Summary
- Trusts in Australia are not taxed as separate entities; instead, the trustee distributes income to beneficiaries, who are then taxed at their individual rates.
- Where no beneficiary is entitled to trust income, the trustee is taxed at the highest marginal rate of 45%.
- Discretionary trusts offer flexibility in distributing income, which can be used to manage the overall tax burden across beneficiaries.
- This article is a plain-English guide to how trust taxation is calculated in Australia, written for business owners and operators considering or currently using a trust structure.
- The content has been produced by LegalVision, a commercial law firm that specialises in advising clients on trust structures and business taxation.
Tips for Businesses
Identify all beneficiaries and their marginal tax rates before each distribution. Ensure the trustee makes a formal resolution before the end of each financial year. Keep accurate records of all distributions. Review your trust deed regularly to confirm it permits the distributions you intend to make.
A trust is not a separate legal entity but rather a legal relationship whereby a person or company (the trustee) agrees to hold certain assets on behalf of (and usually for the benefit of) certain persons(the beneficiaries). Because a trust is not a separate legal entity, the trust itself does not pay tax. Instead, the tax on income generated by a trust structure is paid either by the beneficiaries or the trustee.
In this article, we look at:
- when a beneficiary must pay tax on trust assets and income;
- when a trustee must pay tax;
- whether the capital gains tax (CGT) discount is available for certain transactions in which the trustee is a party; and
- how to account for tax losses.
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1. Tax Paid By Trust Beneficiaries
Usually, beneficiaries of a trust pay tax on their share of trust income to which they are made “presently entitled”.
Accordingly, when the beneficiary prepares their tax return, they must include any trust distributions as part of their income. It is important to remember that beneficiaries must declare all trust income they are presently entitled to, even if the beneficiary hasn’t received that money yet. The taxation rate on these distributions is:
- the marginal tax rates for individuals; or
- a flat rate of 30% for corporate beneficiaries (or 25% for base rate corporates with less than $50 million of annual aggregated turnover).
Special rules apply if the beneficiary is under 18 years old (i.e., a minor). Unless certain exceptions apply, generally, the tax rate that applies to distributions to minors is the highest marginal rate, being 47%. A relevant exemption is where the applicable trust estate is a testamentary trust.
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 the beneficiary’s favour in a particular year. A trustee will generally exercise this discretion by passing a resolution that states the present entitlement for each beneficiary for that financial year. This resolution must be passed before the end of the financial year. Otherwise, the trustee may have to pay the tax.
Special Rules for Capital Gains and Dividends: Specific Entitlement
A beneficiary is specifically entitled to a capital gain or a franked distribution received by a trust if:
- the trust documents clearly record the beneficiary’s entitlement in its character as an amount referable to the capital gain or franked distribution; and
- the beneficiary expects to receive a net financial benefit in relation to the capital gain or franked distribution.
A trustee can also make a beneficiary specifically entitled to a capital gain or a franked dividend by resolving it within a trustee resolution. In doing so, the trustee effectively “passes through” the characteristics of the capital gain or franked dividend to the beneficiary. This means that, using a distributed capital gain as an example, the beneficiary may have the benefit of being able to treat that amount as capital rather than income, meaning specific discounts and concessions may be available that are not available for income receipts. If a trustee fails to make a beneficiary entitled explicitly to these amounts, then the amounts are distributed in accordance with the present entitlements.
2. Tax Paid by Trustees
If there is a trust income to which no beneficiary is presently entitled, the trustee must pay tax on that income.
The trustee also pays tax when trust income is distributed to minors or non-resident beneficiaries. Beneficiaries must declare their share of the trust’s income in their tax return. They can claim a credit for the tax paid by the trustee.
3. The CGT Discount
The trust’s net income includes capital gains. These flow out to the relevant beneficiaries in accordance with the specific entitlement rules. If no beneficiary is specifically entitled and the trustee opts not to be assessed on the gain, it is distributed based on present entitlements. Any capital gain not allocated to a beneficiary is ultimately allocated to the trustee.
Trusts are eligible for a 50% CGT discount, similar to individuals, when they hold the property or assets for more than 12 months. In contrast, companies are not qualified for this discount.
The CGT discount is not available to a trustee taxed on undistributed income from capital gains. It also doesn’t apply when the trustee is taxed on behalf of non-resident beneficiaries.
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. There are very specific and complex rules for trust losses, so advice should be sought from a tax professional before trying to claim these amounts.
Key Takeaways
Trusts can be a helpful vehicle for holding investment assets. Before setting up a trust, seek tax advice to understand the implications. Ensure the trust aligns with your goals and needs.
LegalVision provides ongoing legal support for businesses through our fixed-fee legal membership. Our experienced taxation lawyers help businesses manage contracts, employment law, disputes, intellectual property, and more, with unlimited access to specialist lawyers for a fixed monthly fee. To learn more about LegalVision’s legal membership, call 1300 544 755 or visit our membership page.
Frequently Asked Questions
Yes, if no beneficiary is presently entitled to trust income, the trustee can accumulate income, but they must pay tax on it at the highest marginal rate. This ensures the trust’s purpose is fulfilled, i.e., distributing income to beneficiaries.
Generally, beneficiaries cannot offset their income using the trust’s tax losses. However, the trustee may carry forward losses and offset them against future trust income. It’s advisable to seek professional advice when dealing with trust losses.
No. Beneficiaries cannot use trust losses to offset their personal income. The trustee carries forward losses and offsets them against future trust income.
Yes. Trusts receive a 50% CGT discount when they hold assets for more than 12 months, similar to individuals. However, this discount does not apply to companies or non-resident beneficiaries.
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