Discretionary Trust: How It Works in Australia

A discretionary trust lets its trustee choose which eligible beneficiaries receive income or capital, and how much each receives, within the trust deed. The deed determines the choices available. A family connection or trading activity alone does not establish those powers.

What Makes a Trust Discretionary

A trust is discretionary when its trustee can choose beneficiaries or their shares within the deed’s rules. Being named as a potential beneficiary does not automatically give someone a fixed percentage of each year’s income.

The Queensland Public Trustee’s explanation distinguishes discretionary distributions from fixed entitlements. For your client, start with the executed deed and every valid variation. Identify the powers over income separately from the powers over capital.

A trust is a legal relationship in which a trustee holds property for beneficiaries. A company is a separate legal person. A company can be the trustee without turning the trust into a company.

Trading, investment and family describe what a trust does or whom it benefits. A discretionary investment trust and a discretionary trading trust can have similar distribution powers while earning income differently.

The Trustee, Beneficiaries and Trust Assets

The trustee holds legal title to trust assets and administers them under the deed and trust law. Beneficiaries have the rights the arrangement gives them. An appointor’s power over the trustee is a separate role.

Party Relationship Diagram

This hypothetical relationship diagram shows the roles under a deed that gives the appointor power to replace the trustee.

Settlor
  | transfers initial trust property
  v
Trustee <--- Appointor
  |         can replace trustee
  |
  +-- holds legal title --> Trust assets
  |
  +-- decides distributions --> Beneficiaries
                               within deed classes
                               may receive benefits

The settlor supplies the initial property that establishes the trust. The trustee makes the ongoing decisions. An appointor exists only where the deed provides for that office, and its powers depend on the deed.

The beneficiary classes identify who can receive income or capital. They can include relatives of a named beneficiary and eligible related entities. Exclusions matter too. Someone who falls outside the relevant class cannot receive an appointment merely because the trustee wants to include them.

A beneficiary’s potential benefit is different from legal ownership of each trust asset. A trust fund means the property held on trust. A bank account used for the trust holds part of that property. Neither is a separately incorporated company.

A Corporate Trustee Running a Business

In a hypothetical trading trust, a private company is the trustee of a discretionary trust operating a repair business. The company enters customer contracts in its trustee capacity and holds the business assets on trust. Its directors make decisions for the company, including the trustee’s distribution decisions under the deed.

The trust name identifies the arrangement. It does not sign contracts by itself. Keep the corporate trustee’s own assets and accounts distinct from property it holds for the trust. Business.gov.au’s trust guide explains the trustee’s role in holding and running a business for beneficiaries.

Discretionary, Fixed and Unit Trusts

The difference between discretionary and fixed trusts is whether beneficiary entitlements are already fixed or depend on an exercise of discretion. Unit holdings describe how interests are recorded, but the rights attached to those units still need examination.

Compare the Entitlement Rules

Arrangement	How benefits are determined	What to inspect
Discretionary trust	Trustee chooses eligible recipients or amounts	Income and capital powers, beneficiary classes and defaults
Fixed trust	Beneficiaries have fixed entitlements	Whether rights to income and capital can be defeated
Unit trust	Units carry rights under the deed	Unit classes, distribution rights and amendment powers
Bare trust	Trustee holds property for identified beneficiaries with limited active duties	Beneficial ownership and the trustee’s limited duties
Hybrid or mixed trust	Some rights are fixed and others discretionary	Each income and capital entitlement separately

The Board of Taxation’s bare-trust review explains why a bare-trust label alone does not establish tax treatment. Inspect the beneficiary’s actual rights.

For the trust-loss rules, a fixed entitlement requires a vested and indefeasible interest. That means an existing interest which cannot be taken away under the relevant powers. The statutory fixed-entitlement test includes specific rules and a Commissioner’s discretion.

A unit trust label therefore does not prove fixed-trust status for every tax provision. For example, a power to alter beneficiary rights can affect the analysis. Apply the definition used by the particular tax rule.

Irrevocable describes limits on revoking a trust. Discretionary describes choices over benefits. An irrevocable trust can still give its trustee distribution discretion.

A self-managed super fund (SMSF) has regulated purposes and benefit-payment rules. Its trustee cannot allocate retirement savings among family members as an ordinary discretionary family trustee might allocate income. The ATO’s sole purpose test guidance explains the retirement-benefit purpose.

Family and Investment Trust Labels

Family trust commonly means a discretionary trust used for a family. For the trust-loss provisions, family-trust status instead depends on a family trust election being in force. A family-style deed alone does not establish that tax status.

A family trust election specifies the individual whose family group is relevant. Distributions outside that group can trigger family trust distribution tax, even if the recipient is eligible under the deed. Deed eligibility and election consequences need separate checks.

An investment trust might hold shares or property. A trading trust might operate a business. The trustee acquires and holds the property in its trustee capacity, subject to the deed’s powers. Those activities do not determine whether beneficiary entitlements are fixed.

The Australian Business Register’s Discretionary Services Management Trust category describes a discretionary trust whose main income comes from service or management activities. It is an entity-type label, not the name of a service provider.

If your client is choosing an arrangement, the family trust setup guide covers establishment. For an existing client, use the trust deed to establish the powers actually available before discussing distributions.

How Trust Income is Taxed

Trust taxation generally connects a beneficiary’s present entitlement to trust income with an assessment on the corresponding share of taxable net income. These are different amounts, and cash payment is a separate event.

Trust income is determined under the deed and trust law. Taxable net income is calculated under tax law. A resident adult beneficiary who is presently entitled and under no legal disability generally includes the relevant share in assessable income. Division 6 of the income tax law also provides for trustee assessments.

Retained income with no beneficiary presently entitled generally leads to a trustee assessment. Minors and non-residents can also require the trustee to be assessed. Minors’ income rules and exceptions, residency and income source affect the result. There is no single discretionary trust tax rate for every case.

A valid entitlement can exist before cash is paid. Conversely, cash left in the trust’s bank account does not prove that nobody is entitled to it. Record the legal entitlement and later payment separately. The annual trust resolution guide covers the decision and its records.

Capital gains and franked distributions have additional rules. Section 100A can also alter the result where a beneficiary’s entitlement forms part of a reimbursement agreement. The ATO’s section 100A ruling explains the ordinary family or commercial dealing exception.

Corporate Beneficiaries and Bucket Companies

A bucket company is an informal name for a corporate beneficiary used to receive trust income. The corporate trustee performs a different role, although both can exist in a client group.

Suppose a valid decision makes a resident company entitled to $20,000 of trust income. Assume its corresponding taxable share is also $20,000. The company accounts for that taxable share under the company tax rules. If unpaid, the entitlement remains a separate amount to analyse.

The High Court’s decision on unpaid entitlements rejects treating mere non-demand of an entitlement as a Division 7A loan. Examine any actual loan or subsequent dealing separately. Trustee benefits provided to company shareholders or their associates can also engage Subdivision EA.

Apply the Rules to a Client Example

A hypothetical discretionary investment trust holds an interest-bearing investment through its corporate trustee. Its deed permits income appointments to two adult resident family beneficiaries. Neither has a fixed annual share.

Assume distributable income under the deed and taxable net income after the tax reconciliation both equal $60,000 after expenses. There are no capital gains, franked distributions or reimbursement arrangements in this example.

Before the deed’s decision deadline, the trustee validly appoints 60% to one beneficiary and 40% to the other. Both are under no legal disability. Under the assumed facts, the beneficiaries include $36,000 and $24,000 respectively in assessable income. Their personal circumstances determine the tax payable.

If the trustee pays only $10,000 to the first beneficiary, that payment does not reduce the $36,000 taxable share. The remaining $26,000 entitlement must be recorded and reconciled separately.

For the return, retain the executed deed and variations, the income calculation, tax reconciliation and trustee decision. Match each beneficiary’s entitlement with their distribution statement and record payments against it. A spreadsheet entry alone does not establish that the trustee exercised a power validly.

A discretionary label also does not satisfy the significant individual test for small-business capital gains tax (CGT) concessions. The participation rules require at least 20% participation for a significant individual. Relevant income and capital distributions affect the calculation, including the lower percentage where both apply. Assess the particular concession’s other conditions separately.

Separate Existing Rules From Proposed Changes

The proposed minimum tax on discretionary trusts is separate from the existing entitlement and assessment rules explained here. The Government has introduced reform bills, including an election intended to exclude qualifying trusts while they distribute to pre-nominated beneficiaries as nominated.

The Treasury explanation of the introduced legislation describes the proposal and exclusions. Introduction of a bill does not make it operative law. The fixed-distribution election is also distinct from an existing family trust election.

Use the discretionary trust tax changes guide for the reform’s status, eligibility and planning consequences. Keep your client’s current deed powers and annual entitlement work separate from decisions about responding to the proposed regime.