partner (being Angelina) as the test individual for their new trust.
• If that FTE is valid, no FTDT would apply for the distribution of the asset pool to the Brad’s new trust.
• If the FTE is invalid, any distribution would be made outside Angelina’s family group.  
• If so, FTDT will be payable within 21 days of the distribution time and is calculated as 47 per cent of the value of the amount distributed.

A key element for validity is that the ‘family control test’ needs to be met as at 30 June in the year for which the election is made. Formal dissolution of the relationship before this date will give rise to problems:

• Brad establishes the new trust on 10 August 2025 in advance of implementation of a property settlement.
• The property settlement is implemented during September 2025.
• The marriage is formally dissolved on 10 October 2025 which means that Brad is no longer a member of Angelina’s ‘family’ from that date [note: Brad could still be considered as a beneficiary of trusts having Angelina as a test individual without FTDT exposure].
• Brad wants to make a FTE in relation to the 2026 financial year specifying Angelina as the test individual. However, as this is tested as 30 June 2026, Brad will not be a member of Angelina’s family at that time.
• Unless Angelina or another family member, who remains part of Angelina's family, is taken to control Brad's new trust as at 30 June 2026, any election nominating Angelina as the test individual would appear to be invalid.
• As such, Brad’s trust would be outside Angelina’s family group.
• So the $1m distribution by Angelina's trust to the ex-spouse's trust would be subject to FTDT of $470,000.

As the date of dissolution of the marriage is critical to the tax outcomes, the outcome would be different if Brad had established the new trust before 30 June 2025 and made a FTE specifying Angelina as the test individual in relation to the 2025 year.  

This would appear to be a valid election as Brad was a member of Angelina’s family group as at 30 June 2025, meaning that Angelina could be specified as the test individual in relation to any trust that the Brad controlled as at that date.

Key action

Although it is not usually possible to predict in advance how property settlements will be resolved, parties should consider the control mechanisms of new entities established, including perhaps incorporating any anticipated new entities (e.g. trusts and companies to be owned by trusts) in the prior financial year if:

• Formal relationship dissolution may occur before or during the financial year in which the property settlement is implemented.
• Entities that might be involved in a property settlement are covered by existing FTEs and IEEs.
• The new entities are likely to receive property as part of the property settlement.

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If you’d like help planning to avoid exposure to Family Trust Distribution Tax, please contact your Grant Thornton contact Partner to discuss this further.

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