When Family Trust Distributions Go Wrong – Deputy Commissioner of Taxation v Widdup (No 2) [2023] FCA 377

The Federal Court’s recent decision of Deputy Commissioner of Taxation v Widdup (No 2) [2023] FCA 377 (“Widdup”) has confirmed the ATO’s broad powers to pursue unpaid family trust distribution tax, and is a reminder of the dangers for trustees who fail to seek advice in relation to the administration of their family trust.[1]

 

What is a Family Trust?

A family trust is a discretionary trust that is established by someone during their lifetime to manage family assets or investments and to support family members as beneficiaries.

Family trusts offer the benefits of asset protection and tax minimisation, and are usually established for these purposes. They also provide the ability to protect vulnerable or other family members, such as spendthrifts, by ensuring assets are controlled in the family trust structure for their benefit.

One of the most important roles in family trust, or any trust, is that of the trustee. The trustee is typically given broad powers to manage the trust and its assets, including to distribute income earned on trust assets at their discretion to beneficiaries of the trust. Trustees are also bound by various duties, including the responsibility to fulfil the trust’s tax obligations.

 

Family Trusts and Tax Rules

The ATO has strict procedures in place in relation to family trusts. A trust will only be considered a family trust for tax purposes if the trustee has made a valid family trust election (“FTE”). A valid FTE is made when certain tests are satisfied and documents completed in the required manner.

When a valid FTE is in place, the family trust has the potential to access certain tax concessions (i.e. tax benefits). However, if distributions are made outside the family group of the trust, family trust distribution tax (“FTDT”) is applied at the top marginal tax rate plus Medicare Levy (47% at the time of writing).[2] Typically, only members of the family group can be beneficiaries to the trust.

Companies, partnerships or other trusts can also be made members of the family group, and accordingly beneficiaries to the family trust, by the making of what is known as an interposed entity election (“IEE”). One reason for an IEE to be made is so the trustee can, for example, make distributions on or to the entity without the liability for FTDT being incurred by the trustee.

 

The Widdup Case

Widdup highlights the take-no-prisoner’s approach of the ATO, which has been backed up by the Court, in cracking-down on family trust distributions to non-beneficiaries where a tax liability has not been declared.

The Widdups (Mr and Mrs Widdup) and associated companies (together, “the respondents”) applied to the Federal Court to seek that the significant (multi-million) tax liability, which they had paid to the Court after multiple issues arose and freezing orders were made against them, be repaid to them.

By way of background, Mr and Mrs Widdup established a family trust (originally J&C Widdup Family Trust, later Fidelity Holdings Trust, “the family trust”). The trustee of the trust was JCW Capital Pty Ltd (“the trustee”), a company controlled by Mr and Mrs Widdup as directors. Further comments about the background include the following –

• The basis of the respondents’ argument that there ought to be a repayment of the funds paid into Court was that the family trust was not a “family trust” because no FTE had been made.
• However, in 2010, the trustee indicated in its tax return for the previous financial year that an FTE had been made. For each financial year ending 2009 through to 2017, each tax return for the family trust recorded this same information – that an FTE had been made in the financial year ending 30 June 2009 – and detailed the distribution of trust income to Widdup family members throughout this period.
• In October 2017, a capital gain of almost $8 million was made, which was considered by the Court to be the main origin of the tax liabilities. The funds flowed through various bank accounts for a couple of years, and, in about June 2018, the trustee resolved to make a distribution of the entirety of the capital gain to a company known as Fidelity Pacific Life Insurance Company Limited (“Fidelity Pacific”).
• Fidelity Pacific was a company incorporated in Canada and provided offshore financial services in Vanuatu. Four days before the resolution was made, the trustee had made Fidelity Pacific a beneficiary of the family trust.
• The funds referrable to the capital gain were then paid by the Widdups from their joint account to another of the respondents, being FPL Partnership Pty Ltd (“FPL”), recording the payment as representing a capital contribution by another company respondent, being FPLJCW Investment Fund LLC (“FPLJCW”), to FPL, FPLJCW and a further company respondent. The Deputy Commissioner contended that the Widdups retained control of the funds that had been transferred to FPL.
• When the family trust’s next tax return for the financial year ending June 2018 was lodged, the fields on the tax return concerning the FTE and IEE status were left blank.
• In reviewing the family trust’s tax return, the ATO found that Fidelity Pacific was not part of the relevant family group at the time it was conferred a present entitlement to the capital gains, and so the Widdups as directors of the trustee were liable for FTDT.

In the decision handed down in April 2023, the Widdups were ultimately unsuccessful. It was not an appeal case, however, the Court here dismissed the Widdups’ application (this meant they refused the Widdups request for repayment of funds paid into Court for the tax liability plus interest). It was also an additionally costly process, as the Court ordered that costs be paid by the respondents.

So, not only did the Widdups fail to claw back the money they had paid to the Court on account of tax (as a result of the freezing orders), they also had to pay Court costs for the ATO.

 

How Chamberlains Can Help

The Widdup decision underscores the dangers for trustees who attempt to circumvent the ATO’s strict rules regarding family trust elections and family trust distribution tax, and is a timely reminder of the benefits of seeking specialist advice to ensure you are meeting your tax-reporting obligations as trustee.

The Private Wealth Law Team at Chamberlains Law Firm have legal expertise in a range of trusts and tax issues, including in relation to family trusts. If you have a family trust or are considering establishing one, we are here to help answer any of your legal questions.

[1] Deputy Commissioner of Taxation v Widdup (No 2) [2023] FCA 377 (‘Widdup’).

[2] Income Tax Assessment Act 1936 (Cth) sch 2F s271-15; Family Trust Distribution Tax (Primary Liability) Act 1998 (Cth).

 

*This article was prepared with the assistance of Matthew Foster*