So many tax issues need to be considered by private groups when trusts distribute their income to a company (the company). These include:
- determining the distributable income of the trust in accordance with trust law and the terms of the trust deed;
- checking the company is an eligible beneficiary of the trust;
- making sure the company is made presently entitled for an income year by 30 June;
- correctly streaming capital gains and franked distributions;
- correctly applying Division 7A to any unpaid present entitlements (UPEs), noting that the Commissioner of Taxation has appealed the Full Federal Court’s decision in Commissioner of Taxation v Bendel [2025] FCAFC 15 to the High Court;
- checking that a trust that seeks to make a franked distribution to the company has made a family trust election (FTE);
- checking that the company has made an interposed entity election (IEE) to be, or is otherwise part of, the family group of the individual specified in the FTE made by the trust; and
- considering whether the arrangement could be subject to the integrity measure in section 100A of the Income Tax Assessment Act 1936 (ITAA 1936).
Many other tax issues may be relevant, but two in particular are worthy of a detailed discussion. Recently, franking credits claimed by some newly incorporated corporate beneficiaries are being denied by the ATO, resulting in some unexpected tax bills. Separately, issues can arise in relation to newly incorporated corporate beneficiaries under the TFN reporting and withholding rules for closely held trusts.
These issues are explained below.
Franking credits and the 45-day holding period rule
Corporate beneficiaries often become presently entitled to franked distributions from related trusts. A trust can pass on franking credits to a corporate beneficiary only if:
- the trust makes an FTE; and
- the company is in the ‘family group’ of the individual specified in the FTE made by the trust.
Further, to claim a franking tax offset against its own income tax liability, the company must satisfy the 45-day holding period rule (45-day rule).
In some cases, the ATO is denying franking credits claimed by corporate beneficiaries because they are outside the family group. Some recent ATO reviews have also seen the ATO deny franking credits on the basis that the company has not satisfied the 45-day rule.
What is the 45-day holding period rule?
The 45-day rule requires a beneficiary to continuously hold shares ‘at risk’ for at least 45 days (90 days for preference shares), not counting the day of acquisition or disposal, to be eligible for a franking tax offset.
A beneficiary of a trust that receives a franked distribution from that trust must satisfy the 45-day rule to claim franking credits attached to the dividend paid on shares owned by the trust in the same way as if the beneficiary held the shares directly. This means that beneficiaries who do not satisfy the 45-day rule before the day on which the shares become ex-dividend are not entitled to the franking credits.
This condition flows from the operation of Division 207 of the Income Tax Assessment Act 1997 (ITAA 1997), which refers to the 45-day rule in determining whether an entity is a ‘qualified person’ for the purposes of paragraphs 207-145(1)(a) and 207-150(1)(a) of the ITAA 1997 in respect of a franked distribution made directly or indirectly to the entity after 30 June 2002.
The 45-day rule is exceedingly difficult to find — it’s contained in former Division 1A of Part IIIAA of the ITAA 1936, as in force on 30 June 2002. Amazingly, these provisions were repealed in 2002 so it can be confounding to taxpayers how they can be subject to provisions that are no longer in the law but must nonetheless be applied ‘as if they were still there’. The references in Division 207 of the ITAA 1997 treat former Division 1A as remaining in effect, despite its repeal more than 20 years ago.
Why is the ATO denying franking credits in some cases?
The ATO’s position, which is not published on the ATO website or widely known, is that a beneficiary of a trust acquires an interest in the underlying shares owned by the trust only on the day that it becomes a ‘potential beneficiary of the trust’.
Accordingly, the ATO takes the view that a corporate beneficiary that did not exist on the ex-dividend date cannot satisfy the 45-day rule. This is because the company will have acquired an interest in the shares only when it became a ‘potential beneficiary’ of the trust, being the day on which it was incorporated, notwithstanding the trust may have held the shares for many years.
This becomes a problem where:
(a) a family trust holds shares in a company that became ex-dividend in an income year (say, on 31 August 2024);
(b) that trust makes a franked distribution to a corporate beneficiary in that income year (say, on 30 June 2025); and
(c) that corporate beneficiary was incorporated just before the end of that income year (say, on 25 June 2025).
Based on the ATO’s current position, newly incorporated corporate beneficiaries are not entitled to the franking credits in these circumstances as they cannot satisfy the 45-day rule.
Why legislative clarity is needed
That the issue is not widely known or understood by practitioners and taxpayers demonstrates the need for clearer provisions and ATO guidance. The inaccessibility of the 45-day rule (the ITAA 1997 contains only references to the former provisions) does not help matters.
Public advice and guidance by the ATO, outlining its position and the Commissioner’s views on the application of the repealed provisions, is desperately needed to prevent unforeseen tax liabilities arising from the loss of franking credits.
The ATO’s position has not been tested before the Administrative Review Tribunal or the Courts, so judicial clarification would be welcome. Better still, legislative reform is clearly warranted.
TFN reporting and withholding rules
Broadly, the tax file number (TFN) reporting and withholding rules subject a trustee of a resident closely held trust (CHT) to TFN withholding where a distribution is made to a beneficiary and the beneficiary has not quoted their TFN to the trustee before the distribution is made.
The measures are contained in Division 4B of Part VA of the ITAA 1936 and Subdivision 12-E of Part 2-5 of Schedule 1 to the Taxation Administration Act 1953 (TAA).
When do the rules apply?
Trustees of resident CHTs are subject to reporting and withholding obligations where:
- either:
a. during an income year, the trustee makes a distribution to a beneficiary of the trust and some or all of the distribution is from the ordinary or statutory income of the trust (payment); or
b. at the end of the income year, a beneficiary of the trust is presently entitled to a share of the income of the trust of that year (distribution);The relevant definitions and exclusions are explained below.
- the trust is not an excluded trust under subsection 102UC(4) of the ITAA 1936;
- the beneficiary is not an excluded beneficiary; and
- the payment or distribution is not excluded.
The relevant definitions and exclusions are explained below.
What is a closely held trust?
For these purposes, a CHT:
- has up to 20 individuals who have between them, directly or indirectly, fixed entitlements to at least a 75% share of the income or capital of the trust;
- is a discretionary trust — this includes a trust that has made an FTE (a family trust) or is covered by an IEE; and
- is not an excluded trust.
Excluded trusts
An excluded trust includes a trust to which, awkwardly, paragraph (b), (c) or (d) of the definition of ‘excepted trust’ in section 272-100 of Schedule 2F to the ITAA 1936 applies. Family trusts (in paragraph (a) of section 272-100) are not on the list in subsection 109UC(4). This means a family trust is subject to the TFN reporting and withholding rules.
Excluded beneficiaries
Excluded beneficiaries include non-residents, charities and minor beneficiaries.
While pension recipients (including the age pension and disability support pension) are specifically excluded from other TFN withholding rules, they are not excluded from quoting their TFN to the trustee of a CHT to prevent a withholding.
Excluded payments and distributions
Excluded payments and distributions include where:
- the payment or distribution is below the prescribed annual threshold of $120;
- payments of UPEs arising in earlier income years were subject to the TFN withholding rules;
- the distribution is made to a trustee beneficiary as the trustee is already required to make a correct trustee beneficiary statement;
- family trust distribution tax is payable on the amount.
Trustees’ obligations
Trustees of CHTs should advise the beneficiaries that withholding may be required if their TFN is not quoted to the trustee before they receive a payment from the trust or become presently entitled to trust income for an income year.
The trustee must also lodge an Annual trustee payment report (part of the trust tax return) to report total payments and distributions made to each beneficiary in the income year.
How does a beneficiary quote their TFN?
A beneficiary quotes their TFN by providing the trustee with their:
- TFN;
- full name;
- date of birth (individual beneficiaries only);
- postal address;
- business or residential address;
- entity type; and
- ABN if the beneficiary has one (non-individual beneficiaries only).
The ATO does not prescribe a format for providing this information, and it can be provided verbally or in writing (including electronically).
Consequences for the trustee
If a beneficiary quotes their TFN
If a beneficiary quotes their TFN to the trustee before the payment or distribution is made, the trustee must lodge a TFN report with the ATO by the last day of the month following the end of the quarter in which the TFN was quoted.
For present entitlements that arise in the June quarter (typically on or shortly before 30 June) of an income year, the due date of the TFN report is 31 July. If no new TFNs are quoted in a quarter, there is no need for the trustee to lodge a TFN report for that quarter.
The trustee can lodge the TFN report using:
- Standard Business Reporting (SBR) enabled software; or
- a paper TFN report (a fillable PDF that can be completed online, saved and printed, or completed by hand).
If a beneficiary does not quote their TFN
If a beneficiary does not quote their TFN to the trustee before a payment or distribution is made, the trustee must:
Beneficiaries can claim a credit for the withheld amount in their tax return for the income year in which the distribution was made. Accordingly, TFN withholding does not give rise to double taxation.
Where the trustee is required to withhold, the beneficiary’s share of the trust’s net income needs to be worked out. This means the trust’s net (taxable) income needs to be calculated by 30 September so the trustee can lodge a correct Annual TFN withholding report. Trustees must make beneficiaries presently entitled to the trust income by 30 June, but the trustee may not determine the trust’s net income until shortly before the lodgment day of the trust’s tax return, likely many months after 30 September.
Penalties
Penalties apply for failing to:
- withhold when required — equal to the amount that should have been withheld;
- pay a withheld amount by the due date — the now non-deductible general interest charge (GIC) applies to missed and late payments;
- lodge reports on time — the amount of the failure to lodge penalty depends on whether the entity is small, medium or large.
Implications for corporate beneficiaries
Where a corporate beneficiary becomes presently entitled to a share of income of a CHT and quotes its TFN to the trustee, the trustee is not subject to:
- withholding from that distribution; and
- the associated reporting obligations (other than the TFN report).
The TFN reporting and withholding rules can be problematic for corporate beneficiaries incorporated in late-June that become presently entitled to a share of trust income for that income year. Where the ATO issues a TFN to the company in early July (following year end), it is clear the company could not have quoted its TFN to the trustee before the present entitlement arose on or before 30 June. It does not matter that the TFN is issued to the company before the due date of the TFN report (31 July).
In this situation, the trustee is required to:
- lodge an Annual TFN withholding report by 30 September;
- issue the company with a payment summary by 14 October; and
- lodge an annual activity statement with the ATO and pay the withheld amount by 28 October.
Closing comments
Trustees of CHTs need to consider the TFN reporting and withholding rules where:
- a newly incorporated corporate beneficiary becomes presently entitled to trust income;
- a new trust is established — the trustee should request the TFN details of all potential (i.e. intended) beneficiaries;
- a beneficiary of an existing trust will become presently entitled to a share of the trust’s income for the first time (e.g. new spouse of an existing beneficiary); and
- minor beneficiaries turn 18 years of age — the age of minors should be monitored annually to ensure they quote their TFN to the trustee once they turn 18.
