Understanding Tax Implications of Using Trusts

Few structures are as widely used but as little understood as trusts, especially when it comes to the potential tax consequences which can arise where they are misused. A trust is basically a structure which allows a person or company to hold an asset for the benefit of others. The person who controls the asset is the trustee and those who benefit are the beneficiaries. The assets held in a trust can vary. Property, shares, businesses and business premises are all commonly held in trust structures. The creator of the trust (the settler) sets out the specific rules as to how these assets should be managed in a document called the trust deed.

By putting assets in a trust, you don't own the assets in your name. The assets are legally controlled by the trustee. However, you can potentially control exactly how those assets are managed now and in the future. You have the power to set out who receives the income arising from the assets and when they receive it, as well as who receives the underlying capital represented by the assets themselves and when. Discretionary Trusts (sometimes known as Family Trusts) are the most common type of trust used by business owners in Australia. They are generally created to hold a family's assets and/or business so as to protect those assets and to facilitate tax planning for family members.

 
Advantages of a trust

In most cases, from an asset protection perspective, assets held in a family trust cannot be attacked by creditors or lawsuits so they are ideal for protecting assets from business or personal disputes and they can also facilitate the transfer of assets from generation to generation tax free.

In addition, under current legislation, discretionary trusts allow lower tax rates to be achieved through ‘income splitting’, where trustees of discretionary trusts allocate all or part of their income to others who have a lower marginal tax rate. Treasury analysis shows that in 2022–23, on average, families with discretionary trusts faced an average tax rate around 4 percentage points lower compared with families with similar incomes who do not use a trust.

 
The problem with trusts

In recent years, to combat the perceived risk of tax avoidance by the use of trusts the ATO established a special Trusts Taskforce, given the job of looking into non-compliance amongst the millions of trust structures in place. Amongst the areas the taskforce look at are the following:
 

• trusts or their beneficiaries who have received substantial income and are not registered, or have not lodged tax returns or activity statements (meaning that in many cases, distributions of income from trusts have never been disclosed on a tax return)
• trusts involving offshore dealings through tax havens
• agreements with no commercial basis which direct income entitlements to a low-tax beneficiary (a spouse or child for example) while the benefits are enjoyed by others (a business owner or partner, for instance)
• where there is an artificial characterisation of amounts, such that tax outcomes do not reflect the economic substance of what actually took place, with the result that some parties have received substantial benefits from a trust while the tax liabilities corresponding to that benefit have gone elsewhere for example, by making trust resolutions that artificially reduce trust income in an attempt to direct minimal entitlements but full tax liability to entities with no capacity or intention of paying the tax
• where there has been mischaracterisation of revenue activities to achieve concessional CGT treatment for example, by using special purpose trusts to attempt to re-characterise mining or property development as discountable capital gains (a very common situation arises where profitable property disposals are claimed as capital to enjoy the 50% discount whilst loss making disposals are claimed as income to enjoy full benefit of the tax losses)
• where changes have been made to trust deeds or other constitutional documents to achieve a tax planning benefit, and are not credibly explainable for any other reason
• where transactions have excessively complex features or sham characteristics, such as round robin circulation of income among trusts (which basically means that income flows through a convoluted and hard to follow trail of entities before ending up back where it started, without a corresponding tax liability arising anywhere).
• where new trust arrangements have materialised that involve taxpayers and/or tax scheme promoters who have histories of or connection to previous non-compliance for example, people connected to liquidated entities that had unpaid tax debts.

 
Changes to the Taxation of Trusts

As part of the 2026–27 Federal Budget, the Government announced it will introduce a 30% minimum tax on discretionary trusts from 1 July 2028.

The tax will be paid by the trustee as it is the trustee who controls distributions. Beneficiaries will still need to declare their trust income in their tax returns, but beneficiaries, other than corporate beneficiaries, will receive non-refundable credits for the tax payable by the trustee.

Corporate beneficiaries are generally excluded from claiming this credit, making the practice of retaining trust profits in low-tax "bucket companies" less financially viable.

Certain trusts will be excluded from this measure, such as testamentary (deceased estate) trusts, charitable trusts and special disability trusts, to protect individuals who rely on trusts for genuine succession planning and asset protection rather than tax manipulation. 

For discretionary testamentary trusts, the exclusion will be limited to income from assets of the deceased estate.

For discretionary testamentary trusts established on or after 1 July 2028, the exclusion will only apply to trusts that can only benefit individuals and income tax exempt entities.

The Government anticipates that around half of discretionary trusts will not be affected by the changes. Small businesses will be able to reduce the impact of the minimum tax by employing beneficiaries working in the business, rather than paying them a trust distribution. Payments of salary or wages to employees will not attract the minimum tax.

Alternatively, small businesses could choose to restructure their operations, for example into a company or a fixed trust structure, not subject to the minimum tax.

Rollover relief will facilitate restructuring by ensuring there are no income tax consequences, including capital gains tax, for those that wish to move out of discretionary trust structures. 

Small businesses that choose to restructure into a company will benefit from access to dividend imputation and a lower 25 per cent corporate tax

The Government will introduce a time limited (3 years) restructure rollover with this measure. The proposed rollover relief will:
 

• be available from 1 July 2027
• facilitate the transfer of assets out of discretionary trusts to entities that are not discretionary trusts.

The minimum 30% tax on discretionary trust distributions heavily impacts income-splitting strategies, but does not entirely negate the usefulness of discretionary trusts, as they remain beneficial for asset protection, family succession and business structuring. 

Visit Tax and Business Services for more information and discuss whether you need to make changes to your existing business structure.