Many Australian business owners use the terms “discretionary trust” and “family trust” as if they mean the same thing. Sometimes they do, at least in everyday conversation. But for tax purposes, the distinction can be important.
A discretionary trust describes how the trustee may distribute income and capital under the trust deed. A family trust, in the tax-law sense, is a trust whose trustee has made a family trust election. One trust can be both.
Understanding the difference matters before you distribute profits, bring in new beneficiaries, use trust losses, receive franked dividends or plan for succession. An election can create useful tax outcomes in the right circumstances, but it can also narrow future options.
Start with the right distinction
A discretionary trust is generally a trust where the trustee has discretion, within the terms of the deed, to decide which eligible beneficiaries receive trust income or capital and in what proportions.
The trust deed is central. It identifies matters such as:
– the trustee and how a replacement trustee can be appointed;
– the appointor or other person with powers affecting control of the trust;
– primary, general and excluded beneficiaries;
– how income and capital may be distributed;
– when trustee resolutions must be made; and
– whether capital gains and franked distributions can be dealt with separately.
A family trust is not necessarily a different legal structure. For Australian income tax purposes, a trust becomes a family trust when its trustee makes a valid family trust election and that election remains in force.
That election nominates an individual around whom a defined family group is established. From that point, the trust may access certain concessions and simplified rules, but distributions outside the relevant family group can have serious tax consequences.
The 7 key differences business owners should understand
1. A discretionary trust describes the trustee’s powers, while a family trust election creates a tax status
The first difference is the most important.
A discretionary trust is created by its deed. The trustee’s discretion comes from the legal terms of that document. Depending on the deed, the potential beneficiary class may include family members, companies, other trusts, charities or other entities.
A family trust election is a separate tax decision made by the trustee. It does not automatically rewrite the deed, change the legal ownership of trust assets or turn the trust into a new entity. Instead, it creates a tax-law framework based on the nominated individual and their family group.
This means a trust can be:
– a discretionary trust with no family trust election;
– a discretionary trust that has made a family trust election;
– a fixed trust, such as some unit trusts, that has made a family trust election; or
– a trust called a “family trust” in its name but not treated as a family trust for tax purposes because no election is in force.
The label on the trust bank account, ABN record or deed cover page is not enough. The question is whether a valid election has actually been made and remains effective.
2. Distribution flexibility is broader before a family trust election is made
A discretionary trust can offer considerable flexibility because the trustee may generally choose among the beneficiaries permitted by the deed.
For example, a trustee may be able to distribute income to adult family members, a corporate beneficiary or another trust, provided the deed allows it and the distribution is properly documented. That flexibility can be commercially useful where family circumstances, business ownership or income levels change over time.
Once a family trust election is in force, the trustee must think beyond the deed. A person or entity may be an eligible beneficiary under the deed but still fall outside the family group for family trust election purposes.
The election therefore creates a practical boundary around distribution decisions. It may suit a business that intends to keep ownership and benefits within one family group. It may be less suitable where the trust needs flexibility to bring in unrelated investors, business partners, employees, charities or a different family group in the future.
3. A family trust election requires a nominated individual and defined family group
A discretionary trust deed may have a broad class of beneficiaries. A family trust election, however, centres on one specified individual.
The tax law then determines who is within that person’s family group. This can include the specified individual and certain family members, as well as particular entities that qualify under the relevant rules. Other trusts, companies and partnerships may need an interposed entity election before they can be treated as part of the same family group.
This is especially relevant where a discretionary trust distributes to:
– a bucket company;
– another discretionary trust;
– a corporate beneficiary;
– a business partnership;
– an adult child’s trust;
– a trust established for a different branch of the family; or
– an entity used in a broader business group.
Before making an election, it is important to map the whole group, not just the immediate family. A structure that appears simple on a family chart can become more complex once companies and multiple trusts are involved.
4. The election can assist with some tax rules, but it is not a general tax-saving tool
A family trust election can be useful where a trust needs access to certain tax outcomes under the trust loss, company loss tracing and franking credit rules.
For example, a family trust election may be relevant where a trust has prior-year losses, bad debt deductions or certain other deductions that could otherwise be restricted under the trust loss rules. It can also be relevant to the holding-period rules that regulate access to franking credits in some circumstances.
However, making an election does not automatically reduce tax. It does not create a special income tax rate for the trust, guarantee access to losses or make every distribution tax-effective.
Trust distributions must still be supported by the trust deed, trustee resolutions and the tax law. The beneficiaries’ own tax positions remain relevant, and anti-avoidance provisions can apply to arrangements that do not reflect genuine family or commercial dealings.
In particular, trustees should be cautious where a beneficiary is made entitled to income but another person receives the real economic benefit. The ATO has detailed guidance on reimbursement arrangements involving trust distributions. Simply distributing income to a lower-taxed beneficiary on paper, while directing the funds elsewhere, can create significant tax risk.
5. Distributions outside the family group can trigger family trust distribution tax
This is the key trade-off.
Where a family trust election is in force, a distribution of income or capital, or a conferral of present entitlement, outside the relevant family group can trigger family trust distribution tax.
The consequences can be severe. It is not a minor compliance issue that can safely be fixed later by changing the accounting entry or calling the payment something else.
Importantly, the rules can apply to conduct that occurred before the election was formally made, depending on the election’s operation and the relevant period. That is why trustees should review earlier distributions before making an election, rather than treating the election as a simple formality at tax return time.
Before distributing from an elected family trust, ask:
1. Is the intended recipient permitted under the trust deed?
2. Is the recipient within the family group for election purposes?
3. If the recipient is a company, partnership or trust, does it need an interposed entity election?
4. Has the distribution been correctly authorised and recorded?
5. Does the arrangement have a clear family or commercial purpose?
6. Both structures need year-end resolutions, but family trust status adds another compliance layer
A discretionary trust is not a “set and forget” structure. Trustees need to understand the deed, keep proper records and make valid resolutions in accordance with the deed’s requirements.
If a trustee wants a beneficiary to be presently entitled to trust income, the resolution needs to be effective. If it is not, the tax outcome may be very different from what the trustee intended. In some cases, the trustee may be assessed instead.
This becomes more important when the trust has:
– business income;
– capital gains from the sale of assets;
– franked dividends;
– unpaid beneficiary entitlements;
– beneficiaries under legal disability;
– corporate beneficiaries; or
– losses carried forward from earlier years.
Capital gains and franked distributions may be streamed in some situations, but only if the trust deed permits it and the relevant tax requirements are met. A general resolution that simply distributes “all income” may not achieve the intended result.
For a family trust, the annual process should also include a family-group check. The trustee should not assume that a person who is related socially or commercially is necessarily inside the family group for tax purposes.
7. A family trust election can limit future restructuring and succession options
Business owners often make structural decisions based on current circumstances, then discover the consequences years later when the business grows, relationships change or succession planning begins.
A discretionary trust without a family trust election may have more room to adapt, subject to its deed and general tax law. It may be easier to consider new investors, revised beneficiary classes or group restructuring, although these changes still require careful advice.
A family trust election can narrow that room. Elections generally cannot be casually withdrawn or changed merely because a new distribution strategy would be more convenient. The law provides limited circumstances for variation or revocation, but they are not a substitute for planning before the election is made.
This does not mean a family trust election is a poor choice. It means the choice should follow a review of the business’s likely future, including:
– whether unrelated investors may be introduced;
– whether the business may be sold or transferred;
– whether multiple family branches may become involved;
– whether a corporate beneficiary is likely to be used;
– whether another trust may receive distributions;
– whether losses or franked investment income are likely to be relevant; and
– who should hold control roles, including trustee director and appointor roles.
A practical example
Consider a trading business operated through a discretionary trust. The trust deed permits distributions to adult family members, a company and a broad range of related entities.
The trustees are considering a family trust election because the trust has investment income and the group may need access to rules affecting losses and franking credits. At first glance, the election appears straightforward because the business is family-owned.
However, the trust has previously distributed income to another trust associated with a sibling, and it may later admit an unrelated business partner through a separate entity. The trustees also use a company as a potential beneficiary.
Before making the election, the group needs to review prior distributions, identify who would be in the nominated individual’s family group, consider whether interposed entity elections are needed and assess whether the election would restrict the proposed future ownership plan.
The right answer may still be to make the election. But it should be a documented decision based on the deed, the group structure and the business plan, not simply a box ticked when the trust tax return is prepared.
How to decide what suits your business
The decision is rarely “discretionary trust or family trust”. More often, the real question is whether a discretionary trust should make a family trust election.
A useful starting checklist is:
– Obtain a complete copy of the trust deed and all amendments.
– Confirm who controls the trust in practice and under the deed.
– Review the appointor, trustee and corporate trustee director arrangements.
– Identify all actual and potential beneficiaries.
– Map companies, trusts and partnerships in the wider group.
– Review previous distributions and unpaid present entitlements.
– Consider future investors, succession plans and possible business sales.
– Assess whether trust losses, bad debts, franking credits or company loss tracing are relevant.
– Ensure resolutions are prepared before the deadline required by the trust deed.
– Obtain tax and legal advice before making an election or distributing outside the expected family group.
A well-managed discretionary trust can be a flexible structure for an Australian business-owning family. A family trust election can add valuable tax-law advantages in the right circumstances, but it also creates a meaningful long-term commitment.
The key takeaway
A discretionary trust and a family trust are not opposing choices. A discretionary trust may become a family trust for tax purposes if its trustee makes a family trust election.
The potential benefits can be worthwhile, particularly where trust losses, franking credits or group ownership rules are relevant. But the election may also restrict who can receive trust income or capital without adverse tax consequences.
This article is general information only and is not personal financial or tax advice. Trust deeds, family relationships, prior distributions and business plans all matter. Speak with a registered tax agent or accountant, such as, before making a family trust election or changing how your trust distributes income or capital.