A discretionary trust can be a flexible structure for holding investments, running a business, or doing both. But the tax outcome does not depend simply on the label used in the deed, bank account or tax return. It depends on what the trustee is actually doing with the assets, why the assets were acquired, and how the income and gains are documented and distributed.
Getting the distinction wrong can affect deductions, losses, capital gains tax treatment, year-end trust resolutions and the beneficiaries who are assessed. The right approach is to establish the commercial purpose first, then ensure the trust deed, records and tax reporting support that position.
The starting point: a trust can invest, trade or operate a business
A discretionary trust is not automatically an “investment trust” or a “trading trust”. The trustee may hold a long-term rental property or share portfolio, operate a business, develop property for sale, or hold different categories of assets within the same trust.
The important issue is the character of each activity and transaction. For example, assets held for long-term income and capital growth may be on capital account, while assets acquired and dealt with in the ordinary course of a business may be revenue assets or trading stock. The income tax law defines trading stock broadly to include items held for sale or exchange in the ordinary course of a business.
That distinction is particularly important where a trust buys and sells shares, develops land, renovates and sells property, or regularly trades goods. An intention to make a profit is relevant, but it is not enough on its own to prove that a business is being carried on. The overall pattern of activity matters, including repetition, scale, organisation, decision-making and the purpose for which assets are held.
1. The purpose of acquiring the asset is different
An investment trust generally acquires assets to produce ongoing income, preserve wealth or achieve longer-term capital growth. Common examples include rental properties, managed funds, dividend-paying shares and commercial premises held for lease.
A trading trust generally acquires or creates assets with the purpose of selling them in the ordinary course of a business. This may include a retail business buying stock for resale, a share trading operation, or a property development activity carried out with a commercial sale objective.
The original purpose is important, but it must be tested against later conduct. A trustee may say that a property was acquired as a long-term investment, yet subsequent subdivision, development, marketing and repeated sale activity may indicate that the profits are revenue in nature.
The ATO has specifically raised concerns about trusts involved in property development reporting sale proceeds as capital gains where the trust is in fact carrying on a development business or undertaking a profit-making venture.
2. Trading profits and investment gains can be taxed differently
Income from trading activities is generally dealt with as ordinary income. This can include sales made in the ordinary course of a business, as well as profits from some commercial profit-making ventures. General deduction rules may allow expenses that are sufficiently connected with earning that income or carrying on the business, provided no specific rule denies the deduction.
Investment income may include rent, interest, dividends and distributions. A later sale of an investment asset may instead give rise to a capital gain or capital loss, subject to the capital gains tax rules.
This difference matters because an amount that is properly revenue income should not be reported as a capital gain simply because the asset was held by a discretionary trust. Calling business proceeds a “capital gain” in a trust resolution will not change their legal or tax character.
For a trading business, stock on hand can also affect the annual tax calculation. The tax law requires many businesses to account for changes in the value of trading stock held at the beginning and end of an income year.
3. The CGT discount may be available for investments, but not ordinary trading income
A key potential advantage of holding genuine investment assets in a discretionary trust is access to the general capital gains tax discount. Broadly, a capital gain may qualify as a discount capital gain where the relevant asset was acquired at least 12 months before the CGT event, along with other legislative requirements.
For eligible trusts and beneficiaries, the general discount can reduce the amount of a capital gain included in taxable income. However, it does not convert ordinary business income into a capital gain, and it is not a substitute for analysing the underlying activity correctly.
This is often a major point of difference between a buy-and-hold investor and a trader:
- An investor who holds an asset for income and long-term growth may potentially make a capital gain on disposal.
- A trader who buys and sells assets as part of an organised business will generally have revenue profits instead.
- A property developer may have sale proceeds that are ordinary income or otherwise on revenue account, even if the property was held for more than 12 months.
- A trust with both investment and trading activities may need to keep particularly clear records to support the treatment of each asset and transaction.
A capital loss also has a different use from an ordinary business loss. Capital losses are applied against capital gains under the CGT rules, rather than being deducted from ordinary income in the same way as general business expenses.
4. Deductions, losses and cash flow do not work the same way
Trading activities may generate regular deductible expenses, such as stock costs, premises costs, staff wages, advertising, insurance and business systems. The deductions must still be properly incurred, connected to the income-producing activity and supported by records.
An investment trust may incur deductible costs as well, such as property management fees, loan interest where the borrowing is used for an income-producing purpose, repairs, agent fees and some professional expenses. However, capital expenditure is not automatically deductible just because it relates to an investment asset.
The treatment of losses is also important. A discretionary trust cannot distribute an overall tax loss to beneficiaries for them to offset against their own salary, business income or investment income. Subject to the relevant trust loss rules, the loss may instead be carried forward and used by the trust against future income.
This means a new trading venture held in a discretionary trust may not provide the immediate personal tax benefit that some business owners expect. Before using a trust for a higher-risk or early-stage business, consider whether the likely timing of profits, losses and funding needs suits the structure.
5. Distribution planning is more flexible for income, but capital gains require extra care
A discretionary trust can give the trustee flexibility to decide which eligible beneficiaries receive trust income, provided the trust deed permits the distribution and the trustee makes a valid resolution.
For ordinary trust income, the timing and wording of the resolution are critical. The ATO states that trustees of discretionary trusts must make beneficiaries presently entitled to trust income by 30 June of the relevant income year. If this is not done properly, the trustee may be assessed on income that was intended to be distributed.
Capital gains and franked distributions have additional rules. Where the deed allows it and the legislative requirements are met, a trust may stream capital gains or franked distributions to particular beneficiaries by making them specifically entitled to those amounts. This can be useful where one beneficiary has capital losses, can access a relevant CGT concession, or is otherwise an appropriate recipient of the gain.
However, streaming is not achieved merely by using the word “stream” in a resolution. The beneficiary must receive, or reasonably be expected to receive, the relevant financial benefit, and the trustee must comply with the recording requirements. For franked distributions, the relevant written entitlement must be recorded by 30 June. For capital gains, written recording may be possible by 31 August following the income year, although a gain that already forms part of trust income dealt with by 30 June may need to be addressed by that earlier date.
6. Record-keeping needs to match the trust’s real activities
The more a trust combines investment assets, trading operations and related-party dealings, the more important its records become.
For an investment-focused trust, useful records typically include:
- purchase contracts and settlement statements
- loan documents and interest records
- rental agreements, agent statements and repair invoices
- dividend statements and investment portfolio reports
- evidence of the trustee’s investment strategy and holding intention.
For a trading trust, records should also show:
- the business plan and sales strategy
- stock purchases and stocktake records
- sales invoices and customer records
- advertising, supplier and operating expenses
- bookkeeping records used to prepare BAS, payroll and income tax reporting
- evidence of how the trustee makes trading decisions.
A separate bank account, orderly bookkeeping and clear trustee minutes will not by themselves determine the tax result. They can, however, provide valuable evidence that the trustee has acted consistently with the stated purpose of the activity.
7. Company beneficiaries can assist with retained profits, but create Division 7A risks
Some discretionary trusts distribute income to a corporate beneficiary where this is permitted by the deed and commercially appropriate. This can be part of a broader business structure, but it is not a simple way to make tax disappear.
If a private company is made presently entitled to trust income and the entitlement remains unpaid, an unpaid present entitlement may arise. Where the trust continues to use those funds, Division 7A can apply and the arrangement may be treated as a loan or otherwise create a deemed dividend risk.
Related-party trust arrangements should therefore be documented carefully. The trustee, company and advisers need to understand who is entitled to the money, whether it has actually been paid, whether the funds remain available for the beneficiary, and whether any loan arrangement meets the relevant requirements.
Trust distributions also need a genuine commercial or family explanation. The anti-avoidance rules in section 100A can be relevant where a beneficiary is made entitled to trust income but another person obtains the benefit under a reimbursement arrangement. The ATO’s compliance guidance focuses on the facts, the use of the funds, and whether the arrangement is explained by ordinary family or commercial dealing rather than simply reducing tax.
A practical scenario
Consider a discretionary trust that owns a long-term rental property and also begins buying older houses, renovating them and selling them shortly after completion.
The rental property may remain an investment asset, with rental income and a possible capital gain on a later sale. The renovation-and-sale activity may be a separate business or profit-making venture, depending on the full facts.
The trustee should not assume that every property sale receives the same tax treatment. It may need separate accounting records, clear evidence of purpose, appropriate GST and BAS reporting where applicable, and a distribution resolution that distinguishes ordinary income from capital gains.
Choosing the right approach for your trust
The tax benefits of a discretionary trust are strongest when the structure reflects the real commercial position. A genuine investment activity may offer access to capital treatment and flexible distribution planning. A genuine trading activity may provide a practical vehicle for operating a business and managing business income, expenses and working capital.
The key is not to chase a preferred result after a sale or at EOFY. Decide the intended activity early, keep records that support it, review the trust deed before making distributions, and obtain advice before changing an asset’s purpose or introducing a company beneficiary.
This article is general information only and is not personal financial or tax advice. Trust, investment and business tax outcomes depend heavily on the facts, the trust deed and the timing of each transaction. Speak with a registered tax agent or accountant, such as, for advice tailored to your circumstances.