How discretionary trusts work for Australian small businesses

When you set up a business in Australia you choose between operating as a sole trader, a partnership, a company or a trust. Discretionary trusts, usually called family trusts, are one of the most common structures for small and family businesses, and the idea behind them is simple. A trustee holds the business and its assets, and each year decides which of a nominated group of beneficiaries receives the income and the capital. That flexibility is the reason the structure exists. But it only works if you understand the moving parts: who holds the assets, who makes the distribution decisions, how the tax lands, and what happens when things go wrong.

This guide explains how a discretionary trust actually operates, including the roles involved, how a trading trust runs day to day, how year-end distributions are made and taxed, and where the structure most often comes unstuck. Two moments matter more than any others: the day the trust is set up, and the trustee's distribution decision at the end of each income year.

The people behind a discretionary trust

A discretionary trust is a legal relationship, not a thing, and it has four core roles:

Trustee: the legal owner of the trust's assets and the person or company that runs the trust. The trustee signs the contracts, holds the bank accounts, employs the staff and makes the distribution decisions. It is the trustee, not the trust, that owes the debts.
Beneficiaries: the people and entities named in the class of beneficiaries in the trust deed, often family members, companies or other trusts. They have no fixed right to anything until the trustee resolves to give it to them. That is what makes the trust discretionary.
Settlor: the person who creates the trust by contributing a nominal amount, often $10. The settlor is usually an independent third party with no interest in the trust, so the trust is properly constituted from the start.
Appointor: the person or company holding the power to remove and replace the trustee. Control of a discretionary trust usually sits with the appointor rather than the trustee, which is why the appointor role matters for succession planning.

Everything these people can and cannot do is governed by the trust deed, the document that defines the beneficiary class, the trustee's powers, how distributions can be made and when the trust must come to an end.

Why the trust itself never signs anything

A common point of confusion is whether the trust is a separate legal entity. At general law it is not, in the way a company is. The trustee is the party that owns the assets, enters into contracts and is liable on the trust's obligations. When a contract or invoice says "ABC Pty Ltd as trustee for the ABC Family Trust", the contracting party is ABC Pty Ltd acting in its capacity as trustee.

For tax and GST purposes the arrangement is still treated separately from the trustee's own affairs. The trust has its own tax file number, its own ABN and, if it carries on an enterprise, lodges its own returns. Income tax law deals with the trust estate as its own taxpayer under Division 6 of the Income Tax Assessment Act 1936 (Cth), and the ATO explains how the income of a trust is taxed. But at general law the person on the hook is the trustee, which is why choosing the right trustee, and making sure contracts are signed in the right name, matters so much.

Setting one up: the deed, the registrations and the vesting date

A discretionary trust starts with a trust deed drafted for the purpose. Generic template deeds are cheap, but the deed sets the rules that will govern the business for decades: who can be a beneficiary, what powers the trustee has (including borrowing and investing), how the trustee can be changed and when the trust ends. Once the deed is executed and the settlor contributes the nominal sum, the trust exists.

The registrations follow in the trustee's name as trustee for the trust:

a tax file number for the trust;
an ABN if the trust carries on an enterprise; and
GST registration once GST turnover reaches $75,000 or more in a year, with registration required within 21 days of that point under the ATO's GST registration rules.

The deed will also fix a vesting date, the date on which the trust must end and its capital be dealt with. Most modern deeds set vesting within 80 years of the trust being created, reflecting the legal limits on how long a trust can run. On vesting, the trustee's discretionary powers end and the beneficiaries' interests become fixed, and the ATO sets out what vesting means for the trust and its tax position. It sounds like a distant event, but vesting dates arrive sooner than owners expect, and amending a deed to extend one can be difficult and costly.

Running a business through the trust

A discretionary trading trust is simply a discretionary trust that carries on an active business. The trustee operates the cafe, consultancy, construction business or online store, and the trust's income can come from trading, rent, dividends or capital gains. Contracts should be signed in the trustee's name with the "as trustee for" wording so that everyone knows who the contracting party is. If the trust employs people, the employer is the trustee as trustee for the trust, and the ordinary workplace laws apply to those employees just as they would in any other structure.

In practice, most trading trusts use a company as trustee, which is covered below. Whatever the choice, the running of the business is the same: the trustee acts, the trust is the framework, and at year end the trustee decides how the income is dealt with.

Year end: resolutions, entitlements and the tax

At the end of each income year the trustee decides how to distribute the trust's income among the beneficiaries. Three things have to line up for a distribution to work:

The distribution must be permitted by the deed, so only beneficiaries in the defined class can receive anything.
The trustee must make a resolution, and the beneficiary must be presently entitled by the end of the income year. Presently entitled means the beneficiary has an immediate right to demand payment from the trustee, and the ATO explains that the entitlement must exist by the end of the year.
The resolution has to be documented. The ATO works from what the trustee actually resolved, not what was intended afterwards.

The tax treatment then follows the entitlement. A beneficiary who is presently entitled to a share of the trust's income is assessed on that share of the trust's net income at their own tax rates under s 97 of the Income Tax Assessment Act 1936 (Cth). The amount a beneficiary is assessed on does not have to equal the accounting figure the deed says they are entitled to. Income of the trust estate is worked out under the deed and ordinary concepts, while net income is a tax figure, and the High Court confirmed the distinction in Commissioner of Taxation v Bamford (2010) 240 CLR 481. In the usual case the beneficiary is assessed on a proportionate share of the trust's net income, whether or not the money has actually been paid to them.

When no beneficiary is presently entitled

If income is not validly distributed, no one is presently entitled to it, and the trustee pays tax on that share of the net income at the top marginal rate that applies to individuals, which is 45 per cent plus the Medicare levy, under s 99A of the Income Tax Assessment Act 1936 (Cth). A missed resolution, a resolution naming someone outside the class, or a resolution made too late all land the trustee in that default rate. This is what makes the annual resolution more than paperwork.

Minors, companies and reimbursement arrangements

A few distribution scenarios need special care:

Children under 18: higher rates of tax apply to most trust distributions to minors, so distributing income to the kids is rarely the tax-effective move it once was.
Company beneficiaries: a company can be a beneficiary and pays tax on its share at the corporate rate. If the company's entitlement is left unpaid, it becomes an unpaid present entitlement, and how the money is then used matters. Arrangements between the trust and the company that operate in practice like loans or dividends can be recharacterised under Division 7A of the Income Tax Assessment Act 1936 (Cth), with tax consequences for the company and its shareholders.
Reimbursement agreements: under s 100A of the Income Tax Assessment Act 1936 (Cth), if a beneficiary's present entitlement arises out of a reimbursement agreement, broadly an arrangement where someone else ends up with the benefit of the income, the beneficiary is deemed not to be presently entitled at all. The result is that the trustee pays tax on that income at the top rate. The ATO has been examining these arrangements closely in recent years, so distribution planning that routes income through a chain of trusts needs proper advice before it is implemented.

Individual trustee or company trustee?

The trustee can be an individual or a company, and the choice shapes the liability of everyone involved:

Individual trustee: simple and inexpensive, but the individual is personally liable for the trust's debts and obligations, subject to their right to be reimbursed out of trust assets.
Corporate trustee: the company is the party that owes the trust's debts, and directors can change without the trust's assets having to be transferred, which helps with succession and administration. But the company itself is still exposed, its directors owe duties under the Corporations Act 2001 (Cth), and lenders will often still ask the directors for personal guarantees when the trust borrows. A corporate trustee also needs to be registered with ASIC and usually needs its own constitution.

For most trading trusts the corporate trustee is the practical choice, but it adds cost and administration, and it does not remove risk. It shifts where the risk sits.

The indemnity: how trust assets can be reached anyway

A trustee who properly incurs expenses on behalf of the trust has a right to be reimbursed out of trust property. In New South Wales that right is confirmed in s 59 of the Trustee Act 1925 (NSW), and the same principle exists at general law across Australia. The indemnity protects the trustee, but it also explains why asset protection through a trust is not automatic. If a corporate trustee becomes insolvent, creditors can stand in the trustee's shoes and reach the trust assets to satisfy the debts it incurred. If the trustee acted outside its powers, or the trust assets are not enough to cover the debts, the trustee's own assets are exposed.

Asset protection through a trust therefore depends on how the whole structure is implemented in practice: who gives personal guarantees, how contracts are signed, whether trust money is kept separate from personal money, and whether the trustee company has assets of its own that could be pursued. A well-run structure can isolate risk. A carelessly run one can concentrate it.

The mistakes that cost the most

The problems owners actually hit with discretionary trusts cluster in a few places:

Missing the vesting date: when a trust vests, the discretionary powers end and the capital must be dealt with under the deed. Amending the deed late is difficult and can trigger tax and duty consequences of its own.
Late or informal distribution resolutions: a resolution made after the end of the income year, or not made at all, means no one is presently entitled and the trustee pays the top rate.
Signing contracts in the wrong name: a contract signed by an individual where the corporate trustee should have signed can create personal liability, or leave the trust unable to enforce its rights against the other party.
Mixing trust money with personal money: blurred accounts make the indemnity, the accounts and the tax position harder to defend.
Borrowing without clean security: lenders taking security over business assets will usually want a general security agreement registered on the Personal Property Securities Register, and the registration and the guarantor arrangements need to be correct.

Where a lawyer comes in

A business lawyer's role in a discretionary trust runs from setup through to the annual cycle. At setup, a lawyer drafts or reviews the deed so the beneficiary class, the trustee's powers, the vesting date and the appointor arrangements match what the business actually intends, and sets up the corporate trustee with an appropriate constitution. During the life of the trust, a lawyer prepares the distribution resolutions and governance records, reviews customer, supplier, lease and employment contracts so the right entity signs them, and works through finance documents and PPSR registrations. For succession, a lawyer handles changes to the trustee and appointor and any amendment of the deed.

The tax side sits with the accountant, and the two need to work together. The lawyer gets the deed and the governance right; the accountant works out the distribution numbers, the entitlements and the returns. Trying to run a trust on template documents alone, without either, is where the expensive mistakes start.

The deed is where the value and the risk sit

Almost everything that can go right or wrong with a discretionary trust is decided on the day the deed is signed: the class of beneficiaries, the powers, the vesting date and who holds the appointor role. Fixing those decisions later is hard, and amending a deed can carry tax and duty consequences of its own. If you are setting up a trust, the work is to get the deed drafted for the business you actually run, and then to put every distribution through a documented resolution each year. If you already have a trust, the cheapest thing you can do is have the deed and the distribution history reviewed now, before a vesting date arrives or a tax audit does. That review costs far less than restructuring, and it is where a lawyer earns their fee.