In brief
This year’s budget contained significant changes to the taxation of discretionary trusts, headlined by a 30% minimum tax on trust taxable income.
Key takeaways
The Government has announced a 30% minimum tax on discretionary trusts, effective from 1 July 2028. This is a significant change to the general approach to trust taxation, which has to date generally treated discretionary trusts as flow-through vehicles and instead taxed the income at the level of the Australian beneficiaries at their applicable tax rates.
The measures are said to address income splitting, where discretionary trusts split income among beneficiaries who are subject to a lower income tax rate, thereby reducing overall tax on the income.
The proposed changes will provide non-corporate beneficiaries with non-refundable tax credits for tax paid at the trustee level. The exclusion of corporate beneficiaries from receiving this tax credit could spell the end of bucket companies.
Certain limited types of trusts and types of income will be excluded.
Rollover relief will be available from 1 July 2027 for three years for those who wish to transition from a discretionary trust structure into other entity types, such as companies or fixed trusts.
Draft legislation has not been released at this time and is expected to be subject to consultation with stakeholders before enactment.
Minimum tax on discretionary trusts
30% minimum tax
From 1 July 2028, trustees of discretionary trusts will be subject to a 30% minimum tax on the trust’s taxable income. This is a significant departure from the current default approach to trust taxation, which is to treat the trust as a flow-through vehicle and to instead tax the beneficiaries on their share of income at their applicable tax rates.
Under the current approach to trust taxation, trustees are subject to tax only in limited circumstances (for example, where a presently entitled beneficiary is subject to a legal disability). The Government’s proposal will expand trustee-level taxation to discretionary trusts generally, subject to the exclusions and relief outlined below.
The Government’s stated objective is to tax income earned through a discretionary trust at the same 30% rate that salary earners pay on income earned between AUD 45,001 and AUD 135,000, thereby improving “fairness and sustainability of the tax system”. However, in so doing, the Government’s proposal will also effectively bring the taxation of discretionary trusts and their beneficiaries closer to the taxation of companies and their shareholders – that is, by taxing both the ‘entity’ and its participants, with relief to address potential economic double taxation in limited circumstances. However, unlike franking credits for shareholders in a company, the relief from double taxation for beneficiaries is (a) not able to generate a tax refund and (b) not available at all for corporate beneficiaries.
Relief for tax paid at the trustee level
Non-corporate beneficiaries will receive non-refundable tax credits for tax paid by the trustee. In other words, where a non-corporate beneficiary is subject to a tax rate lower than 30%, it will not be eligible for a refund of the excess tax paid at the trustee level. This is consistent with the stated policy objective to introduce a minimum tax on discretionary trusts, but represents a departure from the general approach where trustee-level taxation currently applies (for example, where a presently entitled beneficiary is subject to a legal disability), which is to provide beneficiaries with a refund for excess tax paid by the trustee.
The Government’s announcement specifically excludes corporate beneficiaries from receiving non-refundable tax credits. This is said to prevent corporate beneficiaries from converting those tax credits into franking credits (i.e. refundable credits for corporate income tax paid that can be passed onto shareholders) to circumvent the minimum tax. But denial of the credit for corporate beneficiaries could also lead to double taxation of the same income at both the trust level and the company level. If this is not addressed in the legislation, this measure will make corporate beneficiaries unattractive and may spell the end of the use of corporate beneficiaries (often referred to as bucket companies).
Exclusions
The Government’s announcement foreshadows that the minimum tax will not apply to certain types of trust, such as fixed trusts, widely held trusts, complying superannuation funds, special disability trusts, deceased estates and charitable trusts. Moreover, the minimum tax is not expected to apply to certain types of income, such as primary production income, certain income relating to vulnerable minors, income to which non-resident withholding tax and income from assets of discretionary testamentary trusts existing at announcement.
Rollover relief
To encourage taxpayers to transition out of discretionary trust structures, the Government has announced “expanded rollover relief” for restructures out of discretionary trusts to other entity types, such as companies or fixed trusts. The rollover relief will apply from 1 July 2027 and will be available for three years.
A copy of the Federal Budget papers can be found here.
Jeremy Hyman, Head of Communications, and Sky Friend, Business Development Consultant, have contributed to this legal update.