Fixed trust or discretionary trust and choosing your business structure

The moment the question gets asked

Every growing business eventually reaches the point where its ownership structure stops being a background detail. For most owners it happens at a specific moment: an outside investor asks what stake they will actually receive, a second family member starts drawing a share of the profit, or the accountant points out that the year's income is landing in one tax return when it could be spread across several. That is the moment a trust gets raised, and with it the choice between a fixed trust and a discretionary trust.

The two structures on the table

Both structures are trusts, which means a trustee holds and manages assets for beneficiaries under the rules of a written trust deed. Both are also flow-through for income tax, in that the trust itself generally does not pay tax on its income; the beneficiaries do, on the shares they are entitled to. The real difference is narrower than the names suggest. It comes down to who is entitled to the income and capital, and who gets to decide.

A fixed trust gives each beneficiary a fixed entitlement, and in a business context it is almost always a unit trust. Beneficiaries hold units, rather like shares, and income and capital are distributed in proportion to the units held. A discretionary trust, usually called a family trust, gives the trustee discretion, within the limits set by the deed, to decide each year which beneficiaries receive income and capital and in what amounts. No beneficiary has a fixed entitlement until the trustee resolves in their favour.

One option that is not really available is deciding later. Trusts can be varied, but significant amendments risk the trust being treated as a new trust for tax and duty purposes, a result known as resettlement, which is discussed further below. In practice the structure choice is largely made on the day the deed is signed.

Who is entitled to what, and who decides

The first question to answer is not about tax at all. It is about who should have a right to the business's income and capital, and whether that right is fixed or discretionary.

Option A, a fixed or unit trust:

• Entitlements: each unit holder has a fixed, proportionate entitlement to income and capital.
• Decision-maker: the trustee administers the trust, but distribution entitlements follow the units.
• Feels like: shareholding in a company, with units standing in for shares.

Option B, a discretionary or family trust:

• Entitlements: no beneficiary has an entitlement until the trustee resolves to distribute.
• Decision-maker: the trustee decides each year, within the class of beneficiaries named in the deed.
• Feels like: a family pool of assets and income, with control held close.

If the people who will benefit are family members and you want to be able to change who receives what as circumstances change, a discretionary trust matches that. If the people who will benefit are unrelated investors who need a defined return for their capital, a fixed trust gives them what they are asking for.

How much distribution flexibility you need each year

The tax mechanics of the two structures are the same in outline, and different in operation. Under s 97 of the Income Tax Assessment Act 1936 (Cth), 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. The trustee is only taxed on income no beneficiary is entitled to: under s 99A, that undistributed income is assessed in the trustee's hands at the top marginal rate. The ATO's guidance is that a trustee who wants to make beneficiaries presently entitled by resolution should do so by the end of the income year, 30 June, unless the deed allows otherwise.

For a discretionary trust, this is where the flexibility lives. Each year the trustee resolves how the income will be distributed, and the resolution determines whose tax return the income appears in. That flexibility is real but not unlimited:

• The tax law contains streaming rules that govern how particular kinds of income, such as capital gains, are directed to beneficiaries.
• Distributions of unearned income to children under 18 attract the special minors' rates.
• The ATO has published guidance on when Division 7A of the tax legislation may apply to trust entitlements of private company beneficiaries, particularly where income is distributed to a corporate beneficiary and left unpaid rather than paid out.
• Under s 100A of the Income Tax Assessment Act 1936 (Cth), an entitlement that arises out of a reimbursement agreement can be disregarded, leaving the trustee to be assessed under s 99A.

A fixed trust offers none of this year-to-year flexibility, because entitlements follow the units. What it offers instead is predictability: unit holders know their share of income and capital in advance, and the year-end resolution, and the risks that come with it, largely fall away.

How important asset protection is to you

Asset protection is often the reason owners reach for a trust at all, and the two structures protect differently. In a discretionary trust, a beneficiary has no more than an expectation until the trustee resolves to distribute. That expectation generally cannot be seized by the beneficiary's creditors or counted in a bankruptcy, because the beneficiary does not own it yet. In a fixed trust, a unit holder has a vested interest in the trust property, and that interest is property in the ordinary sense, capable of being reached by creditors or dealt with in a family law or estate context.

The strength of these protections depends on the facts. It matters when entitlements are resolved, whether the trustee follows the deed, and whether the arrangement is a genuine commercial structure rather than a device. A corporate trustee also changes the risk profile, because the company, not an individual, owns the assets and enters contracts, though directors can still face personal liability in specific situations such as insolvent trading. These are the questions a practitioner stress-tests before the structure is settled, not after a dispute arises.

Whether outsiders will hold a stake

Unit trusts and outside investors fit together. Units can be issued, transferred and valued, and a unitholders agreement can set out how decisions are made, how investors exit and how disputes are resolved. That is why a fixed trust is the natural vehicle when you are raising capital from people outside the family, or offering a genuine equity-style interest to key staff.

Promising that kind of stake in a discretionary trust is harder. Because no beneficiary has a fixed entitlement, there is no interest to hand to an employee or investor without either converting part of the trust to units or using a different structure, such as a company the trust owns. If you expect to raise outside capital at any point, say so early. It changes the recommendation before the deed is drafted, not after.

Who controls the trust and what happens when things change

Control sits with whoever holds the powers under the deed. The trustee runs the trust, and the appointor, sometimes called the principal, usually holds the power to replace the trustee. Many owners use a corporate trustee, because the company owns the assets rather than an individual, and control can pass by changing directors or shareholders without disturbing the trust itself.

Succession is where discretionary trusts commonly come unstuck. If the appointor dies or loses capacity without a plan, the family can find itself unable to remove an unwanted trustee, or with control passing to unintended hands. The deed should deal with what happens to the appointor role, just as it should set the vesting date, the point at which the trust must wind up.

The same forward planning matters for changes you think you might want later. A trust can be varied under the powers in the deed, but an amendment that goes beyond those powers, or that changes the substance of the trust, can be treated as a resettlement: a new trust over the same assets. Resettlement can trigger CGT event E1 under s 104-55 of the Income Tax Assessment Act 1997 (Cth), which applies when a trust is created over a CGT asset, and it can also carry state duty consequences. Designing the deed with the flexibility you genuinely need, for example the ability to add beneficiaries or stream particular kinds of income, is cheaper than repairing the structure later.

How an Artificer Legal practitioner helps you choose

The choice between fixed and discretionary is made with a deed, an accountant's modelling and, in most cases, legal advice. An Artificer Legal practitioner would start by stress-testing the assumptions the structure is built on: who genuinely needs a fixed interest, who should hold control and what happens to it on death or incapacity, and whether the equity you have discussed with staff or investors can actually be delivered by the structure you are contemplating.

From there, we would model the downside. That means working through the year-end mechanics of the trust, the s 99A position if income is left undistributed, the streaming rules, and the scrutiny around distributions to corporate beneficiaries, so the structure does not create a tax problem in its first profitable year. We would then draft the documents the chosen path needs: a trust deed that matches the structure and builds in the flexibility you need, a unitholders agreement where investors are involved, a corporate trustee constitution, and, where the trust will hold shares in a trading company, the governance documents at company level. If you are restructuring an existing arrangement, we would advise on whether the changes can be made by variation or risk resettlement before anything is signed.

Start with entitlement, not tax

The mistake that costs the most in trust structuring is choosing the structure for the tax saving on offer in year one, rather than for who is entitled to what over the life of the business. The tax outcomes of a discretionary trust can be attractive, but they are available only where the trustee genuinely has discretion, and they evaporate where income is left undistributed or the ATO sees a reimbursement arrangement. A fixed trust is less flexible but delivers exactly the certainty that outside investors and staff are usually being promised. Answer the entitlement question first: who should have a right to the income and capital, and who decides. The tax position, the deed and the supporting agreements all follow from that answer.

In short, a fixed or unit trust suits a business where investors hold defined, proportional interests and certainty matters more than flexibility, while a discretionary or family trust suits a business where distributions should flex each year, control stays close and asset protection is a priority. Both flow income through to beneficiaries for tax, both depend on a deed drafted to match how the business will actually run, and both reward getting the trustee, control and governance arrangements right on day one. If outside capital is coming, or the structure may need to change later, those factors should shape the choice before the deed is drafted, not after.