Beware: Trusts Under the Microscope

With the ATO significantly increasing its scrutiny on trust arrangements in recent years, family trusts – once considered a routine structure for asset protection and tax planning – are now firmly under the regulatory spotlight. The evolving tax landscape, driven by finalised section 100A guidance, growing use of section 99B of the Income Tax Assessment Act 1936 and an aggressive focus on Family Trust Elections (FTEs) and Family Trust Distribution Tax (FTDT), means the management and distribution of trust income has never been more complex – or more high-stakes.

Recent commentary in the Australian Financial Review describes family trust compliance as akin to “forensic genealogy”, with the FTDT regime now capable of producing liabilities in the tens or even hundreds of millions of dollars for large private groups. The concern is not just for ultra-wealthy families – the same rules can threaten the long-term viability of family-owned businesses and investment structures if elections, distributions and records are not carefully managed.

Family Trust Distribution Tax and ATO Focus: Why the Pressure Is Rising

Family trusts have long served as flexible vehicles for income distribution, asset protection and succession planning. But the ATO is now far more willing to challenge trust arrangements – especially in private groups and high-net-worth families – where distribution patterns, beneficiaries or records do not line up with the strict requirements of the tax law.

What’s Driving the Rise in Risk?

Several factors are pushing trusts “under the microscope”.

• ATO compliance programs targeting private groups: The ATO’s “Next 5,000” and other private-group programs expressly focus on family trusts, FTEs and distributions to entities outside the defined “family group”. FTDT assessments at 47% (top marginal rate plus Medicare levy) have already been reported in the media.
• Finalised section 100A guidance (2022): Practical Compliance Guideline PCG 2022/2 and associated rulings clarify when trust distributions may fall foul of anti-avoidance rules, particularly where an arrangement is not an “ordinary family or commercial dealing” or where someone other than the beneficiary effectively enjoys the benefit of the income.
• Section 99B and foreign/legacy structures: There is increasing use of section 99B to tax certain receipts from foreign trusts and deceased estates where amounts represent previously untaxed or accumulated income. This is a particular issue for families with overseas assets, older offshore structures or inherited foreign wealth.
• FTDT and Family Trust Elections under Schedule 2F: The FTDT regime imposes tax at the top marginal rate where a trust that has made an FTE distributes to someone outside its “family group”, or where interposed entities fall outside the elections. The rules are complex, and recent commentary notes that some FTDT exposures now run into hundreds of millions of dollars.
• Unlimited review period and record-keeping expectations: Unlike ordinary income-tax assessments, FTDT and some trust anti-avoidance rules can effectively operate with no statutory limitation period. That means trustees may need to substantiate distributions and family relationships many years – or even decades – after the event.

Against this backdrop, trustees and advisers can no longer treat trusts as “set and forget” structures. Regular health checks – including a review of FTEs, interposed entity elections, distribution patterns and documentation – are now essential.

FTDT: From Backstop Rule to Front-Line Risk

Family Trust Distribution Tax was introduced as part of Schedule 2F to ensure that family trusts and related entities that benefit from concessional trust-loss and franking-credit rules do not distribute income or capital outside the “family group” without consequence. When they do, FTDT is imposed at the top marginal rate (currently 47%) on the offending distribution.

For many years, FTDT was seen as a rarely encountered backstop. In practice, accountants often made FTEs “just in case”, so that losses and franking credits could be accessed more readily. As structures have aged, families have grown and businesses have passed to new generations, previously benign elections and distribution patterns can now create serious problems – particularly where:

• Distributions have been made to related trusts, companies or individuals that are not in fact within the defined “family group” for FTE purposes.
• Interposed entities have never made their own FTE or Interposed Entity Election (IEE) with the same test individual.
• The original test individual has passed away, or the practical control of the group has shifted to a new branch of the family.

Because FTDT assessments may be raised many years later and at penalty rates with interest – and because the ATO has limited scope to remit FTDT once it is triggered – honest mistakes and poor record-keeping can now pose an existential risk to family wealth and long-standing private businesses.

Section 100A: Has the Dust Settled?

Section 100A is an anti-avoidance provision that can apply to trust distributions that arise from “reimbursement agreements” – arrangements where someone other than the beneficiary enjoys the real benefit of the income and a purpose of the arrangement is to reduce tax.

What Is Excluded as “Ordinary Family or Commercial Dealing”?

The ATO’s view is that section 100A is not aimed at normal family or commercial dealings, such as parents supporting adult children or reinvesting profits in a genuine family business. However, it can apply to contrived arrangements and income-cycling strategies where the economic benefit does not align with the legal entitlement.

Riskier examples include:

• ✕ Distributions to adult children where funds are immediately paid back to parents or used for general family expenses without the child’s genuine control.
• ✕ Distributions to a low-tax-rate beneficiary who then gifts or loans the money back to another family member or entity in a way that lacks commercial substance.

Distributions to Adult Children: Proceed With Caution

The ATO is paying close attention to distributions made to adult children, particularly when the beneficiary is unaware of the distribution or does not have practical access to the funds, or when funds are used solely for parental or business purposes without appropriate documentation.

In these cases, trustees must be able to demonstrate that the beneficiary has genuinely received and controlled the benefit. Our dedicated article, ATO Targeting Trust Distribution to Adult Children, provides a detailed discussion of the ATO’s “green, blue and red” risk zones and practical examples.

Combined with FTDT exposures in groups that have made FTEs, section 100A can dramatically increase the effective tax cost of trust distributions that are not carefully structured and documented.

Section 99B: The Silent Trap

While section 100A has attracted most of the recent headlines, section 99B is quietly becoming a major area of risk – particularly for families with foreign assets, older offshore structures or complex intra-group arrangements.

What Is Section 99B?

Broadly, section 99B can apply where a resident trust or individual receives an amount from another trust (including foreign trusts and deceased estates), and that amount represents income that has not previously been taxed in Australia.

This can include:

• Distributions from foreign family trusts or deceased estates funded by previously untaxed earnings.
• Amounts representing accumulated income that has been parked offshore or in other entities and later “repatriated” to an Australian trust or beneficiary.
• Certain re-settlements or reorganisations of trust structures that convert previously untaxed income into apparent “capital” paid to beneficiaries.

Tax Implications

Amounts caught under section 99B may be assessable even if they were exempt or non-taxable in the original jurisdiction, or if they are characterised as corpus/capital in the distributing trust. No franking credits or CGT discounts attach to these inclusions, so the effective tax rate can be high.

Recent ATO guidance emphasises the need to trace the origin and historic tax treatment of amounts received from foreign or interposed trusts – often a challenging exercise if records are incomplete or the structure dates back many years. For a broader estate-planning perspective on foreign inheritances, trusts and business interests, see Do You Know the Tax Effects on Your Estate Plan?

Five Practical Fixes to Reduce Your Family Trust Distribution Tax Risk

In light of the recent AFR commentary and ATO activity, it is no longer enough to “file and forget” your trust documents. A structured review program can materially reduce the risk of an unexpected FTDT, section 100A or section 99B assessment.

Final Thoughts: Don’t Wait for a Review Letter

Family trusts remain a powerful tool in tax and estate planning, but they are no longer low-risk or passive structures. With the ATO’s sharpened focus on integrity, documentation and elections – and with FTDT carrying both a 47% rate and an effectively unlimited review period – trustees and advisers must be proactive rather than reactive.

Whether you are dealing with discretionary trust distributions to family members, foreign-sourced inheritances, or multi-generational business groups with long-standing FTEs, it is critical to undertake a structured health check now, rather than waiting for an ATO review, audit or court proceeding to expose historic weaknesses.

NEED HELP? This article provides general information and should not be considered legal or tax advice. For personalised guidance, please contact our expert team of tax accountants at The Quinn Group by calling 1300 QUINNS (1300 784 667) or +61 2 9223 9166, or submit an online enquiry form to arrange an appointment.