How trust distributions are taxed, a guide for business owners

Running a business through a trust is a popular structure for separating ownership from control and for keeping flexibility about how profits are shared. But the way tax applies to trust distributions catches many business owners out, because the rules are nothing like the rules for companies.

In simple terms, a trust is not a separate taxpayer that keeps its profits and pays company tax on them. Instead, the trustee decides each year who is entitled to the trust's income, and the tax on that income is generally paid by those people or entities at their own rates. The decision that triggers all of this is the trustee's distribution resolution, and it must be made by the end of the income year. This guide walks through how the scheme actually operates: the two income figures that drive it, what makes a beneficiary taxable, who ends up paying the tax, how capital gains and franked dividends can be streamed to particular beneficiaries, and the traps that leave the trustee paying tax at the top marginal rate.

The players: trustee, beneficiaries and the ATO

The scheme has three moving parts, and each one has a distinct role:

Trustee: The person or company that holds the trust's assets and exercises the powers in the trust deed, including the power to decide who receives the income each year.
Beneficiaries: The people and entities named in the deed as eligible to receive income or capital. They can be adult individuals, companies, other trusts, or in some cases minors.
ATO: Assesses the tax by reference to three things: what the deed allows, what the trustee actually resolved before the deadline, and whether the trust's records match the resolution.

Because the trustee is the one who decides, most of the risk in this system sits with the trustee personally. A resolution that is late, vague or outside the deed can shift the tax bill onto the trustee at the top marginal rate, which is an expensive outcome that is also a common audit trigger.

The two income figures that drive the tax

Every trust distribution question starts with two different figures that are often confused: the income of the trust and the net income of the trust.

The income of the trust is worked out under the trust deed. Most deeds define it by reference to accounting profit, with adjustments for items like capital gains and franked dividends. The net income of the trust is worked out under tax law. Under s 95 of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936), it is the trust's assessable income calculated as if the trustee were a resident taxpayer, less allowable deductions. As the ATO explains, because the income of a trust is determined by the deed and its net income is determined by tax law, the two amounts are often different.

The distinction matters because the tax follows a proportionate approach. If a beneficiary is entitled to 50% of the trust's income, they are assessed on 50% of the trust's net income, even if the two figures differ. The mechanism that connects one figure to the other is present entitlement.

Present entitlement: what makes a beneficiary taxable

Under s 97 of the ITAA 1936, where a beneficiary who is not under a legal disability is presently entitled to a share of the trust's income, that share of the net income is included in the beneficiary's assessable income. The ATO defines present entitlement as having, by the end of the income year, a present or immediate right to demand payment from the trustee. Whether that right exists depends on the trust deed and on any discretion the trustee has under the deed.

The ATO's resolutions checklist sets out the practical requirements for making beneficiaries presently entitled by way of a resolution:

By 30 June: A resolution is only effective for an income year if it is made by the end of that year. If the deed requires an earlier date, that date governs.
Vested and indefeasible: The entitlement must be a present right, not one that depends on a future event, and it must not be capable of being taken away.
Unambiguous: Vague wording can defeat the resolution. The ATO gives the example of a resolution distributing "the balance of the income" to two beneficiaries, which on one reading gives all of it to the first.
Consistent with the deed: The intended recipients must fall within the class of beneficiaries in the deed. If the trustee appoints income to someone outside that class, the default beneficiaries (if any) or the trustee may be assessed on the corresponding part of the net income.
Recorded: Whether a resolution must be in writing depends on the deed, but a written record provides the evidence needed to avoid a dispute later, and it is essential if the trustee wants to stream capital gains or franked distributions.

Conditional or "variation of income" resolutions deserve special caution. These are resolutions that try to redirect income if the ATO later adjusts the trust's net income. In Lewski v Commissioner of Taxation [2017] FCAFC 145, the Full Federal Court considered this kind of arrangement, and the ATO's current guidance notes that these resolutions give rise to considerable uncertainty and often do not achieve what the trustee intended. Where a resolution can be read more than one way, the ATO may raise alternative assessments, including an assessment of the trustee under s 99A on the highest amount that could be assessed under any interpretation.

Who pays the tax on the distribution

Once present entitlement is established, the tax falls in different places depending on who the beneficiary is:

Adult individuals: Assessed on their share of the net income at their own marginal rates.
Companies: Assessed at the company tax rate that applies to them. This is the logic of the "bucket company", which receives surplus trust income so the tax is capped at the corporate rate rather than at the higher personal rates of the owners.
Minors: Subject to special penalty rates. Division 6AA of the ITAA 1936 applies higher rates of tax to most trust distributions to children under 18, which removes most of the perceived tax benefit of distributing to them. Where the beneficiary is under a legal disability, the trustee is assessed on their behalf under s 98 of the ITAA 1936, and the minor declares the share in their own return and claims a credit for the tax the trustee paid.
Non-resident beneficiaries: Also taxed through the trustee, who pays tax on their behalf on the relevant share of the net income.
No beneficiary presently entitled: If any part of the trust's income has no beneficiary presently entitled by year end, the trustee is assessed on the corresponding share of the net income under s 99A of the ITAA 1936, at the top marginal rate that applies to individuals, currently 45%. Some trusts are treated more leniently, such as deceased estates, which are taxed at modified individual rates under s 99.

Streaming capital gains and franked dividends

Where the trust makes a capital gain or receives a franked distribution, the trustee can often direct that amount to a specific beneficiary for tax purposes. This is called streaming, and it works through the concept of specific entitlement.

As the ATO explains, a trust's capital gains and franked distributions can be streamed to beneficiaries for tax purposes by making them specifically entitled to the amounts, provided the trust deed does not prevent it. The trustee needs a power to stream, either express or implied, in the deed.

The practical requirements are strict:

The specific entitlement must be recorded in writing in the trust's records by 30 June for franked dividends, and by 31 August for capital gains.
A capital gain can be streamed to a beneficiary even if that beneficiary has no present entitlement to the trust's income, provided the deed does not prevent it.
Where no beneficiary is specifically entitled to a capital gain or franked distribution, it is allocated proportionately to beneficiaries according to their present entitlements, and the trustee is taxed on any part to which no beneficiary is specifically or presently entitled.

Streaming is valuable because it lets beneficiaries offset capital gains with their own capital losses and apply the CGT discount, and lets them get the benefit of franking credits attached to a franked distribution. There are limits: for a trust that is not a family trust, a beneficiary without a fixed entitlement to the franked distribution is generally not entitled to use the franking credits unless their total franking credits from all sources for the year are $5,000 or less.

Where the traps bite

The same scheme that gives flexibility also concentrates risk in a handful of recurring mistakes:

A late or defective resolution: Leaves income with no beneficiary presently entitled, and the trustee is assessed at the top marginal rate. This is the most expensive failure and the most common.
Appointing outside the beneficiary class: Makes the appointment ineffective. The default beneficiaries, or the trustee, may then be assessed on the income.
Unpaid present entitlements to corporate beneficiaries: Where a private company is made presently entitled to trust income but the amount is not paid out, the unpaid entitlement is exposed to the integrity rules in Division 7A of the ITAA 1936. If the trust then makes a payment or loan for the benefit of a shareholder or associate while the company's entitlement remains unpaid, the amount can be included in the shareholder's assessable income as if it were a dividend under ss 109XA and 109XB. These arrangements need active management, not benign neglect.
Reimbursement agreements under s 100A: If a beneficiary's present entitlement arose out of a reimbursement agreement, for example where income is directed to a corporate beneficiary and the benefit ultimately returns to the family, s 100A deems the beneficiary never to have been presently entitled. The trustee is then assessed on the income, generally at the top rate. The ATO has been applying this provision closely to unpaid present entitlement arrangements.
Family trust elections: If the trust has made a family trust election to access tax concessions, distributing income or capital to a person outside the family group triggers family trust distribution tax, which is payable by the trustee.
Trust losses: Cannot be distributed to beneficiaries. They are carried forward and used to reduce the trust's net income in a later year, so a year of losses simply reduces the pool available to distribute later.

Where professional help is usually needed

Most of this scheme can be managed internally, but there are points where a lawyer or accountant earns their keep:

Deed review before 30 June: Before each year end, someone needs to confirm who is in the beneficiary class, how the deed defines income, whether capital distributions are allowed, whether the trustee has streaming powers, and what deadlines the deed imposes. An outdated deed may need to be varied, and variations need to be done carefully so they do not create their own tax or trust law problems.
Drafting the resolution: The resolution is the document the ATO and any court will look at. A lawyer can draft wording that is unambiguous about amounts or percentages, names the right beneficiaries, and records any streaming of capital gains or franked distributions in the form the law requires.
Unpaid present entitlement planning: If a corporate beneficiary's entitlement is to be left unpaid, the structure should be reviewed for Division 7A and s 100A risk before year end, not after the ATO writes to the trustee.
Advice on the flow of funds: Where cash will not follow the resolution immediately, the arrangement should be documented so the accounts and the trustee's decision tell the same story.

An accountant usually handles the numbers and the tax return, while a lawyer checks the deed, the resolution and the governance. The two should be in the same room before 30 June, not after an assessment arrives.

The 30 June resolution decides the tax bill

Every part of this scheme funnels into one moment: the resolution the trustee makes by 30 June, or by the earlier date the deed requires. If it is on time, within the deed, unambiguous and consistent with the records, the tax lands exactly where it was planned. If any of those things fail, the default is expensive, because the trustee is assessed at the top marginal rate on income that no beneficiary can be taxed on.

That is why the highest-value step for any business trust is a short review of the deed and the year end resolutions before 30 June each year. Fixing a resolution or varying a deed in May costs a fraction of what it costs to unwind a defective distribution or defend an assessment afterwards, and a consultation with a lawyer who knows trust structures can confirm which parts of your arrangement are working before the deadline passes.