Discretionary trust distributions in the spotlight

Each year, the trustee of a discretionary trust should determine which beneficiaries will be entitled to share in the trust’s net income.  In many instances, some of the income may be distributed within the broader family (for example adult children or parents) who would include that income in their tax return and pay tax on that income based on their marginal tax rate.

Draft Guidance released

The Australian Taxation Office “ATO” has recently released comprehensive draft guidance in relation to trust distributions.  This draft guidance confirms their view that any beneficiary who has income distributed to them must also receive the economic benefit (e.g. cash) relating to that distribution.  Where the economic benefit does not flow to the beneficiary or the economic benefit is subsequently transferred to someone else and a tax saving is achieved, the ATO states that the original distribution is void and the trustee can be liable for 47% tax on the distribution (instead of the beneficiary paying tax at their marginal tax rate) unless the transfer was entered into in the “course of an ordinary family or commercial dealing”.

“Ordinary family or commercial dealing” is not defined, however, the ATO’s draft guidance shows that their interpretation of what is an “ordinary family or commercial dealing” is different to how many advisors have previously understood.

The draft guidance indicates that:

  • Expenses relating to a child while they were under the age of 18 (e.g. school fees) are expenses of a parent and cannot be offset against trust distributions; and
  • Gifts or loans from “less financially advanced parties” (e.g. adult children) to “more financially advanced” (e.g. parents generating business or investment income) parties may have a tax-driven purpose and can potentially be unwound, especially if the gift or loans occur repeatedly over a few years.

In light of the new draft guidance, distributions to broader family members outside of the controllers of the trust/operators of the business should be considered carefully, especially if the beneficiary does not have unrestricted access and use of the corresponding economic benefit linked to the distribution.

Learn More

We recommend discussing this draft guidance with Josh Meggs or your Pilot Advisor as part of preparing your trust resolutions.