Will small business clients clamour for restructuring following changes to discretionary trust taxation?

The article is relevant to members in Australia and was current at the time of publication.

A surge in restructuring work is expected after the government’s Budget announcement of a minimum 30 per cent tax rate on discretionary trust distributions from 1 July 2028. 

The government says the measure is designed to improve tax system fairness by limiting the ability of individual trustees to reduce tax by distributing income to beneficiaries, usually family members, on lower tax rates. 

From 1 July 2027, three years of rollover relief will also be available for small businesses and others seeking to move from discretionary trusts into alternative structures, such as companies or fixed trusts not subject to the minimum tax. 

Expect a wave of restructuring enquiries 

Tax practitioners should expect an increase in inquiries from discretionary trust clients, especially small businesses seeking advice on whether they need to restructure. 

Budget papers put the number of trusts in Australia at more than one million, including around 840,000 discretionary trusts, which distributed $142.4 billion to other entities in 2022–23. 

The government says there are around 350,000 active small businesses operating through a discretionary trust structure, of which around 210,000 are expected to pay additional tax or need to restructure in any given year, although primary production income and fixed trusts are exempt. 

“Rollover relief will facilitate restructuring by ensuring there are no income tax consequences, including capital gains tax, for those who wish to move out of discretionary trust structures,” the government stated in its Budget papers, noting that the papers are silent on state taxes like stamp duty. 

Lacking the details 

A key issue at this early stage — before the legislation has been released — is that the full details on this proposed tax change, including the nature of the rollover relief, are still unknown. 

A current point of discussion in tax circles is whether state and territory stamp duties and other non- Commonwealth taxes will be applied separately when discretionary trust assets, especially real property and business assets, are moved into another structure. 

“We know what the broad strokes of the proposed reforms to trusts are going to be, but critically, at this time, we don’t have any detail, and that’s what will determine how it’s going to affect clients,” says Frank Hinoporos, Partner and Head of Tax at law firm Hall & Wilcox. 

“For example, when it comes to moving assets such as real property, if the states don’t come to the party and align stamp duty restructure relief with income tax restructure relief, then the costs of implementing a restructure may be prohibitive. 

“Clients would have to confront an unfunded tax liability in the form of a stamp duty charge for moving assets within what is still a family group structure.” 

Identifying potential exposures 

Hinoporos says now is a good time for tax practitioners and trustees to identify potential exposure for those transitioning to the new set of tax rules, particularly with respect to how distributions from trusts to corporate beneficiaries are carried out. 

“Subject to the detail we see about that, that’s going to significantly change practices and strategies that client groups would have adopted in the past,” he says. 

Currently, trusts can distribute income to corporate beneficiaries that pay the corporate tax rate and have access to franking credits, allowing tax to be deferred for underlying shareholders, who are often also trust beneficiaries. 

The government says that under a 30 per cent minimum tax rate, corporate beneficiaries will be assessed based on taxable income of the trust, without being able to claim credits for tax payable by the trustee. This will ensure the minimum tax cannot be avoided by cycling income through a “bucket” company. 

Assessing optimal tax structures 

Under a 30 per cent minimum tax regime, there is potentially a tax advantage for certain trading businesses using a discretionary trust to move to a corporate structure paying a base 25 per cent tax rate. 

Simon Mifsud, Partner at Corrs Chambers Westgarth, says that going forward, discretionary trusts are likely to be an optimal structure in circumstances where the intention is to distribute income directly to adults and where there is no intention to retain any income. 

“It’s also looking unlikely to be the optimal structure in which to run a trading business if you would otherwise run that business through a company that would get the base tax rate of 25 per cent.” 

Mifsud adds that the new regime will mean distributions from a discretionary trust to a bucket company will become “completely inefficient for tax purposes”, if those corporate beneficiaries will no longer receive a credit for the tax paid by the trustee. 

“And so, then the question is, what do I do in terms of restructuring? Should I restructure, and how do I do that?” 

“This puts people in a holding pattern, because they really need to see the detail of the rollover relief. Until they see that, it’s very difficult to advise people on what they should do,” Mifsud says.