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The 26-27 Federal Budget outlined a minimum tax measure that will impact the treatment of franking credits flowing from discretionary trusts to beneficiaries.
The proposed treatment, which would apply from 1 July 2028, means franking credits will no longer be refundable to the individual and that trustees will pay a minimum rate of at least 30% tax on distributions from discretionary trusts.
The Government has long had a focus on discretionary trusts because these trusts are able to distribute income to lower income individuals, typically children, and thereby reduce the overall tax collected by the Commonwealth. The proposal is that a minimum tax will apply to income from discretionary trusts, which must be offset against any franking credits received, inevitably resulting in the loss of those franking credits. The lustre of discretionary trusts fades and their exclusive benefit is now asset protection, rather than income flexibility, unless you are a wealthy beneficiary.
Is a 30% tax on income from discretionary trusts fair?
At first glance, paying tax at a 30% rate seems reasonable given the 30% tax rate kicks in at $45,001. Indeed, articles refer to the ‘marginal’ rate of 30%, which occurs when taxpayer individuals have incomes within the range of $45,001 to $135,000.
In other words, tax is paid at a rate of 30% on amounts above $45,000, but not on amounts below $45,000. So if the rate is 30% after $45,000, it’s only the first $45,000 affected, isn’t it?
Well, we shouldn’t look at marginal rates of tax.
Doing so obscures the real cost of holding shares in discretionary trusts. Instead, we should consider the average rate of tax.
Under the current rules, an individual earning $45,000 of dividend income, including the franking credit of $13,500 through their trust, would pay a total amount of $4,863 tax in 2025-26: an average rate of 10.8%. Given that, in our example, $13,500 in tax had already been paid through the imputation system, the individual should expect a refund of $8,637. This is exactly the same position if the taxpayer held the shares in their personal name.
Under the announced Budget measure, the individual beneficiary of a discretionary trust holding shares, would not receive the refund of $8,637. They would have no further amount to pay, but they would have paid tax of $13,500: an average rate of 30%.
| Current rule | After 1 July 2028 | Current rule | After 1 July 2028 | Current rule | After 1 July 2028 | Current rule | After 1 July 2028 | |
|---|---|---|---|---|---|---|---|---|
| Trust income | 45,000 | 45,000 | 70,000 | 70,000 | 199,188 | 199,188 | 300,000 | 300,000 |
| Tax payable | 4,863 | 13,500 | 13,188 | 21,000 | 59,756 | 59,756 | 107,138 | 107,138 |
| Tax paid | 13,500 | 13,500 | 21,000 | 21,000 | 59,756 | 59,756 | 90,000 | 90,000 |
| Tax payable (refund) | (8,637) | 0 | (7,812) | 0 | (0) | 0 | 17,138 | 17,138 |
| Net cash position | 40,137 | 31,500 | 56,812 | 49,000 | 139,432 | 139,432 | 192,862 | 192,862 |
Personal income would need to reach $199,188 before an average tax rate of 30% applies. Up until that point, a taxpayer would have received a refund had they received fully franked dividends. At an average $70,000 income for an Australian, an individual taxpayer would be $7,812 worse off if their income was held through a discretionary trust after 1 July 2028. Effectively, mum and dad investors holding their investments in a discretionary trust each need to receive an income of $199,188 before they are in the same tax position as an individual investing in their own name. Wealthy people investing through discretionary trusts are not directly impacted by this part of the Budget, where their incomes exceed $199,188, but the same cannot be said for the low or middle-income earning Australians.
For individuals receiving more than $199,188 in franked dividends through a discretionary trust, the benefits of both asset protection and flexible income distribution remain unchanged, and for them discretionary trusts will live on.
FOR MORE INFORMATION
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