A discretionary trading trust can be an effective structure for Australian business owners who want greater flexibility around profit distributions, asset ownership and succession planning. It can also create significant tax and compliance risks if the trust deed, trustee decisions and business records are not managed carefully.
The key point is that a trust is not a “set and forget” tax structure. Its value depends on the way it is established, how the business operates in practice, who receives benefits from it and whether the trustee follows the trust deed each year.
What is a discretionary trading trust?
A discretionary trust is a trust where the trustee has discretion, within the limits of the trust deed, to decide which beneficiaries receive trust income or capital and in what proportions.
When the trust carries on a business, it is often described informally as a discretionary trading trust or family business trust. The trust may operate the business, enter contracts, employ staff, own trading stock and receive business income. Legally, however, the trustee is the party responsible for running the trust’s affairs.
The main people and entities involved are usually:
- The trustee, which makes decisions and holds trust property for the beneficiaries.
- The beneficiaries, being the people or entities who may receive income or capital under the deed.
- The appointor or principal, where the deed includes this role. This person may have the power to remove and appoint trustees.
- The corporate trustee, if a company is used as trustee instead of an individual.
- The trust deed, which is the governing document that sets the trustee’s powers, identifies beneficiaries and determines how income and capital can be dealt with.
Many business owners choose a company to act as trustee. A corporate trustee can provide a cleaner separation between the people behind the business and the entity acting as trustee. It may also make succession and administration more manageable than having individuals act personally as trustee.
That said, a corporate trustee does not turn a trust into a company. The company is acting in a trustee capacity, and the trust assets should be clearly identified and properly administered as trust assets.
Why business owners use discretionary trusts
The appeal of a discretionary trust is usually flexibility, rather than a single guaranteed tax outcome.
A well-designed trust can allow the trustee to consider, each year, which eligible beneficiaries should receive income or capital. This may be useful where family circumstances, business profits or investment income change over time.
For example, a business-owning family may have adult beneficiaries with different income levels, a spouse involved in the business, or a separate company that is an eligible beneficiary under the deed. Subject to the deed and tax law, the trustee may have options about how trust income is allocated.
Other potential reasons for using a discretionary trust include:
- separating business ownership from personal ownership;
- holding investments or business assets in a structure intended to support long-term family wealth planning;
- providing flexibility for future family members or succession arrangements;
- allowing a business to be carried on by a trustee rather than directly by an individual;
- supporting estate planning when coordinated with wills, company documents and any appointor succession arrangements; and
- making it easier to introduce a new trustee where the deed permits.
However, flexibility is not the same as unlimited freedom. The trustee can only distribute to people or entities who are beneficiaries under the trust deed. The trustee must also exercise its powers genuinely, for the purposes allowed by the deed and the law.
A trust structure should be selected because it suits the commercial and family circumstances of the business, not simply because someone has heard that trusts “save tax”.
How income tax works in a discretionary trust
A discretionary trust generally calculates its taxable income for the income year, but the tax outcome often depends on who is presently entitled to the trust income.
Where an adult beneficiary is presently entitled to a share of the trust income and is not under a legal disability, that beneficiary is generally assessed on their corresponding share of the trust’s taxable income. The trustee’s distribution resolution is therefore a central tax document, not just an administrative formality.
The distinction between trust income and taxable income is particularly important.
Trust income is determined under the trust deed and trust law principles. Taxable income, often referred to in the trust context as the trust’s net income, is determined under tax law. These amounts can differ because of items such as deductions, depreciation, capital gains, franked distributions and prior-year tax losses.
This means a trustee should not simply distribute a percentage based on a draft profit and loss statement without considering the deed and tax position. The wording of the resolution, the trust’s definition of income and the character of particular amounts can all matter.
If no beneficiary is properly made presently entitled to relevant trust income, the trustee may instead be assessed. This can produce an unfavourable tax result, particularly where income has not been dealt with in accordance with the trust deed.
Trustees commonly need to make a distribution resolution by 30 June for beneficiaries to be presently entitled to trust income for that income year. Where franked distributions or capital gains are involved, further rules around specific entitlement and the form and timing of resolutions may apply. The trust deed can impose additional requirements or earlier deadlines, so it should always be reviewed before the end of the financial year.
Capital gains and franked distributions need extra care
A trust can hold business assets, shares, property or investments. If it makes a capital gain, special tax rules may allow the gain to retain its capital character for beneficiaries in certain circumstances.
This can be important because beneficiaries may have capital losses or may otherwise qualify for CGT treatment that differs from ordinary income treatment. However, the outcome depends on the trust’s circumstances, the type of gain, the terms of the deed and how the trustee records the relevant entitlement.
Franked distributions also have their own rules. A trustee may need to make beneficiaries specifically entitled to particular franked distributions for the intended tax result to follow. There can also be integrity rules affecting access to franking credits.
The practical lesson is simple: do not leave capital gains, dividends and distribution planning until the tax return is being prepared. These issues should be considered before the relevant trustee resolution is made.
Asset protection: useful, but never absolute
Asset protection is often a major reason business owners consider a discretionary trust. A trust may help separate particular assets from particular business risks, but it is not an impenetrable shield.
The protection available depends on what the trust owns, what liabilities it incurs, who signs contracts, whether assets have been used as security and whether the structure has been operated properly.
For instance, where a trading trust carries on a business, the trustee may incur liabilities to suppliers, landlords, employees, lenders and customers. If the trustee is a company, the company’s separate legal status may help contain some liabilities. But directors and business owners can still face personal exposure in a range of circumstances.
Common examples include:
- giving a personal guarantee to a bank, landlord or supplier;
- providing security over personal property or the family home;
- breaching director duties or trustee obligations;
- failing to meet certain tax, employee entitlement or superannuation obligations;
- acting outside the powers available under the trust deed; or
- operating the trust in a way that undermines the trustee’s right to be indemnified from trust assets.
It is also important to understand that simply transferring an asset into a trust does not automatically make it protected. A transfer can have legal, tax, finance and state-based duty consequences. The result will depend on the asset, the ownership history, the relevant state or territory and the surrounding circumstances.
A common approach is to separate higher-risk trading activities from valuable passive assets, but there is no standard structure that suits every business. A construction business, professional practice, online retailer and property investor may each have very different risk profiles.
Asset protection planning is therefore best considered alongside legal advice, insurance, lending arrangements and estate planning. The structure should match the real commercial risks, rather than exist only on paper.
Tax planning is legitimate, but distributions must reflect reality
A discretionary trust can provide tax planning opportunities because the trustee may have a choice between eligible beneficiaries. However, the arrangement must be properly implemented and must reflect the legal and economic reality of the distribution.
A beneficiary who is made presently entitled to trust income has a real entitlement. That entitlement should not be treated as a notional bookkeeping entry that can simply be ignored after 30 June.
Where trust income is distributed to one person but the benefit is effectively directed to another person, anti-avoidance rules may apply. The ATO has published detailed guidance on arrangements involving reimbursement agreements, including arrangements where a lower-taxed beneficiary is used while another person ultimately receives or enjoys the economic benefit.
This does not mean every unpaid distribution is a problem. It does mean trustees need clear records showing:
- who received the distribution;
- whether the distribution was paid, retained in the trust or applied on the beneficiary’s behalf;
- whether the beneficiary consented to any use of their entitlement;
- whether funds were lent or otherwise made available to another party; and
- how the transaction was recorded in the trust accounts and balance sheet.
Corporate beneficiaries and unpaid present entitlements
Some discretionary trusts have a company as an eligible beneficiary. This can be useful in some circumstances, particularly where the business does not need to distribute all available cash to individual family members.
However, a corporate beneficiary adds another layer of complexity. If the trustee resolves to distribute income to the company but does not pay the amount, the unpaid present entitlement must be properly managed.
Division 7A can become relevant where a private company beneficiary has an unpaid present entitlement and the trust provides payments, loans or debt forgiveness to shareholders of the company or their associates. Depending on the facts, amounts can potentially be treated as assessable dividends.
This is an area where casual advice can be costly. A distribution to a corporate beneficiary should be supported by a clear plan for the cash, the accounting entries, any loan arrangements and the ongoing management of the unpaid entitlement.
Personal services income cannot simply be split through a trust
Business owners who earn income mainly from their own personal efforts or skills also need to consider the personal services income rules.
Using a trust does not automatically allow income from an individual’s labour to be split among family members. Where the rules apply, income may be attributed to the individual who performed the services unless the relevant personal services business requirements are satisfied.
This is particularly relevant for consultants, contractors, tradespeople, medical professionals and other service-based operators. The correct treatment depends on the facts, including the source of the income, the nature of the services and the business’s working arrangements.
Trust deeds, records and annual compliance matter
A discretionary trust is only as strong as its governing deed and administration.
Before relying on a trust for business operations or tax planning, it is important to confirm that the deed is current and fit for purpose. Older deeds may not adequately deal with streaming of capital gains or franked distributions, corporate beneficiaries, successor appointors, modern business activities or changing family circumstances.
The trustee should also ensure the trust is administered consistently throughout the year. Good practice typically includes:
- operating bank accounts in the trustee’s capacity for the trust;
- ensuring invoices, contracts and finance documents identify the correct trustee and trust capacity;
- maintaining separate accounting records for the trust;
- preparing trustee resolutions before applicable deadlines;
- recording unpaid beneficiary entitlements accurately;
- lodging trust tax returns and associated schedules where required;
- meeting BAS, PAYG withholding, superannuation and employer obligations where applicable;
- maintaining beneficiary tax file number and reporting records where required; and
- reviewing the deed before admitting beneficiaries, changing trustees, varying terms or making major asset transfers.
A family trust election may also be relevant in some situations, including where the trust is seeking access to certain tax rules or interacts with other family-controlled entities. But an election can restrict who may receive distributions without attracting family trust distribution tax. It should not be made automatically.
Trust losses can also be subject to separate rules. A discretionary trust that incurs losses may face limitations on using them in later years if control, distributions or other relevant circumstances change.
A practical example
Consider a family-owned business operated by a company acting as trustee for a discretionary trust.
The trust earns income from the business and also owns certain business equipment. Near EOFY, the owners review draft accounts with their accountant. They consider expected taxable income, the trust deed, beneficiaries’ circumstances, potential capital gains and whether any income is personal services income.
The trustee then makes a properly documented resolution within the required timeframe. Some income is distributed to adult beneficiaries who are eligible under the deed, while an amount is allocated to a corporate beneficiary under a documented plan. The trust’s accounts record the resulting beneficiary entitlements, and the business does not use funds that belong to the corporate beneficiary without considering the Division 7A implications.
This approach does not guarantee a particular tax outcome. It does, however, demonstrate the difference between thoughtful annual planning and simply deciding after year-end where profits should have gone.
Is a discretionary trading trust right for your business?
A discretionary trading trust can be a valuable structure for the right business owner. It may offer flexibility in distributing income, support longer-term family and succession planning, and assist with separating business activities from other assets.
But it also requires disciplined administration. The trust deed, trustee resolutions, beneficiary records, cash movements and tax reporting all need to work together. A poorly managed trust can create tax exposure, disputes between family members and unintended personal liability.
This article is general information only and is not personal financial or tax advice. Before establishing, changing or distributing from a trust, speak with a registered tax agent or accountant, such as, about your specific circumstances.