Key takeaways:
- From 1 July 2028, discretionary trusts will be subject to a minimum 30% tax on trust income at the trustee level.
- Individual beneficiaries will receive a non-refundable tax credit for the tax already paid by the trustee. Beneficiaries on tax rates above 30% will pay additional tax, while those below 30% may lose excess credits.
- No grandfathering relief will apply, meaning existing discretionary trust structures will also be captured from 1 July 2028.
The Government has announced it will introduce a minimum 30 per cent tax on trust distributions.
The rationale for the measure is to make the tax system fairer and more sustainable by narrowing the gap between tax paid on discretionary trust income and tax paid by wage and salary earners on comparable income, limiting the role of corporate beneficiaries and raising revenue to support broader tax reform.
How does the existing approach work?
Under the current rules, trusts are treated as flow-through vehicles for income tax. This means they do not pay tax themselves, but beneficiaries pay tax on the amounts of income they are presently entitled to each year at their marginal rates.
Where the trust retains amounts in a year, the trustee is taxed at the top marginal tax rate including Medicare levy (47%). This flow-through treatment, together with asset protection and flexibility is a key reason discretionary trusts are commonly used for business and investment, including by small private enterprises through to large family groups.
What’s the proposed change and how does it work?
From 1 July 2028, trustees of discretionary trusts will pay a minimum tax of 30% of the trust’s taxable income. Beneficiaries other than companies will receive a non-refundable credit for the tax paid by the trustee. This means that if the beneficiaries’ tax rate is above 30% they will pay top up tax and if it is below 30%, the excess credit will be lost.
From the Budget papers it appears corporate beneficiaries will not receive a credit for the tax paid by the Trustee. The Government has indicated this is to ensure that they cannot be used to get around the minimum tax. It appears this design element is intended to result in double taxation to discourage the use of corporate beneficiaries.
Who are the winners and losers from the change?
All users of discretionary trusts will be impacted by the changes. Those who distribute to certain types of beneficiaries such as corporate beneficiaries, or individuals with marginal tax rates below 30% (e.g. non-working spouses), will be particularly impacted.
Groups with complex trust structures, or layers of discretionary trusts and companies will also be significantly impacted.
The measure excludes, among others, primary production income, fixed trusts, widely held trusts, superannuation funds, special disability trusts, deceased estates, certain testamentary trusts and charitable trusts. These taxpayers should consider their broader structures carefully, particularly where they are beneficiaries of discretionary trusts or shareholders of bucket companies. Importantly, testamentary trusts that are established after budget night are intended to be caught by the rules.
Private groups and individuals using discretionary trusts should consider whether their existing structures remain appropriate and assess potential restructuring options. In certain circumstances, discretionary trusts may become less attractive compared to holding investments directly in individual names or through companies.
While primary production income is specifically excluded from being subject to the minimum trustee-level tax, restructuring may still be required where primary production land is held by a discretionary trust.
Grandfathering and transitional arrangements
No grandfathering applies for the measure, however the Budget papers indicate rollovers will be made available for eligible taxpayers who wish to restructure out of a discretionary trust. Existing structures will be subject to the new 30% minimum tax from 1 July 2028.
A number of key design questions are still to be resolved, including how the tax will be collected, how the income and credit regime will operate when the trust distributes to a corporate beneficiary, the scope of the rollover relief for those who restructure out to a company or other structure, and when such relief will be available.
Impacts on structuring
All private groups which include discretionary trusts should review their structures to ensure they remain suitable. If a restructure out of a trust is appropriate, groups should look to take advantage of rollover relief ahead of commencement of the measure.
Corporate beneficiaries and discretionary trusts may no longer be a tax-effective option for some taxpayers, however discretionary trusts may still be advantageous from an asset protection perspective and thus careful consideration will need to be given as to their role in future structures.
Corporate structures will likely be preferred for operating entities, however taxpayers will need to manage known risk areas, including Division 7A.
Groups should consider whether their current structures remain workable and appropriate or whether adjustments are needed to the way in which they access retained profits and wealth. Simpler structures may also prove more attractive following the changes.
Wills should be reconsidered given discretionary testamentary trusts are not excluded from the changes where they were not in existence as at Budget night.
Taxpayers should proactively review their structures and use the transition window wisely. The transition period is limited and we do not know when we will have full clarity on how these rules will apply, or when draft legislation and guidance will be forthcoming.
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