Introduction

Discretionary trusts, also known as family trusts, are an important asset protection tool. They provide flexibility in deciding how and when beneficiaries get income and assets. This quality makes them ideal for families aiming to handle wealth smartly, cut down taxes, and safeguard the trust’s treasures. Delving into this topic is crucial for anyone wanting to grasp how a discretionary trust serves as a superb estate planning tool, offering both security and peace of mind.

Understanding Discretionary Trusts

Discretionary trusts, often referred to as family trusts, are a type of trust where the beneficiaries do not have a fixed entitlement to the assets or income of the trust. Instead, the trust deed specifies a broad range of potential beneficiaries, and the trustee has complete discretion to decide who among these beneficiaries receives distributions of income and capital, and in what amounts.

In a discretionary trust, until the trustee exercises their discretion to allocate funds, potential beneficiaries are considered “objects” of the trust. They do not have a fixed interest or right to the trust’s assets, but have the right to be considered by the trustee for distributions. The broad flexibility in determining beneficiaries allows trustees to adapt to changing circumstances and the needs of the beneficiaries, providing advantages in asset protection and tax planning.

Despite the flexibility, the trust deed must clearly define the range of potential beneficiaries to avoid being voided for uncertainty. Discretionary trusts are commonly used in estate planning, family businesses, and for managing private investments due to their ability to offer asset protection and efficient tax distribution.

Key Features of Discretionary Trusts

Key Feature	Description
Discretionary Distribution	The trustee has full discretion over distributions, deciding who benefits and in what proportion.
Potential Beneficiaries	Broadly defined as “objects”; includes individuals, companies, other trusts, or unborn children.
Lack of Fixed Entitlement	No guaranteed share for beneficiaries; only a right to be considered for distributions.
Trustee’s Power and Responsibilities	The trustee manages assets and makes distribution decisions, with significant power and responsibility.
Role of Appointor	Provides a layer of oversight and control of the trust administration. The appointor has the power to remove trustees and appoint new ones.
Asset Protection	Assets are protected from creditors’ claims due to no fixed beneficiary entitlement.
Tax Efficiency	Income can be distributed to beneficiaries in lower tax brackets, reducing overall tax burden.
Flexibility	Allows adjustments based on family circumstances or tax planning needs.
Estate Planning	Used to control asset distribution after death, ensuring wishes are followed and taxes minimised.

Types of Discretionary Trusts

Discretionary trusts can be of various types, depending on their structure and function:

• Discretionary Family Trusts: These trusts are commonly used to manage family wealth and assets. They allow trustees to distribute income and capital among a broad range of potential beneficiaries, typically limited to family members. Discretionary family trusts can also offer tax benefits, such as the ability to pass franking credits and carry forward tax losses, provided a ‘family trust election’ (FTE) is made.
• Testamentary Trusts: Testamentary trusts are established through a will and come into effect upon the death of the testator. They are often used for estate planning, offering flexibility in distributing the deceased’s assets and providing tax advantages. These trusts can protect assets for beneficiaries, particularly minors or individuals who may require financial management.
• Child Maintenance Trusts: These trusts are specifically designed to provide for the maintenance of children after a relationship breakdown. They help manage and distribute assets for the children’s benefit and can offer tax efficiencies by distributing income to the children at lower tax rates.
• Special Disability Trusts: Established to provide for the care and accommodation needs of a person with a severe disability, these trusts offer specific social security and tax concessions. They are often set up by immediate family members and must adhere to strict regulations regarding the use of trust funds.

Benefits of a Discretionary Trust in International Estate Planning 

Discretionary trusts offer a range of benefits, making them an attractive option for international estate planning. Here are some key advantages:

• Accumulation of Assets for Beneficiaries: Discretionary trusts allow for the accumulation of assets, including capital, which can be distributed to beneficiaries in a tax-efficient manner. This feature is particularly beneficial for long-term wealth preservation and strategic estate planning.
• Flexibility in Distribution: One of the main advantages of discretionary trusts is the flexibility they provide in distributing income and capital. Trustees have the discretion to adjust distributions among beneficiaries based on changing needs and circumstances, without the need for altering the trust deed.
• Simplified Reporting: By restricting and specifying beneficiaries, discretionary trusts can simplify tax reporting. For instance, claiming tax losses, debt deductions, and managing franking credits becomes more streamlined under this structure.
• Capital Gains Tax Discount: Discretionary trusts benefit from a capital gains tax discount on the disposal of assets held for more than 12 months. This discount is applicable to the trust itself and can be passed on to beneficiaries, reducing the overall tax burden on capital gains.
• Tax Efficiency: The trust can allocate income to beneficiaries in lower tax brackets, thereby optimising tax liabilities. Additionally, small business concessions can be accessed, enhancing tax efficiency.
• Tailored Trust Deed: The trust deed of a discretionary trust can be customised to meet the specific needs of the principals and beneficiaries, providing further flexibility in estate planning and asset management.
• Asset Protection: Discretionary trusts offer a degree of asset protection, as the beneficiaries do not have a fixed entitlement to the trust’s assets. This protection is enhanced if a corporate trustee is used, shielding the trust’s assets from potential claims against individual beneficiaries.
• Ease of Winding Up: The structure of discretionary trusts allows for relatively straightforward winding-up processes compared to other business structures, making them a practical choice for estate planning.

Disadvantages of a Discretionary Trust for Asset Protection  

While discretionary trusts offer many benefits, they also have several drawbacks:

• Lack of Beneficiary Equitable Interest: Beneficiaries of a discretionary trust do not have a fixed equitable or proprietary interest in the trust property, so it is crucial to understand what are your rights as a beneficiary in NSW. This means they cannot count on receiving specific assets or income, as the trustee can change distributions at their discretion. This lack of certainty can be problematic for beneficiaries relying on the trust for financial stability.
• Legal Vulnerability: The flexibility of discretionary trusts can sometimes be a liability. Courts can intervene in the administration of these trusts, especially in family law cases. For instance, in Kennon vs Spry [2008] HCA 56, the High Court of Australia included assets from a discretionary trust in a property settlement, effectively overriding the trustee’s decisions and the trust’s structure. More recently, the courts have expanded this view, stating that even a beneficiary’s right to be considered for a distribution from a trust could be valued as “property” in a settlement, even without that person having control over the trust. This means that even an interest in a long-standing family trust could be vulnerable in a family law dispute.
• Family Trust Distribution Tax: Distributions made outside the designated “family group” in a family discretionary trust can attract a family trust distribution tax at the highest marginal tax rate. For the 2024-2025 income year, this tax is levied at 47%. The Australian Taxation Office (ATO) has identified FTDT compliance as a key area of focus for 2024 and 2025, especially for high-net-worth families. It’s crucial for trustees to make the appropriate elections and select the correct “test individual” to avoid this tax.
• Regulatory and Compliance Burdens: Managing a discretionary trust involves significant regulatory compliance, including complex tax reporting and PAYG calculations. This can be burdensome for business owners and add to the administrative overhead of operating a business.
• Trapped Losses: Losses incurred by the trust cannot be transferred to other entities, such as companies, and are “trapped” within the trust. These losses can only be used to offset future gains within the trust, which can limit tax planning flexibility.
• Complex Trust Loss Provisions: The trust loss provisions in tax law are complex and can complicate the administration of the trust. Understanding and applying these rules requires careful consideration and often professional advice.
• Potential for Resettlement: Changes to the trust deed, such as varying the terms or adding new beneficiaries, can be considered a “resettlement” of the trust. This can trigger capital gains tax (CGT) and stamp duty liabilities, which can be substantial.
• Personal Liability of Trustees: Trustees can be personally liable for the debts and obligations of the trust if the trust assets are insufficient to meet these liabilities. This can be a significant risk, especially if the trust is engaged in business activities.
• Land Tax Liabilities: Discretionary trusts are not entitled to the land tax exemption thresholds available to individual property owners. This can result in higher land tax liabilities for properties held within the trust.

These disadvantages highlight the complexities and potential risks associated with using discretionary trusts for asset protection and estate planning. It is essential to seek professional legal and financial advice to navigate these challenges effectively.

How Do Discretionary Trusts Different from Other Trusts for Wills and Estate Planning?

Aspect	Bare Trusts	Unit Trusts	Discretionary Trusts
Purpose	Holds assets for beneficiaries with defined shares.	Used for investment purposes, like property or business ventures.	Used for family and income distribution, providing flexibility in asset distribution.
Trustee’s Role	Acts according to beneficiaries’ instructions; no discretionary powers.	Manages trust assets and issues units to investors.	Has discretion in distributing income and capital among a broad class of beneficiaries.
Beneficiaries’ Rights	Beneficiaries have a fixed entitlement to the assets.	Unit holders have a fixed entitlement based on units owned.	No fixed entitlement; beneficiaries may receive income or capital at the trustee’s discretion.
Asset Ownership	Assets are held by the trustee; beneficial ownership is with beneficiaries.	Assets are held by the trust; unit holders own units.	Assets are held by the trust; beneficiaries do not have legal ownership.
Privacy and Asset Protection	Provides privacy; legal ownership is with trustee, not beneficiaries.	Limited privacy; unit holders’ interests are usually recorded.	Offers asset protection; assets are not owned by beneficiaries, protecting them from personal creditors.
Tax Efficiency	Limited tax benefits; income is typically taxed at beneficiaries’ rates.	Taxed at unit level, similar to partnerships.	The trust may distribute income to beneficiaries in lower tax brackets, optimising tax efficiency.
Flexibility	Less flexible; trustee follows set instructions.	Moderate flexibility; units can be transferred or sold.	Highly flexible; trustee can adjust distributions based on circumstances and tax planning needs.
Succession Planning	Assets usually pass directly to beneficiaries upon death.	Unit holders’ interests are transferred according to unit ownership.	Does not automatically form part of an individual’s estate; requires planning for succession.

How to Set Up a Discretionary Trust?

Establishing a discretionary trust involves several key steps, each crucial to ensure the trust’s legal and operational foundation. Here is a comprehensive guide on how to set up a discretionary trust:

• Select Trustee: The trustee manages the trust’s assets according to the trust deed. The trustee can be one or more individuals or a proprietary limited company (corporate trustee). Using a corporate trustee minimises personal liability and simplifies administration when there are changes in trustees, as the company remains the registered owner of the trust’s assets.
• Draft Discretionary Trust Deed: The trust deed outlines the rules governing the trust, including:
  • Beneficiaries: Defines who can benefit from the trust.
  • Trustee Powers: Details the trustee’s authority in managing and distributing the trust’s income and capital.
  • Financial Provisions: Addresses issues like trustee remuneration and payment of taxes or other expenses.
  • Trustee Changes: Procedures for appointing or removing trustees.
• Settle the Trust: The settlor, usually someone unrelated to the beneficiaries (to avoid tax implications), signs the trust deed and provides the initial settlement sum (often a nominal amount like $10). The settlor has no further involvement with the trust after this initial act.
• Trustee(s) Sign Trust Deed: The trustee(s) must formally accept their role by signing the trust deed and agreeing to be bound by its terms. This process typically involves holding a meeting where the appointment is officially acknowledged.
• Stamping: Stamp duty may be payable on the trust deed, depending on the jurisdiction. In New South Wales, stamp duty must be paid on the trust deed. For any trust deed signed on or after 1 February 2024, the stamp duty payable is $750, as per Section 58 of the Duties Act 1997 (NSW). This must be paid to Revenue NSW within three months of the trust’s establishment to avoid interest and penalties. An additional fee, typically $20, is charged for each duplicate of the deed that is stamped.
• Apply for ABN and TFN: The trust must obtain an Australian Business Number (ABN) and a Tax File Number (TFN). These can be applied for online through the Australian Business Register or with the help of an accountant. The process can take up to 28 days.
• Open a Bank Account: A bank account should be opened in the name of the trustee, acting as the trustee for the trust. The bank may require the trust ABN and a certified copy of the trust deed. The initial deposit in this account should be the settlement sum, followed by other contributions or transactions.
• Trust is Operational: Once these steps are completed, the trust is fully operational and can accept further contributions, borrow money, and make investments as allowed by the trust deed.

Australian Discretionary Trusts and Cross-Border Complexities

For families with international assets or beneficiaries, using an Australian discretionary trust requires careful navigation of specific tax traps.

Capital Gains Tax for Non-Resident Beneficiaries

A significant tax disadvantage exists when distributing capital gains to non-resident beneficiaries. Following the case of Peter Greensill Family Co Pty Ltd (Trustee) v Commissioner of Taxation [2021] FCAFC 99, the ATO’s confirmed position is that non-resident beneficiaries of a discretionary trust are taxed in Australia on capital gains distributed to them. Crucially, they are not entitled to the general CGT exemption that non-residents can normally claim for assets that are not “taxable Australian property” (like shares). This makes a discretionary trust a highly tax-inefficient vehicle for distributing capital gains to beneficiaries living overseas.  

Cross-Border Tax Implications

Distributing income to beneficiaries in other countries can create complex tax outcomes and severe reporting obligations. The treatment varies significantly by jurisdiction.

Jurisdiction	Tax on Beneficiary in Home Country	Key Australian Tax Consideration	Double Taxation Risk
United Kingdom	UK-resident beneficiaries are generally taxable on distributions. New rules from April 2025 may change how foreign income is treated.	In Australia, the trustee pays tax on behalf of the non-resident beneficiary on Australian-sourced income.	Medium: Double tax agreements largely provide credit for Australian tax paid, but the rules are complex.
United States	US beneficiaries are taxed on worldwide income, a key consideration covered in our guide to the United States for international estate planning. Punitive “throwback rules” with interest can apply to accumulated trust income. US “grantor trust” rules may tax the US person who set up the trust on income as it is earned, regardless of distribution.	The trustee pays tax in Australia on the distribution.	High: There is a significant risk of double taxation, as US and Australian rules may tax different people (e.g., the settlor vs. the beneficiary), making it difficult to claim tax credits. Mandatory, complex IRS reporting on forms like the 3520 and 3520-A is also required, with severe penalties for non-compliance.
Singapore	Resident beneficiaries must declare their share of taxable income, a topic explored in our comprehensive guide to international estate planning in Singapore. Singapore does not tax capital gains.	The trustee pays tax in Australia on Australian-sourced income. Capital gains are taxable in Australia, even if not in Singapore.	Low to Medium: The double tax agreement provides relief for income, but the different treatment of capital gains can result in tax being paid in Australia with no corresponding credit in Singapore.
Hong Kong	Hong Kong has a territorial tax system, so foreign-sourced income from an Australian trust is generally not subject to tax for a Hong Kong resident beneficiary, as explained in our guide to international estate planning in Hong Kong.	The trustee pays tax in Australia on behalf of the non-resident beneficiary on Australian-sourced income.	Low: Tax is paid in Australia, but typically no further tax is levied in Hong Kong on the distribution.

Conclusion: Discretionary Trusts Help You Distribute Your Trust Income and Capital as You Like

Discretionary trusts offer a unique blend of flexibility, asset protection, and tax benefits, making them a valuable tool in estate planning. However, they come with specific responsibilities and complexities that require careful management.

If you’re considering setting up a discretionary trust, it’s vital to seek professional advice to ensure it aligns with your family’s needs and financial goals. For personalised guidance and support, contact our international estate planning lawyers at PBL Law Group today.

Frequently Asked Questions (FAQ)