Are Discretionary Trust Structures heading towards extinction?

In the recent federal budget, the Australian Government have put forward major changes to the taxation framework surrounding discretionary trust structures.

These changes, once approved, will significantly impact the tax effectiveness of those trust structures, leaving small businesses, who don’t act quickly, stranded in a tax avalanche.

The Current Tax System

Under the current system, small business owners are capitalising on the use of discretionary trust structures to distribute trust income to beneficiaries who fall into different income brackets, at different tax thresholds.

By allocating the income in this way, they are using low-income beneficiaries to prevent the trust income from being ‘pooled’ in the name of one tax entity, which would result in tax being paid at higher tax thresholds.

New Minimum Tax Threshold

The reform introduces a minimum tax rate of 30% for discretionary trusts, meaning that the trustee will pay tax at a rate of 30% on the trust income, regardless of whether the income is distributed to beneficiaries of the trust in the same financial year.

When the income is then distributed to beneficiaries of the trust, the tax effect is as follows: -

1. If the beneficiary is an individual, and their income tax bracket in the financial year is 30% or less, the beneficiary will not pay any tax on the distribution.
2. If the beneficiary is an individual, and their income tax bracket in the financial year is more than 30% (e.g., they are in the 47% bracket), that beneficiary will pay tax on the difference between their tax bracket and the 30% tax rate.
3. If the beneficiary is a company, they will pay tax at the company tax rate (usually 30%). This means that the income is effectively being taxed twice, once while in the hands of the trustee, and once while in the hands of the company.

The result?

Discretionary trust structures, and in particular, the use of bucket companies as a beneficiary of a discretionary trust, will no longer be an effective tax structure.

What can you do?

The government is providing rollover relief from 1 July 2027, to assist small businesses to pivot to a new, more tax-effective structure. The rollover relief will provide CGT and other income tax concessions on the transfer of assets held in a discretionary trust to another legal structure.

Don’t get left behind!

See your advisors today to work out the best tax structure for you, and to evacuate the sinking discretionary trust ship while you can!