The 30% minimum tax on trusts options explained

The 30% minimum tax on discretionary trusts stepped closer to finalisation with the release of the exposure draft legislation by Treasury this week.

Who and what is impacted?

How does the minimum tax work?

The 30% minimum tax will apply to the net income of discretionary trusts from 1 July 2028. From this point forward, where the tax on the relevant net income of the trust falls below 30% in a given income year, the tax payable is ‘topped up’ to 30%.

Non-corporate beneficiaries will be entitled to a non-refundable tax offset where the minimum tax has been paid on their share. Any rebates the beneficiary is entitled to cannot reduce the 30% minimum tax.

To ensure that franked distributions cannot ‘flow-through’ to beneficiaries, trustees that receive franked dividends will be required to use franking credits when paying the minimum tax. Any excess franking credits can be claimed as a refund. This means the trustee will include the franking credits in its assessable income and claim the franking credits as an offset to reduce its minimum tax. Any excess franking credits will be refunded to the trustee. For example, if the trustee has $1,000 net income, including a $400 franking credit, the trustee’s minimum tax is $300, which can be reduced by offsetting against the $400 franking credit. The excess franking credit of $100 will be refunded to the trustee.

If a non-corporate beneficiary is presently entitled to 100% of the trust income, the beneficiary can claim a non-refundable tax offset of $300, being the minimum tax paid by the trustee to reduce their income tax liability. The beneficiary is not entitled to any franking credit attached to the dividend.

What trust structures are impacted?

Not all discretionary trusts are impacted by the impending rules. The legislation introduces a new concept of a “minimum tax trust”. This is a discretionary trust that is not:

• a fixed trust;
• a special disability trust;
• the trust estate of a deceased person;
• a complying superannuation entity (including SMSFs); or
• a trust determined by the Government in the future (by legislative instrument).

A series of other types of trusts by their nature are not minimum tax trusts. These include widely held trusts such as MITS and AMITS, CCIVs and CCIV sub-funds, exempt entities such as charitable trusts, bare trusts because they will now fall within the new definition of a fixed trust[i], and employee share trusts and worker entitlement funds.

Not all trust income is included

Not all income of a minimum tax trust is included in the calculation of net income. The minimum tax will not apply to:

• taxable primary production income;
• amounts subject to non-resident withholding tax;
• And, where certain conditions are met[ii]:
  • a minor’s proportionate share of income of the trust estate;
  • a registered charity’s, DGR’s or exempt entity’s proportionate share of income of the trust estate;
  • income of a testamentary trust.

Any trust capital gains included in the net income distribution can also be excluded from the minimum tax where the above exclusions apply.

The three options for trustees

There are three options for Trustees impacted by the changes:

1. do nothing and accept a minimum 30% tax rate – if you want to keep the flexibility and the tax is inconsequential;
2. put in place a one-off election in the 2028-29 income year fixing beneficiaries and their income and capital entitlements – if you distribute to the same beneficiaries; or
3. utilise the temporary rollover relief provisions and restructure by 30 June 2030 – if the current structure is no longer fit for purpose.

1. The one-off election option

The minimum 30% tax will not apply if the trustee elects to nominate the beneficiaries it intends to distribute to. This excluded election trust (EET) nomination sets out:

• Each beneficiary the trustee intends to make presently entitled to a share of the income and capital of the trust in each year of income.
  • Must be an eligible beneficiary, as defined under the trust deed as at 1 July 2028.
  • Be consistent with any other elections in place, i.e., family trust elections interposed entity elections.
  • A company or another trust can be a beneficiary as long as it existed prior to 1 July 2028, is an object of the trust deed (i.e., no super funds or partnerships), and there are no material discretionary elements affecting the rights or interests of the company’s members.
• the relevant percentage share for each beneficiary (totalling 100%) of the income and the capital (i.e., cannot allocate 100% of the income to one beneficiary and 100% of the capital to another). No percentage can be retained by the trust.

In effect, you specify who/what and how much of the income and capital of the trust the beneficiary is entitled to.

Once in place, the election cannot be changed unless a beneficiary dies, there is a family breakdown or the election is revoked. There is no provision for new children or a marriage.

The controls on the election are stringent:

• the election can only be made once and must be in place by 30 June 2029 (notified by the earlier of the due date of the trusts tax return or the lodgement of the return),
• nominees can only change on a beneficiary's death (share is reallocated to existing beneficiaries or beneficiaries of the deceased estate) or a family breakdown (court order or enforceable agreement),
• if the trustee distributes inconsistently to the election, it is automatically revoked, and
• If a company nominated as a beneficiary is wound up, deregistered or the shareholders change (other than death or divorce), the election is automatically revoked.

If revoked, either deliberately or by default, the trustee will be taxed at 47% on the net income in the income year in which the election is revoked, with the 30% minimum tax applying in future years.

The trustee can choose the election or rollover relief, not both. For example, if the trustee chooses to put an election in place and then decides that the election is not workable, they cannot then access the transitional rollover relief. The only remaining options would be to pay the minimum tax, or the trust vests or is wound up.

Before an EET is made, there are some legal issues to consider including whether the trust deed allows the trustee to fix the beneficiaries’ entitlements to income and capital, and the implications of doing so for the trust and its beneficiaries as a whole.

2. Rollover relief for restructuring out of a discretionary trust

For some, a discretionary trust will no longer be fit for purpose come 1 July 2028. In these cases, the transitional rollover relief enables trustees to restructure from a discretionary trust into another structure without triggering the income and capital gains tax consequences that would otherwise arise.

Assuming the trust deed allows it, the rollover relief applies where both the transferor and transferee have chosen to apply the rollover and:

• All relevant assets are held and transferred by an entity in its capacity as trustee;
• the asset is transferred to an eligible transferee such as a company, individual, partnership (with some special rules at partnership level) or another trust that is not a minimum tax trust (no super funds or exempt entities). Continuity must be maintained between the transferor and transferee;
• there are no material discretionary elements that affect the rights or interests of the members of the transferee; and
• the transferor and transferee satisfy the residency requirements.

Trustees of a minimum tax trust have until 30 June 2030 to complete the rollover. If the conditions are met and the rollover completed within the timeframes, the transfer has no direct consequences under the income tax law, and the transferee generally inherits the transferor’s tax cost and the relevant tax history for the assets.

Some assets are excluded and do not have to be rolled out of the trust. These include those not capable of transfer (e.g., carried forward tax losses), a CGT asset used to generate primary production income, and assets used to discharge any liabilities (debts, tax, rights of indemnity or reimbursement for liabilities, and if winding up, any expenses required to cover the cost of the wind-up).

The notification for rollover relief is made to the Commissioner each income year where the restructure occurs over more than one income years (prior to the earlier of the due date of the return or the income tax lodgement of the transferee and transferor). The Commissioner is also notified if the transfer is in progress across income years.

Next steps

While the proposed changes to the taxation of discretionary trusts, including the 30% minimum tax, EET and transitional rollover relief, are in exposure draft form, it’s essential to plan ahead.

• Identify trusts potentially affected by the new rules, including reviewing the current group entities and structures.
• Review the trust deeds and seek legal advice, in particular if an EET is being considered.
• Identify the potential beneficiaries and assess the medium to long-term implications of an EET, including any potential changes to the beneficiaries’ circumstances.
• Assess an appropriate transferee structure if the restructuring rollover is being considered, having regard to your broader commercial, tax and succession objectives.

We will continue to monitor the development of the legislation and provide updates to assist you in making an informed decision.

If you need assistance, Hayes Knight's tax advice division can assist by clarifying the issues, options and go forward position for your client.

Linda Jing
Director, Tax Services

[i] Under the new definition, the trust is a fixed trust where: the trust’s beneficiaries have fixed entitlements to all of the income and capital of the trust; or there are no material discretionary elements affecting the entitlements or rights of the trust’s beneficiaries. Further details are provided in the explanatory materials.

[ii] See the explanatory materials for full details on the criteria. The criteria are consistent with existing principles.