What Is a Discretionary Family Trust?
A discretionary (family) trust is a structure where a trustee holds assets for a class of beneficiaries, with the discretion to distribute income and capital each year in any proportion they choose. This flexibility makes family trusts one of the most powerful tax planning tools for Australian investors and business owners - and one of the most scrutinised by the ATO.
- Structure: A deed creates the trust; a trustee (individual or company) manages the assets; a settlor establishes the trust with a nominal settlement (usually $10); beneficiaries are named (typically a class - e.g., all lineal descendants + associated entities)
- Discretion is the key feature: The trustee decides each year who gets what - income and capital can be directed to the lowest-tax beneficiaries; this is the core income-splitting advantage
- Corporate trustee: A company as trustee limits personal liability to corporate assets (not the individual director's personal assets); a company trustee also never dies - avoiding trust re-settlement issues on trustee death; corporate trustee company typically costs $59/yr ASIC annual review fee
- Duration: Most trusts are set for 80 years (the perpetuity period under most state laws); Victoria extended to 125 years in 2021
- Assets in the trust: Property, shares, ETFs, managed funds - any investment; the trust structure sits above the investment, not inside it
- Losses stay in the trust: Trust losses cannot be distributed to beneficiaries - they are retained in the trust and offset future trust income; this is a key limitation compared to direct investment
Income Splitting - How Family Trusts Reduce Tax
The primary tax benefit of a family trust is the ability to split investment income across multiple beneficiaries in different tax brackets, reducing the overall tax paid on the trust's income.
- Example: A trust earns $120,000 in income. The trustee distributes $41,000 to each of three adult beneficiaries. Each pays tax on $41,000 (tax-free threshold to ~18.2% effective rate) rather than one person paying 47% on $120,000 - potential saving exceeds $35,000 in a single year
- Eligible beneficiaries: Distributions can go to any person or entity named in the deed - spouse, adult children, parents, related companies; the trustee nominates the amounts before 30 June each year in the resolution
- 30 June resolution deadline: Trustees must pass a valid distribution resolution by 30 June each income year; a failure to resolve means income is taxed to the trustee at the top rate of 47% (plus Medicare levy) - a costly mistake
- Minors (under 18): Trust distributions to minors are taxed at punitive rates under Division 6AA - up to 47% on amounts over $416; income splitting to children under 18 is generally not effective for investment income (different rules apply to active business income)
- Adult children: Distributing to adult children at low income rates is the classic family trust strategy - works well if they genuinely have low income; the ATO's Section 100A integrity rules are specifically designed to challenge arrangements where the benefit does not genuinely flow to the adult beneficiary
- Timing: Distributions must be resolved by 30 June but do not need to be physically paid immediately - the unpaid present entitlement (UPE) is a liability of the trust to the beneficiary; Division 7A applies if UPEs are owed to a company beneficiary
Section 100A - The ATO's Key Anti-Avoidance Rule
Section 100A of ITAA 1936 is the ATO's primary tool for challenging family trust distributions where the economic benefit does not flow to the beneficiary who is taxed on the income. Since the Full Federal Court's Guardian AIT decision in 2023, the ATO has significantly expanded its enforcement posture.
- What Section 100A targets: Arrangements where a beneficiary is made presently entitled to trust income, but the actual cash or economic benefit is redirected to someone else (e.g., an adult child is distributed $60,000 but the money goes to the parents' mortgage)
- Guardian AIT case (2023): Full Federal Court found that reimbursement agreements (informal arrangements where trust entitlements fund other parties' expenses) fall within Section 100A - the ATO won; applies to current arrangements, not just retroactive; a watershed for trust planning
- Ordinary family dealings exemption: Section 100A does not apply to arrangements that are part of 'ordinary family and commercial dealings' - the definition is contested but generally means genuine gifts and normal family support without a tax-driven reimbursement arrangement
- High-risk arrangements: Distributing to adult children living at home where the cash goes toward shared household expenses; distributing to a low-income spouse who then funds family costs; distributing to a corporate beneficiary with unpaid present entitlements that fund family lifestyle expenses
- ATO Taxpayer Alert TA 2022/1: The ATO flagged trust reimbursement arrangements as a compliance priority - the practical effect is that distributions to adult beneficiaries need genuine economic substance (the money must actually benefit the named beneficiary)
- Documentation: Maintain evidence that distributions were actually paid or credited to beneficiaries - bank records, loan account statements, resolutions - Section 100A requires a 'reimbursement agreement' to apply; documented genuine loans or actual payments are defensible
Streaming Capital Gains and Franked Dividends
A major advantage of family trusts is the ability to stream specific classes of income - particularly capital gains and franked dividends - to the beneficiaries for whom they provide the greatest tax benefit.
- Streaming capital gains: Under Division 7A trust streaming rules (applicable since 2011), trustees can allocate capital gains to specific beneficiaries; a beneficiary who pays lower tax (e.g., low income, or a company at 25–30%) retains the 50% CGT discount if the trust held the asset 12+ months
- 50% CGT discount in trust: The trust claims the 50% CGT discount on assets held 12+ months; the discounted gain flows to a beneficiary who pays their marginal rate on the discounted amount - if that beneficiary is on 19%, effective CGT rate is 9.5%
- Corporate beneficiaries and CGT: Companies do not receive the 50% CGT discount - streaming capital gains to a company at 25–30% tax may be less efficient than streaming to a low-income individual paying 19%; run the numbers before defaulting to corporate beneficiary
- Streaming franked dividends: Franked dividends (plus attached franking credits) can be streamed to beneficiaries who can use the franking credits - a beneficiary with no other income can receive a $7,000 franked dividend with $3,000 franking credit and pay zero tax, pocketing the $3,000 credit as a refund
- Trustee resolution specificity: To stream, the resolution must specifically designate the capital gain or franked amount to a named beneficiary - a generic 'distribute income equally' resolution does not stream
- Anti-avoidance on streaming: The streaming rules require that the allocation reflects economic reality - you cannot stream all gains to a zero-tax beneficiary and all losses to high-income beneficiaries; the rules are technical and require careful drafting
Corporate Beneficiaries - Strategies and Traps
Many family trusts include a related company as a beneficiary. Distributing to a corporate beneficiary at 25–30% tax can be useful, but the interaction with Division 7A creates significant compliance obligations.
- Tax rate advantage: A base rate entity company (turnover under $50M, passive income ≤80%) pays 25% company tax on trust distributions - lower than most individuals' marginal rates; retained profits can accumulate for future investment at lower tax cost
- Division 7A - the major trap: If a trust owes an unpaid present entitlement (UPE) to a company beneficiary and the funds are used by trust beneficiaries (e.g., the trustee's family), the ATO treats this as a deemed dividend from the company - taxable to the individual at full marginal rates with no franking
- Division 7A compliance options: Put the UPE on a formal complying loan (7-year maximum for unsecured; 25-year for loans secured by real property) at the ATO benchmark rate (8.77% for 2024–25); or actually pay the company the entitlement and have the company invest
- Franking credits in company: When the corporate beneficiary eventually pays dividends to its shareholders (the individual family members), those dividends carry franking credits from the 25% company tax already paid - offsetting the individual's marginal rate on the final distribution
- Effective tax rate: On a trust income of $100,000 distributed to a company (25% tax = $25,000 tax, $75,000 retained): when the company later pays a $75,000 dividend with $25,000 franking to a 47% taxpayer, the total tax is $47,000 − $25,000 franking offset = $22,000 additional tax; total effective rate = $47,000/$100,000 = 47% - no advantage for a high-income beneficiary who will always need the cash; the benefit is deferral, not avoidance
- Best use of corporate beneficiary: Accumulating profits for reinvestment at 25% (defer higher-rate personal tax until retirement when marginal rate is lower); funding business investment from the company; building a buffer against Section 100A scrutiny by keeping cash actually in the company
Family Trust Key Rules and Figures (2024–25)
Annual trust distribution resolution: Must be passed by 30 June each income year. Late or no resolution means undistributed income is taxed at 47% to the trustee. Resolution must nominate specific beneficiaries and amounts (or proportions) of each income class if streaming.
Section 100A risk: The Full Federal Court's Guardian AIT decision (2023) confirmed Section 100A applies to reimbursement arrangements in family trusts. The ATO's Taxpayer Alert TA 2022/1 flags trust distributions to low-tax beneficiaries with informal arrangements as a compliance priority. All beneficiaries who receive a distribution should actually benefit from it - maintain documentation.
Division 7A benchmark interest rate 2024–25: 8.77%. Required on any complying loan from a company to a related trust beneficiary. Failure to charge the correct rate causes the UPE to be treated as a deemed unfranked dividend.
Corporate trustee cost: ~$59/yr ASIC annual review fee for a single-director shelf trustee company. Highly recommended over individual trustees - limits personal liability, avoids title transfer on trustee change, never dies.
Trust setup cost: Expect $1,500–$3,000 for a professionally drafted trust deed with a corporate trustee; stamping fees vary by state (SA, ACT, NT, VIC all $200 or under; QLD, WA, NSW vary). Recurrent accounting/tax costs typically $800–$2,500/yr depending on complexity.
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