Minimum tax on discretionary trusts: What the exposure draft means for taxpayers

Treasury has released exposure draft legislation for the proposed 30 per cent minimum tax on certain discretionary trusts. The detail now points to immediate review work for taxpayers, even though the measure is not yet law.

The package gives taxpayers the clearest view so far of how the measure may operate from 1 July 2028 and what choices may need to be made before then.

For the vast majority of private family-owned businesses and investment groups which utilise discretionary trusts, these proposed changes raise fundamental questions about structure. In particular, whether the current trust structure should remain as it is under the minimum 30 per cent tax rule, whether an election into the new exclusion regime could be worth the risks, or whether a restructure should be undertaken before the transitional roll-over window closes.

Why this matters

Discretionary trusts are widely used in Australian family-owned groups for asset protection, succession planning and commercial flexibility. A key element of that commercial flexibility is that they allow income to be distributed to different beneficiaries from year to year, with different tax outcomes arising as a result. The Government's policy objective is to set a minimum tax rate on most classes of income derived by discretionary trusts, thereby removing some of the tax benefits available by changing distribution patterns from year to year.

Most affected will be discretionary trusts that distribute income to companies. Such distributions will suffer double taxation under the proposed measures, leading to draconian tax rates that are clearly intended to prevent such distributions being made. Additionally, groups that rely on the ability to distribute income derived by a discretionary trust to a beneficiary with losses, to offset one against the other, will be badly affected.

As a result, trustees will need to understand whether their trust is within scope, identify what income may be excluded, and consider the tax and non-tax consequences of any structural response to the proposed measures.

What the exposure draft would do

At a high level, the draft imposes tax on the taxable income derived by discretionary trusts at a rate of 30 per cent. The trustee is to be assessed and liable to pay this tax.

When the trustee distributes the income of the trust, non-corporate beneficiaries will generally receive a non-refundable tax offset of 30 per cent of the taxable income distributed to them. This effectively gives the non-corporate beneficiary a credit for minimum tax paid by the trustee in respect of their share of the trust income. Corporate beneficiaries will not receive that credit. As such, income distributed by discretionary trusts to companies will suffer a tax rate of at least 55 per cent to 30 per cent in the hands of the trust, and a further 25 per cent or 30 per cent in the hands of the company.

Because the credit is non-refundable, a non-corporate beneficiary with losses who receives a distribution of income from a discretionary trust will have those losses recouped by the distributed income but will not receive a refund of the tax already paid by the trust.

Discretionary trusts which fail to distribute their income in a particular year will continue to suffer at a tax rate of 47 per cent as is currently the case.

The proposed tax would apply to income years starting on or after 1 July 2028. The draft uses the concept of a 'minimum tax trust' and a 'minimum tax income' amount. This is important because the proposal does not simply label every trust or every trust receipt as subject to the minimum tax.

Trusts and income proposed to be outside scope

The draft materials indicate the minimum tax would not apply to fixed trusts, special disability trusts, deceased estates, complying superannuation entities and other kinds of trusts that may be determined by legislative instrument. Other trusts, including widely held, managed investment, attribution managed investment, bare, employee share, worker entitlement funds and charitable trusts, are expected to be outside scope because of their existing legal or tax character, the proposed fixed trust definition, or their exempt status.

Certain income would also be excluded from minimum tax income. This includes taxable primary production income, certain income relating to vulnerable minors, amounts subject to non-resident withholding tax, and income of discretionary testamentary trusts that meet the relevant conditions.

The testamentary trust carve-out is subject to integrity limits. Income from property injected after 7.30pm on 12 May 2026 and unrelated to the deceased estate is proposed to be subject to the minimum tax. For discretionary testamentary trusts established on or after 1 July 2028, the exclusion would be limited to cases where all beneficiaries of the trust are either individuals or exempt entities.

A broader fixed trust definition

The new fixed trust definition may be one of the most important technical features of the draft. It has been an ongoing concern that relying on the existing fixed trust definition could make the minimum tax broader than intended.

Under the draft, a trust would be a fixed trust if its beneficiaries have fixed entitlements to all income and capital of the trust, or if there are no material discretionary elements affecting beneficiaries' entitlements or rights. The explanatory materials state that some residual trustee discretion should not necessarily prevent a trust from being fixed, provided it does not materially affect beneficiaries' entitlements or rights.

For taxpayers, this means the trust deed, governance documents and practical powers will matter and should be reviewed. Unit trusts and other commercial trusts should not assume they are fixed merely because they have units. Equally, they should not assume they will be captured as a discretionary trust solely because the deed contains administrative powers.

Electing in to a fixed distribution model

The exposure draft introduces an excluded election trust (EET) regime for discretionary trusts that exist on 1 July 2028 and would otherwise be subject to the minimum tax. The election would be made in the 2028-29 income year, or for substituted accounting period trusts, the first income year beginning after 1 July 2028 and cannot be made later.

To use the election, the trustee would nominate beneficiaries and fixed proportions of income and capital. Those proportions must total 100 per cent, and the income and capital proportion for each beneficiary must be the same. The trustee would then need to make beneficiaries presently entitled in accordance with the nomination each year.

This pathway has been proposed to alleviate the impacts of the proposed measures on groups which want to avoid a legal restructure and potential state or territory duty costs. However, it is a significant commercial choice. It generally cannot be varied except where a nominated beneficiary dies or there is a relationship breakdown. A trustee also cannot both elect in to this regime and choose the transitional roll-over relief for the same trust.

If the election is voluntarily revoked, the trust would be subject to the minimum tax in later income years. If it is automatically revoked because the trustee does not distribute consistently with the nomination, the consequences are more severe: beneficiaries are treated as not presently entitled for that income year and the trustee is liable to tax on all income at the 47 per cent rate. The minimum tax would then apply in later years.

Serious concerns have been raised regarding whether this election will be effective to avoid state or territory duty costs and whether by making the election the trustee will be unlawfully fettering its discretion to deal with income in accordance with its powers. There are likely to be significant further developments on both these fronts.

Transitional roll-over relief

The draft roll-over would be available for a three-year period from 1 July 2027 to 30 June 2030. Its purpose is to defer direct income tax consequences that would otherwise arise when relevant assets are transferred out of a minimum tax trust into another structure, such as a company or fixed trust.

There are important limits on the rollover, however. In general, all required assets of the trust must be transferred to one eligible transferee during the transitional period. There are some exclusions, including for primary production assets. If all the required assets are not transferred by 30 June 2030, relief would not be available for any assets transferred as part of the restructure.

The roll-over does not remove all tax and transaction costs. The explanatory materials state that GST, fringe benefits tax, state and territory duties and other taxes continue to apply according to their ordinary operation. The roll-over is also a deferral, not a permanent exemption. The transferee generally inherits the transferor's tax cost and relevant tax history.

Franking credits and beneficiary offsets

The draft confirms that trustees receiving franked dividends would use franking credits when paying the minimum tax. If excess franking credits remain after the trustee has offset its income tax liabilities, the trustee may be entitled to a refund for franking credits associated with minimum tax income. However, the franking credits will no longer pass to the beneficiaries of the trust.

Non-corporate beneficiaries would generally receive a non-refundable tax offset to avoid double taxation where the trustee has paid minimum tax on their share of minimum tax income. Corporate beneficiaries would not receive that offset.

What this could mean for taxpayers

Once finalised, the proposed legislation will create a planning window. However, taxpayers should not rush to restructure before the final form of the legislation is known. Taxpayers should first identify which trusts are potentially minimum tax trusts and whether the proposed exclusions apply. This will require deed review, beneficiary mapping, income characterisation and modelling of effective tax outcomes.

Family groups using corporate beneficiaries or with loss entities should pay particular attention to the double taxation consequences of the proposals.

Groups considering the excluded election trust pathway should test whether they can live with fixed annual income and capital proportions over time. This is not just a tax question. It may affect succession planning, family governance, financing, estate planning and the way profits are reinvested.

Groups considering the roll-over should model the full transaction, including direct income tax relief, duty, GST, financing, asset protection, commercial contracts, accounting, corporate law and future exit consequences.

Recommended next steps

Taxpayers should consider taking the following steps before the draft rules are finalised:

• Identify potentially affected trusts in the group
• Review trust deeds and governance documents to test whether a trust may be a fixed trust under the proposed definition
• Identify income streams that may be excluded, including primary production income, charitable or deductible gift recipient distributions, vulnerable minor-related income and non-resident withholding tax income
• Model the after-tax position if the trust remains in place and the minimum tax applies from 1 July 2028. Particular consideration should be given to the recoupment of losses and the use of corporate beneficiaries.
• Compare the excluded election trust pathway with a restructure, including tax, duty, asset protection, succession and commercial consequences. Any restructures should only be undertaken once the final form of the measures is known.

BDO insight

The exposure draft provides a superficially more flexible regime than the Budget announcement, particularly the election option and the broader fixed trust definition. However, the key concerns for private groups to do with the double taxation of distributions to corporate beneficiaries and loss entities remain.

We recommend that private groups that contain discretionary trusts should model the potential outcomes of the measures and be prepared to implement restructures once their final form is known.
Taxpayers who are required to make investment structuring decisions before the legislation is passed by parliament will need to find a structure that works for them where the exact detail of the provisions is not yet known. Those groups are in the hardest position and should engage with their advisers as early as possible in the investment timeline.

How BDO can help

BDO's tax specialists work with privately owned businesses, family groups, trustees and investors on complex tax and structuring matters. To discuss the potential implications of the proposed changes, speak with your local adviser or learn more about our tax services.