Many Australian business owners and investors reach a point where a sole trader structure or personal ownership no longer feels like the right fit. They may want more flexibility in sharing income with family members, holding investments, managing business risk or planning for succession.
A discretionary trust can be useful in the right circumstances, but it is not a standard tax-saving product. Its value depends on the trust deed, who the beneficiaries are, the assets and activities involved, and how carefully the trust is administered each year.
What is a discretionary trust?
A discretionary trust is a legal arrangement in which a trustee holds and manages property or assets for a group of potential beneficiaries. The trustee may be an individual or, more commonly for business and investment structures, a company acting as trustee.
Unlike a fixed trust, beneficiaries of a discretionary trust do not generally have a predetermined percentage entitlement to trust income or capital. Subject to the trust deed, the trustee decides which eligible beneficiaries receive income or capital distributions in a particular year and in what proportions.
The trust deed is central to how the structure works. It sets out matters such as:
– who can act as trustee
– the class of beneficiaries
– who has power to appoint or remove the trustee
– how income and capital can be distributed
– whether particular classes of income can be dealt with separately
– rules for trustee decisions, record keeping and vesting of the trust.
This flexibility is why discretionary trusts are commonly used by families, business owners and investors. However, it also means the trustee must make decisions carefully and within the powers given by the deed.
A discretionary trust is not a company, even where a company is used as trustee. The trust itself is an arrangement, while the trustee is responsible for operating the trust and holding its assets in that capacity.
Seven key benefits for business owners and investors
1. Flexibility to distribute income among eligible beneficiaries
The best-known benefit of a discretionary trust is the ability to distribute income to different beneficiaries from year to year, provided they are included within the beneficiary class under the deed.
For example, one year a family business may generate profit while one adult beneficiary has reduced income due to parental leave, study, retirement or a change in work arrangements. In another year, that person’s income may have increased while another beneficiary has lower taxable income. A properly administered trust may allow the trustee to take those changing circumstances into account.
This does not mean income can simply be directed to whoever has the lowest tax rate. A distribution must be legally effective under the deed and must create a genuine entitlement for the beneficiary. The tax outcome follows the legal entitlement, not an informal intention written down after the event.
Trust distributions to minors, non-residents and some other beneficiaries can be subject to special tax treatment. These rules need to be considered before a distribution is made, rather than after the trust accounts have been finalised.
2. Potentially more tailored tax outcomes
A discretionary trust can allow a family or business group to consider the overall tax position of eligible beneficiaries when allocating trust income. This may be useful where beneficiaries have different levels or types of income, available tax losses, deductible expenses or capital losses.
The key word is “potentially”. A trust does not automatically reduce tax, and there may be years where distributing income to a particular beneficiary produces little benefit or creates an undesirable outcome.
The trustee also needs to distinguish between trust law income, taxable net income and available cash. These amounts can differ substantially. For instance, a trust may have taxable income that does not correspond neatly with cash available for distribution because of deductions, timing differences, depreciation, capital gains or non-cash accounting adjustments.
Good annual planning helps ensure that trustee resolutions, financial statements, beneficiary reporting and tax returns all work together.
3. The ability to stream certain capital gains and franked distributions
Where the trust deed permits it and the relevant tax requirements are met, a discretionary trust may be able to direct particular capital gains or franked distributions to specific beneficiaries.
This can be valuable because different beneficiaries may have different tax attributes. One beneficiary may have capital losses available to offset capital gains, while another may be better placed to receive franked dividends.
However, streaming is not a simple bookkeeping exercise. The trust deed must provide the necessary power, the trustee must make a valid and appropriately documented decision, and the entitlement must satisfy the applicable tax rules.
A trustee should not assume that a general income distribution automatically streams capital gains or franked distributions. The wording of the deed and the resolution matters. Inadequate resolutions can lead to a different tax outcome from the one intended, including the possibility of the trustee being assessed on income that was not effectively distributed.
4. Separation of business or investment assets from personal ownership
A discretionary trust can be used to hold business assets, investment portfolios, commercial property or other long-term assets separately from personal ownership.
That separation may assist with managing commercial risk. For example, a business owner may choose to have one entity conduct the trading activity while another structure holds an investment asset. The appropriate arrangement will depend on the nature of the business, financing arrangements, asset type, contractual obligations and overall risk profile.
A corporate trustee is often considered because it can create a clearer distinction between the trust’s activities and an individual’s personal affairs. It can also assist with continuity if there is a change in the people managing the trust.
Asset protection is never absolute. A trust structure will not necessarily protect assets where personal guarantees have been given, obligations have been assumed personally, the trustee has acted improperly, or other legal claims arise. Family law, insolvency, creditor claims and transactions designed to defeat creditors can all affect the outcome.
The right question is not whether a discretionary trust offers complete protection. It is whether it forms part of a sensible, properly implemented risk-management strategy.
5. Flexibility for investment ownership and reinvestment
For investors, a discretionary trust can provide flexibility in holding assets such as shares, managed investments or investment property. Rather than each individual owning a separate percentage of each asset, the trustee holds the asset for the trust and can consider distributions across the beneficiary group over time.
This may be useful where a family wants to build investments over the long term while retaining flexibility around who receives income and capital in future years.
A trust can also retain funds for investment or working-capital purposes where the deed and circumstances allow. However, retaining funds does not remove the need to deal properly with beneficiary entitlements. If a beneficiary has become entitled to an amount but the amount remains in the trust, that can create an unpaid present entitlement and other legal, accounting and tax issues.
Where a corporate beneficiary is involved, additional rules may become relevant if trust funds are made available to individuals or their associates. These arrangements should be reviewed before funds are advanced, borrowed, used privately or left outstanding.
6. Possible access to capital gains tax concessions for eligible small businesses
A discretionary trust that carries on a business, or holds certain business assets, may be able to access capital gains tax concessions if the relevant conditions are satisfied.
The concessions can be significant on a business sale, restructuring event or disposal of an active business asset. However, eligibility is highly fact-dependent and should not be assumed merely because the business is run through a trust.
The rules can involve questions such as:
– whether the trust or connected entities satisfy the relevant small business conditions
– whether the asset qualifies as an active asset
– who controls the trust for tax purposes
– whether distributions made by the trust affect the relevant participation tests
– whether additional conditions apply because the asset is an interest in another entity
– whether there are specific requirements for particular concessions.
The distribution history of a discretionary trust can be particularly important. A decision that appears sensible for annual income-tax purposes may have consequences for future capital gains tax planning.
For that reason, business owners should review their trust structure well before a proposed sale. Waiting until a buyer is found may leave little time to address issues in the deed, distribution history, asset ownership or business structure.
7. Succession and continuity for family wealth
A discretionary trust may assist with succession planning because the trust assets are held by the trustee rather than owned personally by each beneficiary in fixed proportions.
If designed carefully, the trust deed can include mechanisms for changing the trustee and transferring control of the trust. Where there is a corporate trustee, control of that company can also form part of the wider estate-planning process.
This can help a family maintain continuity of ownership and management where there is retirement, incapacity or death. It may also avoid the need to transfer every underlying trust asset each time a family member’s circumstances change.
That said, a trust deed is not a substitute for a will, enduring powers of attorney or a broader estate plan. The person with power to appoint or remove the trustee can be particularly important, and those control arrangements should be considered alongside personal estate-planning documents.
A simple example of how a trust may work
Consider a family-owned consulting business operated through a discretionary trust with a corporate trustee. The trust earns income from client work and holds equipment used in the business.
At the end of the income year, the trustee reviews the trust deed, the year’s financial results, the eligible beneficiaries and their circumstances. It then obtains tax advice and makes a resolution to distribute income in a way that is permitted by the deed and commercially appropriate for the family.
The trustee also keeps proper records, prepares financial statements, reports the distributions in the trust tax return and ensures beneficiaries understand the amounts they are entitled to receive.
If the business later plans to sell an asset or expand into a new venture, the owners can review whether the existing trust remains suitable. They may decide to retain the structure, establish a separate entity for a new activity or change the way future assets are owned.
The benefit comes from deliberate planning and administration, not from using a trust as a one-size-fits-all structure.
Important responsibilities and common traps
A discretionary trust brings ongoing responsibilities. It needs more than a deed in a filing cabinet and an annual tax return.
Trustees should pay close attention to the following areas:
– reviewing the complete trust deed, including amendments
– confirming that proposed recipients are valid beneficiaries
– making distribution resolutions on time and in accordance with the deed
– clearly dealing with income, capital gains and franked distributions where relevant
– keeping financial records that support the trustee’s decisions
– lodging trust tax returns and activity statements where required
– managing unpaid beneficiary entitlements appropriately
– considering whether trust losses can be carried forward under the applicable rules
– reviewing any loans, private use of trust funds or related-party transactions
– checking state and territory duty, land tax and payroll tax consequences before acquiring property or changing a structure.
A trust cannot distribute an overall tax loss to beneficiaries for them to offset against their personal income. Depending on the circumstances, losses may instead remain in the trust for potential use against future trust income, subject to the applicable loss rules.
Trust distribution arrangements also receive close attention from the ATO where a beneficiary is made entitled to income but another person receives the practical benefit of that income. Arrangements should have a genuine family or commercial basis and should be properly documented.
Is a discretionary trust right for you?
A discretionary trust can be a flexible structure for Australian business owners and investors who want to manage income distributions, hold assets for a family group, plan for succession or prepare for future business growth.
It is not always the right answer. The costs of establishment and administration, the complexity of the deed, the need for annual resolutions and the interaction with tax and state revenue rules all need to be weighed against the potential benefits.
The most suitable structure often depends on what you are trying to achieve now and where you expect your business, investments and family circumstances to be in the years ahead. can help you assess whether a discretionary trust fits your broader tax, bookkeeping, business and succession plans.
This article is general information only and is not personal financial or tax advice. Before establishing, changing or distributing through a trust, speak with a registered tax agent or accountant, such as, about your specific circumstances.