The discretionary family trust is one of the most common structures used by Australian small and medium businesses. It is also one of the most misunderstood. Used well, it offers flexibility, protection and a clean path to succession. Used carelessly, it invites scrutiny, penalty tax and family disputes.
This guide walks through how a family trust actually works, the benefits worth having and the trade-offs that catch owners out. The goal is to help you ask better questions before you sit down with your adviser, not to make the decision for you.
How A Family Trust Works
A discretionary trust is a relationship, not a company. A trustee (an individual or, more commonly, a company) holds and controls the assets. The trust deed sets the rules. The people who can benefit are the beneficiaries, usually defined as a family group rather than fixed shareholders.
The word that does the heavy lifting is “discretionary”. Each year the trustee decides which beneficiaries receive income and in what proportions. There are no fixed entitlements, which is exactly what gives the structure its flexibility.
That flexibility comes with formality. The trust deed governs what the trustee can and cannot do. The trustee must act within it. Getting the deed right at the outset matters more than most owners realise.
The Genuine Benefits
The headline benefit is flexible income distribution. Because the trustee chooses how to allocate income each year, business profits can be directed to adult beneficiaries on lower marginal rates, which can reduce the overall family tax bill.
Asset protection is the second draw. Where the trustee (ideally a corporate trustee) holds the assets, those assets generally sit outside the personal estate of any single beneficiary. That separation can offer a measure of protection if a beneficiary faces a personal claim, though it is never absolute and depends heavily on how the trust is run.
Succession is the third. A trust does not die with its owner. Control can pass through the appointor and trustee roles, allowing a business to move to the next generation without the asset itself changing hands and triggering a sale.
The Cost And Complexity
A trust is more expensive to establish and run than operating as a sole trader or partnership. You will typically need a professionally drafted deed, a corporate trustee, annual financial statements and a separate trust tax return.
The administrative load is ongoing, not one-off. Each year the trustee must make and document distribution decisions, lodge returns and keep the structure compliant. For a very small business with modest profits, the cost can outweigh the benefit.
You also lose some simplicity. Funds in the trust are not your personal money in the way a sole trader’s are. Moving cash around carries tax consequences that need thought.
Losses Stay Trapped
This is the trade-off owners most often miss. A trust cannot distribute a loss to beneficiaries the way it distributes income. Where the trust makes a tax loss, that loss is generally trapped inside the trust and carried forward, subject to the trust loss rules, to offset against future trust income.
For a business in an early or volatile phase, that matters. If you expect losses in the first few years, the inability to push those losses out to offset other income is a genuine limitation worth weighing against the income-splitting upside.
Anti-Avoidance Scrutiny
The flexibility that makes trusts attractive also makes them a focus for the ATO. Two regimes deserve attention.
Section 100A targets “reimbursement agreements”, broadly where a beneficiary is made presently entitled to income but someone else gets the benefit, with a tax-reduction purpose. Where it applies, the income is taxed in the trustee’s hands at the top marginal rate. The ATO has set out its compliance approach in PCG 2022/2 and its view of the law in TR 2022/4, so distributions that are not genuine or sit outside ordinary family dealing carry real risk.
Part IVA, the general anti-avoidance provision, can also apply to arrangements entered into for a dominant purpose of obtaining a tax benefit. Distributions to beneficiaries on low rates who never actually receive the funds are a classic trigger. The lesson is consistent: distributions need to be real, documented and defensible.
Family Trust Elections And The Family Group
In some cases a trust will make a family trust election (an FTE), which nominates a “test individual” whose family group defines who can benefit on concessional terms. An FTE can help the trust access certain concessions, including a simpler path through the trust loss rules.
The catch is the family group boundary. Once an FTE is in place, distributions made outside the test individual’s family group attract family trust distribution tax, imposed at the top marginal rate. An election is not something to make lightly, because it locks in who the trust can sensibly benefit for the long term.
Trustee Duties And The 30 June Trap
The trustee carries real legal duties: to act in the interests of beneficiaries, within the deed and with proper care. A corporate trustee does not remove those duties; it houses them.
The practical trap is timing. For a distribution to be effective, the trustee generally needs to make beneficiaries presently entitled to the trust income by the end of the income year, that is, by 30 June. Miss that deadline and the trustee can be assessed on the trust’s income at the top marginal rate.
One related point on income splitting: distributing to minors does not deliver the saving many expect. Unearned income distributed to a minor is generally taxed at penalty rates up to the top marginal rate, so children rarely make effective beneficiaries for income-splitting purposes.
Where Foothold Advisory Fits
A family trust can be a strong foundation for an SME, but only when the structure matches your circumstances, your risk profile and your plans for the business. The wrong structure is expensive to unwind.
Before you decide, run the numbers and pressure-test the options. A structure options review with Foothold Advisory, paired with our structure comparison calculator, will help you see the trade-offs side by side before you take the result to a lawyer and a registered tax agent to implement. Book a consultation to talk it through.
General information only. This article provides general information about Australian business structuring and tax concepts and is current as at its publication date. It is not legal, tax or financial advice. Foothold Advisory is not a registered tax agent and is not a law firm. Structuring, succession and acquisition decisions have legal and tax consequences that depend on your circumstances and timing. Before acting, obtain advice from a lawyer and a registered tax agent.