Discretionary (family) trusts have long been a favoured structure for Australian families and business owners, offering flexibility and asset protection. But with rising scrutiny from the Australian Tax Office (ATO) and increasing compliance complexity, many are asking, are they still worth it?
The ATO has intensified its focus on trust distributions, beneficiary entitlements, and access to tax credits, often applying narrower legal interpretations to established practices. This growing attention is partly due to the significant economic footprint of trusts (over $60 billion distributed to 1.7 million recipients).
While discretionary trusts remain useful wealth vehicles, the administrative burden and compliance costs are undeniably increasing.
Some of the key issues arising from discretionary trusts currently are:
Family trust elections (FTEs)
To access tax benefits like franking credits or carryforward losses, a discretionary trust must elect to be a family trust (FTE), nominating a ‘test individual’ (typically a parent or grandparent). Only members of the test individual’s family group can receive income without triggering the 47% Family Trust Distribution Tax (FTDT).
We’re seeing increased ATO scrutiny around FTDT, especially during succession planning. For example, if a trust with ‘Dad’ as the test individual distributes franked dividends to a company owned by his daughter’s trust (with her as the test individual), FTDT applies - resulting in a $47,000 tax on an otherwise ‘tax-free’ $100,000 distribution.
The ATO also considers broader definitions of “distribution,” including loans, credits, and property transfers. FTEs require careful planning, particularly during intergenerational wealth transfers.
1. Corporate beneficiaries and the 45-day holding rule
The ATO is reviewing whether newly incorporated corporate beneficiaries meet the 45-day holding rule for franking credit eligibility. This rule requires shares to be held ‘at risk’ for 45 days, but if the beneficiary company is created after the dividend is paid, eligibility is questioned. Official guidance from the ATO is still pending.
2. Section 100A: reimbursement agreements
It has been a few years since the ATO issued its guidance on reimbursement agreements. These rules require the beneficiary to receive the ultimate benefit of any appointed trust entitlement. The ATO continues to audit under this provision, despite mixed outcomes in court. Its 2022 public guidance remains in effect.
The Bendel Case
The Bendel Case has received a lot of attention as the Full Federal Court disagreed with the ATO’s long-held view that unpaid entitlements with private companies fall within the definition of loan in Division 7A. The High Court has granted the ATO leave to appeal and the ATO will continue to apply the existing views while the outcome is pending, Regardless of the outcome, the ATO has signalled it may use other provisions to achieve similar tax results.
What changes are being considered?
Treasury and government policy groups are actively reviewing discretionary trusts as part of broader tax reform initiatives. Some theories of what might be included in a potential reform include:
• Imposing a flat tax rate of 24-30 per cent on trust distributions
• Treating trusts like companies for tax purposes
• Reducing the capital gain tax discount available
• Introducing a dual income tax system, where labour income is taxed progressively and passive income is taxed at a flat rate.
So, are trusts still worth it?
Despite the growing attention and complexity, discretionary trusts remain valuable where they are managed diligently and sufficient investment is made in their administration.
Although the changes remain to be seen, we expect the legal flexibility will continue to outweigh the tax complexity. This all needs to be considered and appropriate advice is required throughout each stage of a trust’s lifecycle. Trusts should not be set up just because someone said it was a good idea.
Peter Bardos is a tax partner at HLB Mann Judd, Sydney. This article is for general information only. It should not be accepted as authoritative advice and any person wishing to act upon the material should obtain properly considered advice which will take into account their own specific circumstances.