Business structures
Discretionary trust
A discretionary trust, often called a family trust, is a trust where the trustee decides each year how much income or capital each beneficiary receives, within the limits set by the deed.
A discretionary trust is a trust in which no beneficiary has a fixed entitlement to income or capital. Instead, the trustee has the power to decide, usually each year, who among the class of beneficiaries receives what. This flexibility is what makes the structure popular for family businesses and investments, since the trustee can respond to changing family circumstances and distribute income to those who will be taxed at lower rates, within the rules.
The trust deed sets out who the beneficiaries are, which often include family members, related companies and other trusts. It also sets out the trustee's powers and the date by which distribution decisions must be made, typically before 30 June. If the trustee fails to make a valid decision in time, the deed may provide for the income to go to a default beneficiary, or the trustee may be taxed on it at the highest marginal rate.
For tax purposes, the trust lodges a trust return, and beneficiaries include their share of net income in their own returns. The trust itself is not taxed on distributed income. Rules apply to prevent arrangements that are purely tax avoidance, and the ATO has guidelines on distributions to adult children and on the use of corporate beneficiaries. A family trust election may be made in some cases to access particular tax outcomes, particularly around trust losses.
A discretionary trust operating a business needs an ABN and, where GST turnover reaches $75,000, must be registered for GST. The trustee is the entity that charges GST, claims credits, lodges BAS and pays any net GST. If the trust employs staff, the trustee must withhold PAYG and pay super for them. Beneficiaries do not receive wages for being beneficiaries, and distributions are not subject to GST because they are not a supply.
Distributions to individuals who are under 18 can be taxed at higher penalty rates, which limits the benefit of distributing to minors. Distributions to a company beneficiary can create an unpaid present entitlement that has tax consequences if the money is not paid over. These are specialist areas that need professional advice.
A common misunderstanding is that a discretionary trust is a simple way to reduce tax. In practice it adds compliance obligations, and a poorly documented distribution can be ineffective. Another mistake is to treat the trust bank account as personal money. The trustee must follow the deed and keep trust money for trust purposes.
This is general information only, so confirm any decisions with the ATO or a registered tax professional.
Worked example
A discretionary trust earns net income of $120,000 from a plumbing business. Before 30 June, the trustee resolves in writing to distribute $60,000 each to two adult beneficiaries who have no other income. Each beneficiary includes $60,000 in their own tax return. The trust return reports the full $120,000 and shows the distributions, and the trust itself pays no income tax on the distributed amount.
Practical tips
- Document your annual distribution resolution before the deadline in the deed, usually 30 June, and keep it with the trust records.
- Take advice before distributing to minors or to a company beneficiary, because special tax rules can apply.
- Never use trust money for private expenses without recording it correctly, as this can breach the deed and create tax problems.