What Is a Discretionary Trust?
A discretionary (family) trust is a legal structure where a trustee holds assets for the benefit of a class of beneficiaries. The trustee has discretion each year to decide which beneficiaries receive income and in what proportions - this flexibility is the source of the tax planning power.
- Key parties: Settlor (establishes the trust, often nominal), Trustee (controls and manages), Appointor (power to remove and replace the trustee - the real control position), Beneficiaries (receive distributions)
- Trust deed: The governing document - sets out who can be a beneficiary, the trustee's powers, and distribution rules. A quality deed from a specialist costs $1,500-$3,000
- No separate tax entity: The trust is not a taxpayer - income is assessed to beneficiaries (or the trustee at top marginal rate if not distributed). The trust lodges a tax return but pays no tax itself (unless there are unpaid distributions or specific circumstances)
- Discretion: Each 30 June the trustee resolves to distribute income to specific beneficiaries. There is no requirement to distribute equally - the trustee can direct 100% to one beneficiary and 0% to others
- Family trust election (FTE): Making an FTE restricts the trust family group but enables: streaming franked dividends (Subdivision 207-B), accessing losses, and distributing to companies within the family group. Most family trusts elect FTE
- Not for everyone: Trusts are worthwhile for families with genuine income-splitting opportunities and assets worth protecting. The cost-benefit threshold is typically $150,000+ in annual distributable income or $500,000+ in assets
Setup Costs and Ongoing Compliance
Discretionary trusts have real establishment and ongoing costs that must be weighed against tax savings. Under-estimating ongoing compliance is a common mistake.
- Establishment costs: Trust deed ($1,500-$3,000 from specialist lawyers or $500-$1,000 from online services - quality varies significantly), ASIC registration of corporate trustee ($597 one-off), trustee company annual review fee (~$63/year to ASIC)
- Stamp duty on settlement: Most states charge nominal stamp duty on the trust's initial settlement amount - typically $500 deed settlement is used to minimise. Some states charge stamp duty on assets transferred to the trust
- Annual accounting fees: $2,500-$6,000 per year for trust tax return, trustee resolution, beneficiary distribution statements. Simple trusts at the lower end; trusts with investment portfolios, property, or complex streaming at the upper end
- Trust minutes (annual resolution): Trustees must document distribution decisions by 30 June each year - a signed resolution. Missing this deadline means income defaults to assessed against the trustee at 47%
- ABN and GST registration: Trusts operating a business register for ABN. GST registration required if turnover exceeds $75,000
- Land tax: In NSW, VIC, QLD, and most other states, trusts do not receive the land tax primary production exemption on general land - a trust owning investment property pays land tax from dollar one (no threshold in many states). This can eliminate trust benefits for property-only structures
- Bank accounts: Trusts need a dedicated bank account in the trustee's name as trustee for the trust - personal and trust funds must never be commingled
Income Splitting - The Core Tax Benefit
The primary tax advantage of a family trust is distributing income to lower-income beneficiaries, reducing the overall family tax burden. The mechanics are straightforward but subject to important limitations.
- How it works: Trust earns $200,000 profit. Trustee distributes $45,000 to adult child (student, part-time worker), $45,000 to spouse (part-time income), $110,000 to the business operator. Tax is paid by each beneficiary at their own marginal rates
- Tax saving example: $200,000 all taxed at 47% = $94,000 tax. Split as above: roughly $0 + $8,400 + $40,340 = $48,740. Saving: ~$45,260 per year
- Adult beneficiaries only: Distributions to minors (under 18) are taxed at punitive rates under Division 6AA: 0% on first $416, 66% on $417-$1,307, 47% above $1,307. Minor distributions are rarely advantageous
- Genuine beneficiary entitlement: Beneficiaries must have a genuine present entitlement to distributions - they should actually receive the money or have it credited to a loan account. Manufacturing entitlements without economic substance risks ATO challenge
- Corporate beneficiary: Distributing to a corporate beneficiary (a company owned by family trust members) caps tax at the company rate (25% for base rate entities). The company can retain profits for reinvestment - but extracting those profits later attracts further tax
Section 100A - The ATO's Key Anti-Avoidance Tool
Section 100A of the ITAA 1936 is the ATO's primary mechanism to attack trust income splitting arrangements it considers artificial or lacking genuine economic substance. The Full Federal Court decision in Guardian AIT Pty Ltd (2023) and the ATO's PCG 2022/2 have significantly increased the risk of s100A scrutiny.
- What s100A does: Where a beneficiary has a present entitlement to trust income but the benefit actually flows to another person, and there is a reimbursement agreement, the entitlement is treated as never having arisen - the trustee is assessed at top marginal rate
- Family member exemption: The provision includes an exclusion for 'ordinary family or commercial dealing' - but the ATO has been narrowing this exclusion
- PCG 2022/2 risk zones: The ATO's practical compliance guideline sets out a 'traffic light' framework - green (low risk, no audit intent), yellow (review risk), red (high risk, likely audit). Most standard family income splitting arrangements fall in yellow
- High-risk arrangements: Distributing to adult children who immediately hand money back to parents, distributions to companies that are never paid out as dividends, circular arrangements - all attract red zone treatment
- Low-risk arrangements: Adult beneficiaries who actually receive and spend distributions, distributions retained in genuine loan accounts at commercial interest rates, beneficiaries who file separate tax returns reflecting their entitlements
- Documentation matters: Maintain trustee resolutions, beneficiary acknowledgements, and records of actual cash flows. If distributions are not immediately paid, document the loan account and ensure it is on commercial terms
- Get specialist advice: s100A is complex and the ATO is actively auditing arrangements - do not implement trust income splitting without current advice from a tax specialist
Division 7A - The Unpaid Present Entitlement Trap
When a trust distributes income to a company beneficiary but does not actually pay that amount to the company, an Unpaid Present Entitlement (UPE) arises. Since 2010, unpaid entitlements owed to private companies are subject to Division 7A - one of the most technically complex areas of Australian tax law.
- What triggers it: Trust resolves to distribute $100,000 to a company beneficiary. Company does not receive the cash - the amount sits as a liability on the trust's books. This UPE is treated as a loan from the company to the trust under Division 7A
- Consequence: Unless the UPE is placed on a complying Division 7A loan agreement (at the ATO benchmark interest rate - 8.27% for 2025-26) or fully paid by 30 June of the following year, the entire amount is treated as an unfranked dividend to the shareholder(s) of the company - triggering top-marginal-rate tax
- The trap: Many trust distributions to corporate beneficiaries are resolved in the belief they can 'sort out the cash later'. Without formal documentation and complying loan agreements, the ATO treats UPEs as deemed dividends
- Complying loan agreement: Must be in writing, signed, specify the loan period (7 years for unsecured, 25 years for secured) and minimum annual repayments calculated by the ATO formula. Benchmark interest accrues at 8.27% in 2025-26
- Pre-1997 UPEs: Different rules apply to UPEs arising before 1997 - do not assume all old UPEs are safe
- Annual compliance critical: A Division 7A loan requires minimum annual repayments - missing a repayment in any year triggers the entire outstanding balance as a deemed dividend. This must be tracked every year without fail
Roopon Members: Reducing Everyday Costs While Building Wealth Structures
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