A trust is not a separate taxpayer. It is a legal relationship in which a trustee holds assets for the benefit of other people, the beneficiaries, and the income those assets produce does not stop at the trust. It is taxed in someone's hands at someone's rate. That is the whole mechanism in one sentence: trusts are flow-through structures, and the tax on a trust's income is calculated by working out which person or company the income is attributed to, and then applying that person's ordinary tax rate.
That design exists so families and business owners can direct income to the people whose tax situation makes the most sense. A discretionary trust gives the trustee a choice each year about how income is split between beneficiaries, and the tax law generally respects that choice. The trade-off is that the law also contains strict integrity rules that tax the trustee at the top rate whenever income has no genuine owner. Understanding the calculation means understanding four stages: who is entitled to the income, what happens when no one is, how capital gains are treated, and what can be done with losses.
Who pays tax on a trust's income
There are only two possible taxpayers, and they are alternatives to each other:
- The beneficiary: a beneficiary who is presently entitled to a share of the trust's income includes that share in their own assessable income and pays tax at their own rates.
- The trustee: the trustee pays tax on any income of the trust to which no beneficiary is presently entitled, and also on behalf of beneficiaries who cannot manage their own tax affairs, such as minors.
The two roles pull against each other. The trustee's natural instinct is to stream income to the beneficiaries with the lowest marginal rates, which is exactly what discretionary trusts are for. The tax law's instinct is to make sure that streaming is real: that a beneficiary is genuinely entitled to the income, that minors are taxed at adult rates designed to discourage parents from sheltering income in their children's names, and that arrangements which simply move money around within a family do not defeat tax. Most of the complexity in trust taxation comes from those integrity rules rather than from the basic calculation.
Stage one: when beneficiaries are taxed
The key concept is present entitlement. Under s 95A of the Income Tax Assessment Act 1936 (Cth), a beneficiary is presently entitled to trust income when they have a right to demand payment of it from the trustee at the end of the income year. For a unit trust, that right usually follows automatically from holding units. For a discretionary trust, the beneficiary has no right to anything unless and until the trustee exercises its discretion in their favour, normally by passing a resolution that records each beneficiary's entitlement for the year.
If a beneficiary is presently entitled, s 97 of the Act says their assessable income includes their share of the trust's net income. Three practical consequences follow.
First, the entitlement must exist by 30 June. For a discretionary trust the resolution is what creates the present entitlement, so it generally needs to be made before the end of the financial year. A resolution passed in July may be too late to count for the year just ended, leaving the trustee or the default beneficiaries under the deed exposed.
Second, present entitlement is not the same as receiving the money. Section 95A makes clear that a beneficiary stays presently entitled even if the income is not paid to them, so a beneficiary can be taxed on income they have been entitled to but never received. Business owners who leave money sitting inside the trust need to know that the beneficiaries may still owe tax on it.
Third, the rate applied depends on who the beneficiary is:
- Individuals: pay at their marginal rates, the same rates that apply to their salary and other income.
- Companies: pay at the corporate rate, 25% for base rate entities, which are broadly companies with less than $50 million in aggregated turnover, and 30% for all other companies, per the Australian Taxation Office's published company tax rates.
- Minors: the exception. Under Division 6AA of the Act, most trust income distributed to a child under 18 is taxed at the top marginal rate for individuals, currently 45% plus the 2% Medicare levy where it applies, which is designed to stop parents from shifting income into their children's names. The main exemption is income from a testamentary trust, created by a deceased person's will, which is "excepted trust income" under s 102AG and is taxed at ordinary rates.
Stage two: when the trustee pays
Where no beneficiary is presently entitled to income of the trust, the trustee is assessed on it under s 99A of the Act. The rate is the top marginal rate for individuals: 45%, plus the 2% Medicare levy where it applies. So accumulated income, income that could not be distributed because no resolution was passed, and income caught by an integrity rule all end up taxed at effectively 47%, the most expensive outcome in the system.
The rate is deliberately punitive. A trust exists to distribute income to beneficiaries, and s 99A exists to make sure that holding income inside the trust is never a tax advantage. There are, however, two situations where the trustee pays at gentler rates:
- Deceased estates: income of an estate in the course of administration is taxed to the trustee under s 99 at modified individual rates rather than the top rate, because the estate cannot yet be distributed while the estate is being wound up.
- Beneficiaries under a legal disability: where a beneficiary who is presently entitled is under a legal disability, which includes being a minor, the trustee is assessed on the beneficiary's share under s 98 and pays the tax on their behalf. The beneficiary then reports their share in their own return and claims a credit for the tax the trustee paid, under s 98B, so the income is not taxed twice.
Non-resident beneficiaries sit in a similar position. Where trust income is attributed to a non-resident, the trustee may be assessed on that share, and the beneficiary claims the credit for the tax paid. The important planning point is that the trustee is only the payer of last resort for these groups: the beneficiary still declares the income and the rate that applies is still the beneficiary's own, with the trustee's payment credited against it.
Stage three: how capital gains flow through
Capital gains made by a trustee are part of the trust's net income and flow out to beneficiaries in the same way as other income, but the CGT discount changes the calculation significantly.
Under Division 115 of the Income Tax Assessment Act 1997 (Cth), individuals and trusts that hold an asset for at least 12 months before the CGT event can reduce the capital gain by 50% before tax. The trust itself can make a discount capital gain, and the discount follows the gain when it is distributed. Companies cannot make discount capital gains at all, so a gain made by a company is fully taxable, and a gain that flows to a non-resident beneficiary will generally not attract the discount either.
The mechanism that preserves the discount on the way through is specific entitlement. Subdivision 115-C of the 1997 Act lets the trustee make a beneficiary specifically entitled to a particular capital gain, rather than merely entitled to a share of overall income. The effect is that the gain keeps its character in the beneficiary's hands: the beneficiary can apply their own capital losses against it, and then apply the discount percentage themselves. Where the trust has already applied the 50% discount, the gain is doubled in the trust's hands so that the beneficiary ends up with the same result after applying the discount again. The same logic applies to franking credits on franked dividends, which can be streamed to beneficiaries under Subdivision 207-B so that the credits are not wasted on a low-income beneficiary.
Specific entitlement must be created deliberately, recorded in the trustee's documents, and the gain must actually benefit the beneficiary. If the trustee simply distributes a lump sum without recording that a particular amount relates to a particular capital gain, the gain is treated as part of the ordinary income distribution and the discount may be lost or misapplied. For a discretionary trust that has sold a large asset, the specific entitlement decision is one of the highest-value tax choices the trustee makes all year, and it is one of the easiest to get wrong.
Stage four: what happens to losses
Losses do not flow through a trust the way income does. If a trust makes a tax loss, the beneficiaries cannot use it to reduce their own income from other sources. A business owner cannot offset their salary with the losses of their family trust.
The loss stays inside the trust and can be carried forward to offset against the trust's future income, but only if the strict trust loss rules are satisfied. The rules in Schedule 2F of the Income Tax Assessment Act 1936 (Cth) restrict the carry-forward of losses where the ownership of the trust has changed or the trust's business has changed, and they are notoriously technical. In practice, most trusts never claim a carried-forward loss without an adviser working through the tests first.
There is one compliance point every trustee should know even if losses are not involved: the trust still has to lodge a trust tax return every year, even where all of the income has been distributed. The return is how the ATO cross-checks the distributions the trustee reports against the amounts each beneficiary declares in their own return. When a beneficiary's return does not match the trust's return, the ATO can see it immediately, and the mismatch is a common trigger for review.
Where it goes wrong: the common pitfalls
The calculation is simple in theory, but the traps are specific and expensive:
- A missed resolution: if the trustee does not pass the distribution resolution before 30 June, no beneficiary is presently entitled and the trustee is assessed on the whole year's income under s 99A at the top rate. This is the most common way a discretionary trust pays 47% on income it never intended to keep.
- Accumulation: a trustee can deliberately accumulate income rather than distribute it, but the same s 99A rate applies. Accumulation only makes sense where the trust deed requires it or where there is a non-tax reason, never as a way to defer tax.
- Reimbursement agreements: section 100A of the Act targets arrangements where a beneficiary's entitlement is a paper exercise and the money in substance comes back to someone else, for example income distributed to a low-rate beneficiary who then lends or gifts the funds back to the family company. Where s 100A applies, the beneficiary is deemed never to have been presently entitled, and the trustee is taxed on the income at the top rate with no offset. The section excludes agreements entered into in the course of ordinary family or commercial dealing, but that exclusion has been tested heavily and is not a safe harbour. Reimbursement-type arrangements have been a significant focus of ATO compliance attention in recent years, and they are exactly the kind of structure that looks fine until an adviser or the ATO looks at the whole circular flow.
- Streaming mistakes: distributing a capital gain or franked dividend without recording a specific entitlement can waste the CGT discount or the franking credits, or pass them to a beneficiary who cannot use them.
- Minors and non-residents: distributing to a child under 18 outside the testamentary trust exceptions, or to a non-resident, shifts the tax bill to the trustee at a rate the family did not expect.
When to get professional help
Trust taxation rewards getting in early. A tax adviser should be involved before the structure is created, because the trust deed determines what the trustee is allowed to do, and before each year's distribution decision, because the rates of every beneficiary need to be known before the resolution is passed. A lawyer's role is different: the trust deed, the resolution, and any variation of the deed are legal documents, and s 100A exposure turns on how the arrangement is documented and what the parties actually agreed.
The point where most owners need both is the annual distribution. The adviser works out the most efficient split of income, capital gains and franking credits, and the lawyer checks that the deed permits that split and that the resolution records it properly by 30 June. The same pair should review any plan that involves income moving between family members or back to the family business, because that is where s 100A risk lives.
The 30 June resolution is the whole game
Every year, trust tax comes down to one document: the trustee's resolution, passed before 30 June, recording who is entitled to what. It sets the tax rates that apply to the year's income, it preserves or destroys the CGT discount on any asset sales, and it is the first thing the ATO and any adviser look at. A well-drafted resolution passed on time is cheap, and it converts the trust's flexibility into a genuine tax outcome. A missed resolution, or an arrangement that documents one thing while the money does another, can cost the top rate on the entire year's income and invite an ATO review that takes years to resolve. If your trust has income to distribute this year, the question to answer before 30 June is simple: does your paperwork match what you intend to happen? A short consultation with a tax lawyer before the resolution is signed is usually all it takes to make sure it does.