A new option for existing discretionary trusts
The Federal Government has announced further changes to its proposed taxation of discretionary trusts, providing an additional option for existing trusts to avoid the proposed 30% minimum income tax without needing to restructure.
Under the changes, discretionary trusts in existence as at 1 July 2028 will be able to elect into a new regime under which they can choose to make fixed distributions to pre-nominated beneficiaries. Where the election applies and distributions are made consistently with it, the proposed 30% minimum tax will not apply. This represents an important development for families and businesses currently operating through discretionary trust structures, particularly given concerns about the potential tax, duty and other costs associated with restructuring.
How will the new election work?
Under the proposed regime, trustees of discretionary trusts in existence as at 1 July 2028 will be able to make a one-off election during the 2028–29 income year to nominate individuals and eligible entities to receive fixed percentage distributions of the trust’s income and capital. There will be no limit on the number of beneficiaries who can be nominated.
Importantly, the election is not made afresh each financial year. Once made, the nominated beneficiaries and their respective fixed percentage entitlements to the trust’s income and capital will generally continue to apply in each subsequent income year while the election remains in force. This means that trustees will not be able to choose different beneficiaries, or different percentage entitlements, from year to year. The nominated beneficiaries and their fixed percentage entitlements can generally only be varied in limited circumstances. These include where a nominated beneficiary dies or, in certain circumstances, where two nominated beneficiaries experience a relationship breakdown. Where a nominated beneficiary dies, their fixed entitlement does not automatically pass to their estate. Rather, the trustee may reallocate the deceased beneficiary’s share, subject to certain requirements, including that an individual receiving the reallocated share must be a beneficiary of the deceased beneficiary’s estate.
The trustee/s will then make distributions to the nominated beneficiaries in accordance with their fixed percentage entitlements. The beneficiary receiving the distribution will pay tax at their ordinary marginal tax rate or, where applicable, the relevant company tax rate. Importantly, the election is intended to operate without requiring the trust to restructure and is not expected to trigger state or territory stamp duty. This provides an alternative for trusts that may otherwise have considered restructuring in response to the proposed 30% minimum income tax.
What happens to the flexibility of a discretionary trust?
While the new election provides an alternative to restructuring, it comes with important limitations. Once beneficiaries and their fixed percentage entitlements have been nominated, they generally cannot be changed. Limited exceptions apply, including where a nominated beneficiary dies or where there is a relevant relationship breakdown. Where a nominated beneficiary dies, their fixed percentage may be reallocated, including to existing nominated beneficiaries or other eligible beneficiaries, although any new beneficiary receiving that allocation must be a beneficiary of the deceased beneficiary’s estate.
The trustee can voluntarily revoke the election at any time. The election will also be automatically revoked if, among other circumstances, the trustee fails to make distributions in accordance with the nominated fixed entitlements. Importantly, once the election is revoked, whether voluntarily or automatically, it cannot be reinstated or made again for that trust. A failure to comply with the election would result in the trustee being taxed at the top marginal tax rate plus the Medicare levy for the relevant income year, with the trust then becoming subject to the proposed minimum tax regime in future income years.
What about testamentary trusts?
Importantly for estate planning, the Government has already confirmed that discretionary testamentary trusts will be exempt from the proposed minimum tax, subject to some matters yet to be clarified, such as if the testamentary trust beneficiaries need to be confined to individuals and charities. This remains a significant distinction between discretionary trusts established during a person’s lifetime and discretionary testamentary trusts established under a Will. Accordingly, the latest announcement does not alter the position previously communicated in relation to testamentary trusts.
Charities and other tax-exempt entities
The Government has also announced further exemptions relating to charitable and community organisations. Charitable trusts and distributions from trusts to registered charities and deductible gift recipients are proposed to be excluded from the minimum tax. The exclusion will also extend to distributions to other income-tax-exempt entities, such as sporting clubs, although those distributions will be subject to a cap which is yet to be determined following consultation.
What does this mean for existing discretionary trusts?
The latest announcement provides greater flexibility for existing discretionary trusts than what was contemplated under the Government’s original proposal. For some trusts, electing into the new fixed-distribution regime may provide an alternative to restructuring and the associated costs and potential stamp duty consequences. For others, however, the restrictions associated with fixing distributions between nominated beneficiaries may make the election less suitable.
Potential issues for trustees and beneficiaries
While the election may provide a means of avoiding the 30% minimum tax without restructuring, trustees will need to carefully consider the consequences of fixing beneficiaries’ entitlements.
Asset protection
One of the traditional advantages of a discretionary trust is that a beneficiary generally does not have a fixed proprietary entitlement to the assets of the trust. This can provide a degree of protection where a beneficiary is exposed to personal creditors or involved in family law proceedings. By requiring income and capital to be distributed according to predetermined fixed percentages, the proposed regime may dilute some of the asset-protection benefits ordinarily associated with discretionary trusts. The implications will need to be considered carefully, particularly where nominated beneficiaries are exposed to creditor risk, relationship breakdown or other personal financial risks.
Trustee decision-making and potential disputes
The proposed regime also raises important questions regarding the trustee’s duties when deciding whether to make the election and determining which beneficiaries should receive fixed entitlements. The Victorian Court of Appeal’s decision in Owies v JJE Nominees Pty Ltd [2022] VSCA 142 highlighted the requirement for trustees of discretionary trusts to give real and genuine consideration to the circumstances and interests of beneficiaries when exercising their discretionary powers. It remains to be seen whether the introduction of the proposed election will lead to increased challenges by beneficiaries who are excluded from an election, or who consider that the trustee has failed to properly consider their interests when determining the nominated beneficiaries and their respective percentages. For trustees, this may make the process by which an election is considered and made particularly important, including ensuring that the trustee has properly considered the terms and purposes of the trust, the circumstances of relevant beneficiaries and its broader duties before making an election.
What about trusts set up post 1 July 2028?
These trusts will be subject to the proposed minimum 30% income tax.
Importantly, the proposed changes are not yet law. The draft legislation is currently open for consultation until 18 September 2026, with the Government indicating that it intends to pass the legislation before Christmas. Trustees should therefore avoid making significant changes to existing structures solely in response to the proposed reforms without first obtaining appropriate legal and taxation advice.