The new tax world for discretionary trusts

 

The new tax world for discretionary trusts: Budget changes trustees need to know

 

Last week’s Federal Budget was filled with a number of big tax changes, some of which we haven’t seen for a quarter of a decade.

Treasurer Jim Chalmers “better tax system for businesses” federal budget included a number of new tax reforms as well as reintroduced some existing schemes. However, one of the biggest reforms to hit businesses came in one area: discretionary trusts.

With so many changes in this area and multiple questions from our clients, we’re diving into the details for trustees and beneficiaries alike.

What is a discretionary trust?

Simply put, a discretionary trust is a trust that contains assets such as property, shares or money. Managed by a trustee and popular with trades and small business owners, it often distributes profits to beneficiaries.

Often used for success planning or to split income among family members to lower tax rates, it has become a key focus for this year’s budget.

 

The big changes to discretionary trusts

From 1 July 2028, a new minimum tax of 30% will apply to discretionary trusts. While individual and non-corporate beneficiaries will receive a non-refundable credit, trustees will pay 30% on the taxable income. There will also be changes to capital gains tax (CGT) for properties held within these trust structures.

Since this rule has been announced, it has been revealed that there will be exemptions for existing testamentary discretionary trusts, decreased estates and potentially fixed trusts. While this gives some families relief, it’s still unclear what this means for testamentary trusts still in probate.

Those who appear to be the worst off are bucket companies, with companies also excluded from proposed credits. Here, a company will pay the 30% and then be assessed on the trust income in its own tax return. The Budget Factsheet says this measure has been taken to avoid income being cycled through a “bucket company”.

Have a trust that distributes to an entity with losses? While it may reduce the beneficiary’s own tax, it does not appear to reduce the trustee-level tax in turn.

To support discretionary trusts restructuring into company or fixed trust structures, the Government will be offering expanded rollover relief for three years from 1 July 2027.

 

Anti-avoidance rules still matter

Used by the ATO to combat tax minimisation in discretionary trusts, Section 100A (related to trust reimbursement agreements or distributions replaced with wages, fees or unpaid present entitlements) and Part IVA (the Commissioner’s overarching anti-avoidance framework) will remain.

While the 30% rule may reduce the benefit of some arrangements, it will not make artificial deductions or circular flows safe.

 

Fixed trust conversion may become the new planning point

 

It’s here where some of the biggest planning battles will take place. While the Budget says fixed trusts are excluded from minimum tax rules, it also depends on how the Government’s proposed rollover relief will work.

Assuming discretionary trust can roll into a fixed trust, it opens questions not only around what is considered “fixed” but what this means for

• Deed amendment for assets that trigger Capital Gains Tax (CGT) (CGT events E1 or E2)
• Stamp duty and resettlement risk
• Family trust election / interposed entity elections
• Loss trust rules
• Commercial trust structures

 

Franked dividends need careful rules

Under the new rules, fully franked dividends have effectively already borne company tax. If a trust also pays the 30% tax minimum, there will need to be a clean mechanism to ensure they are not overtaxed.

 

What does this mean for family trusts?

Under the change, low-income adult beneficiaries (such as adult children, spouses or even retired parents on lower marginal rates) would lose the benefit. Even if the beneficiary’s personal tax would be under the 30% threshold, the excess trustee tax is not refunded.

 

Using a trust for small business?

While trusts are used legitimately for commercial reasons (including asset protection and succession planning), the 30% minimum rate rate still applies. This means businesses such as builders and trades, cafes, medical practices, property businesses or family trading groups could be caught in the tax crosshairs.

 

The trustee cash-flow problem

The trustee pays the tax. But the trust may have already distributed or allocated income.

So trustees will need to manage:

• cash retained for the 30% tax
• beneficiary entitlements net of trustee tax
• whether distributions are made gross or net
• trust deed powers
• accounting entries
• beneficiary loan accounts

This will require careful year-end distribution minutes.

 

What action should trusts be taking?

Any clients with bucket companies or businesses or properties held within discretionary trusts should review their structure well before 1 July 2028. Especially trusts where income is being pushed to low-rate or loss beneficiaries. The key here is complete structure modelling now but avoid the restructuring process until the draft legislation confirms the tax mechanics.

These changes also have the potential to create serious trustee cash flow problems and will require careful year-end distribution minutes. With the trustee already paying tax on already distributed or allocated income, trustees with need to manage:

• Cash retained for the 30% tax
• Beneficiary entitlements net of trustee tax
• Whether distributions are made gross or net
• Trust deed powers
• Accounting entries
• Beneficiary loan accounts

 

The double-tax risk of corporate beneficiaries

The discretionary trust changes could create obvious double-tax problems for corporate beneficiaries. Especially when it comes to potential double-tax situations for interactions with credits, franking credits, foreign tax credits and offsets.

Corporate beneficiary income type	Potential tax issue (yet to be defined under legislation)
Franked dividends	Does the franking credit count toward the 30% floor?
Foreign income	How do foreign income tax offsets interact?
Capital gains	How does the trust minimum interact with the separate 30% minimum tax on real capital gains?

With major mechanic information still missing for some corporate beneficiary situations, it’s an area that we’ll need to monitor.

 

Have a discretionary trust and feel overwhelmed by the changes?

Book time with our business advisors to understand your position and recommend next steps long before the changes come into effect.

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