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A trust is a relationship between the trustee and the beneficiaries. Unlike a company, a trust generally does not pay tax on trusts as it is not a separate legal entity. Instead, tax is paid either by the beneficiaries of the trust or the trustee.

In this article, we look at:

  • when a beneficiary must pay tax on trusts;
  • when a trustee must pay tax;
  • whether the capital gains tax (CGT) discount is available; and
  • how to account for tax losses.

1. Tax Paid By Trust Beneficiaries

Usually, beneficiaries of a trust pay tax on their share of trust income to which they are:

  • presently entitled; or
  • specifically entitled.

Accordingly, when the beneficiary prepares their tax return, they must include any trust distributions as part of their income. The taxation rate on these distributions is:

  • the marginal tax rates, for individuals; or
  • a flat rate of 30% for corporate beneficiaries.

Present Entitlement

A beneficiary is ‘presently entitled’ to trust income if they have a right to demand payment from the trustee at the end of an income year. Whether this right exists depends on the:

  • type of trust; and
  • terms of the trust deed.

For example, a beneficiary in a unit trust may have a fixed pro rata entitlement to all of the income and capital of the trust.  On the other hand, a beneficiary of a discretionary trust has no right to any income or capital of the trust, unless and until the trustee exercises its discretion in their favour in a particular year.

Note: Present entitlement is different to physical distribution. Beneficiaries may be taxed on a present entitlement even if nothing was physically distributed to them.

Specific Entitlement

A beneficiary is specifically entitled to a capital gain received by a trust if:

  • the trust documents clearly record the entitlement; and
  • the beneficiary expects to receive a net financial benefit in relation to the capital gain.

Note: A beneficiary can be specifically entitled to a capital gain of a trust even if they do not receive any of the trust’s income.

2. Tax Paid by Trustees

If there is trust income to which no beneficiary is entitled, then the trustee must pay tax on that income.

For example, this may occur if the trustee decides to accumulate income. Trustees must pay tax on this undistributed income at the highest marginal rate of 45%. This rule is in place to make sure the trust is used for the purpose it was made (i.e. to distribute income to beneficiaries).

The trustee must also pay tax on trusts where trust income is distributed to minors of non-Australian residents.

3. The CGT Discount

The trust’s net income includes capital gains. These flow out to the relevant beneficiaries either:

  1. proportionately (if presently entitled); or
  2. in accordance with the specific entitlement rules.

Trusts may be eligible for a 50% CGT discount, depending on whether the beneficiary is an individual or a company. Individuals are generally eligible for the CGT discount in relation to capital gains incurred on properties or assets that they have held for more than 12 months (with certain exemptions). On the other hand, companies do not qualify for this discount at all.

However, note that the CGT discount is not available to a trustee when the trustee is taxed on any undistributed income sourced from capital gains.

4. Accounting for Income Losses

Generally, beneficiaries cannot offset their income using tax losses incurred by a trust. This is regardless of whether the source is a capital loss or not. The trustee, however, may carry forward such losses and offset them against future trust income. 

Note: A trust does have to lodge a tax return, but primarily for data-matching purposes. The Australian Taxation Office (ATO) cross-checks the distributions disclosed in the trust return against the trust distributions stated by the relevant beneficiaries in their tax return.

LegalVision cannot provide legal assistance with this topic. We recommend you contact your local law society.

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