04 Sep Australian Government Releases Exposure Draft Legislation Responding to Concerns on the Impact of Discretionary Trust Reforms on Charities
Yesterday the Australian Government released exposure draft legislation proposed to implement its budget commitment to tax discretionary trusts. Our prior update here outlined the potentially detrimental effect on distributions from discretionary trust to Australian charities and not-for-profits. In releasing the material, the Government has clarified that ‘the exemptions in the draft legislation are intended to ensure there is no disincentive for these distributions to continue.’[1] In this update we analyse the Government’s proposal, taking account of the concerns raised by the sector. As we show, while the Government’s efforts represent a significant improvement on the initial proposal, further changes are needed to ensure that charities and not-for-profits are no worse off than they are under the current law.
EXCLUDING INCOME DISTRIBUTED TO CHARITIES AND DGRS
The reforms propose that ‘all distributions from trusts to registered charities and deductible gift recipients will be excluded from the minimum tax.’[2] This is a welcome response to concerns expressed by the charity sector.
Proposed section 101AE is the provision that excludes income distributed to charities and DGRs from the taxable income of a discretionary trust. Proposed s 101AA assesses the trustee on net income that is ‘minimum tax income’. Proposed section 101AC removes from that definition any income ‘excluded’ by section 101AE. Proposed section 101AE(1)(d) excludes any ‘share of the net income of the trust estate’ attributable to ‘a registered charity or a deductible gift recipient’. This means that businesses that elect to stay within a discretionary trust structure will retain the ability to give in pre-tax dollars to charities and DGRs at their current levels, and with the discretion to include new charities and surplus amounts from time to time. This alteration to the original proposal is a significant change in response to the concerns of the sector, including as outlined in our further prior update here, and will be welcomed by the sector.
Proposed section 101AE(1)(e) excludes any ‘share of the net income of the trust estate’ attributable to ‘an exempt entity’ that is not ‘a registered charity or a deductible gift recipient’. This exempts payments to non-charitable but self-assessing tax exempt entities. These entities are community service organisations, cultural organisations, educational organisations, health organisations, employment organisations, resource development organisations, scientific organisations and sporting organisations.
Proposed section 101AE(2) also provides that the Minister may determine conditions that must be met to satisfy the requirements for excluded income. These conditions may relate to both charities/DGRs and self-assessing entities, anticipating yet to be identified ‘integrity rules’ and notification requirements. This power could encompass, for example, the power to require the trustee of a discretionary trust to identify the charitable beneficiaries and the associated distribution amounts in its tax returns. Trustees are also likely to be required to pass resolutions prior to the end of the financial year in order to ensure that payments made to charities do not incur the trustee tax.
The legislation also proposes that the Minister may impose a cap on the amount that can be distributed as exempt income by a discretionary trust to self-assessing entities. Although it is not expressly stated in the conditions specific to charities and DGRs, those conditions do not prevent the Minister imposing a similar cap on charities and DGRs (this is because the cap that applies to non-charity self-assessing income tax exempt entities under section 101AE(3) is expressed to not limit the powers of the Minister in respect of charities under section 101AE(2)). To provide sufficient certainty to the sector, the reforms should expressly exclude the possibility that the Minister may impose a cap on the amount that discretionary trusts can give to charities and DGRs.
Loss of Philanthropy due to Rollover
While welcome, this reform by itself will not address the concern that discretionary trusts will migrate to other structures with more favourable tax treatment where their beneficiaries are below an average 30% tax rate. Those businesses operated through discretionary trusts in which the primary business owners are below an average 30% tax rate are incentivised to either rollover to base rate companies (which have a lower 25% tax rate), or make an election to fix the current discretionary interests and thus opt-out of the minimum 30% tax rate (that further option is discussed below).
To enable continuing distributions to be made to charities, those entities that rollover to a base rate entity may decide to retain the discretionary trust as a shareholder in the company. However, to ensure the discretionary trust shareholder can continue its current levels of support to charities, it would be necessary to grant those charities that receive distributions from a discretionary trust shareholder a further ability to claim a refundable tax offset (in the form of a franking credit) that is attached to the franked dividend paid by the base rate entity to the discretionary trust and then to the charity.
This will occur where the refundable tax offset provided by the company to the shareholder discretionary trust is treated as excluded income by operation of section 101E(1)(d). The Government clarifies that ‘the tax treatment of corporation distributions flowing through trusts that do not relate to income subject to the minimum tax will be unaffected.’[3] The Government therefore intends that the charity’s ‘share of the net income of the trust estate’ will therefore include the refundable tax offset issued by the company to the trust.
For those trusts that do rollover to base rate companies and retain the discretionary trust as shareholder, the proposal entails burdens on business-operator donors and charities that are not currently imposed. The principal difference for donors is that the rollover of the business to the new company may incur stamp duty and is likely to involve higher ongoing accounting and compliance costs associated with the new company and maintaining the existing trust shareholder. Further, as the percentage shareholding held by the discretionary trust is fixed, the business owners will lose the discretion to vary the amount of their donations to selected charities from year to year. They would be bound to give the same total proportionate amount to charities in each year, although they would retain discretion in selecting the charities the trust gives to year on year. One way for business owners to reintroduce a level of donor discretion may be to establish a charitable trust to receive donations from their discretionary trust, with a view to passing on those donations to other charities over time as the need arises.
The practical effect for charities is that they will now have the additional administrative burden of claiming the refundable tax offset (in the form of a franking credit), and experience a delay in receiving funds they would have otherwise had automatically. This may present cash-flow issues for charities that rely upon regular giving through trusts, at least for the initial stage of the reform. This would effectively enable the same tax outcome as currently exists for the charity, but at a higher compliance cost.
In summary, for those trusts that rollover to base rate companies and retain the discretionary trust as shareholder, the Government’s intent is that the 25% franking credit passes from the company unaffected by its passage through the discretionary trust and is then claimable by the income tax exempt charity. When combined with the fact that the payment through the trust to the income tax exempt entity is not subject to the 30% discretionary trust tax, the net effect is that the income tax exempt entity would be in the same position under the reform as it is under the current law (albeit with the loss of the discretion that it currently enjoys to distribute additional or varying amounts to charities year on year, as identified above).
ELECTIONS
In addition to the above, the Government also proposes that trustees may make an election to ‘make fixed distributions to pre-nominated beneficiaries, and not have the minimum tax apply as a result’. This is proposed ‘as an alternative to restructuring’ to base rate entities.[4] Under proposed section 102UYB the election must nominate the beneficiaries who are to receive income and capital and state their unalterable proportion of that income and capital. In so doing, the Government seeks to minimise discretion in the streaming of income amongst members of a family unit to lessen the overall tax burden of the family, as the ability to make an election will not be available to future discretionary trusts.
However, the imperative to minimise income streaming does not necessitate limiting the ability of discretionary trusts to make distributions to charitable institutions. The beneficiaries listed in the election can include charities, deductible gift recipients and tax exempt entities.[5] However, the election may be made only once, within the 2028-29 financial year, and cannot be altered. This means that the current ability for business owners that operate discretionary trusts to distribute to differing charities each year and to allocate differing amounts to those charities in each year in accordance with their preference will be lost.
Enabling donor discretion is key to philanthropic effort. By way of illustration, under the reform a business owner would be precluded from giving one-off tax-free distributions to alleviate the needs of persons afflicted by sporadic future natural disasters, of which the floods in Nepal are a current illustration. To take a further worked example, if a business owner living in Sydney in 2028 elects to make a distribution to support their local tennis club, but then ten years later retires to the Central Coast, they will be prevented from transferring their support to their new local tennis club. These arbitrary outcomes will prove to be a significant disincentive to those who wish to continue their philanthropic efforts through discretionary trusts.
These barriers to Australian philanthropy do not currently exist. To avoid these outcomes, and maintain the current status quo in terms of philanthropic support to the community, the Government should amend the proposed legislation to enable trustees to retain the discretion to distribute tax-exempt income to any registered charity or deductible gift recipient. This should not be limited to charities that are existing and which are nominated in the initial election, but rather should include those charities identified from year to year according to the philanthropic discretion that the business owner wishes to exercise at that time. To give effect to this reform, the definition of ‘eligible company’ at section 102UYC will need to be amended to enfold charities, DGRs and self-assessing institutions, as the current limitations stated at that section will exclude many such entities.
This would enable the ‘first fruits’, as it were, of the effort of the business owners to be applied to charitable causes. The fixed proportions allocated to individual business owners should then relate to the remainder of the taxable income of the trust after each year’s distribution to charities, deductible gift recipients or self-assessing entities. This will enable the continuation of the practice of discretionary surplus giving in good years, not according to fixed proportions over time, but according to the discretion that the business owners wish to apply from year to year.
In summary, it is proposed that the election framework should be modified to establish a voluntary conversion framework allowing discretionary trusts to convert into a hybrid trust structure in which family holdings are limited to fixed units and in which a separate non-fixed discretion to make distributions to charities is provided. As this option would not require the discretionary trust to become a shareholder in a separate base rate entity, there would not be a need for charities and income tax exempt entities to claim a refundable tax offset (in the form of a franking credit), negating the cash flow issues and additional administrative burden identified above in respect of the option involving discretionary trust shareholders.
In retaining the ability to give to charities on a discretionary basis, this option also avoids the loss of the discretion entailed with the option of a discretionary trust shareholder identified above, whereby business owners are bound to give the same proportionate amount to charities in each year, being determined by the associated shareholding. In keeping the reform internal to the existing trust framework, this option will also avoid the ongoing additional accounting costs incurred as a result of the creation of an additional entity required under the discretionary trust as shareholder option.
Conclusion
The proposal that an existing discretionary trust may assume the role of a shareholder in the same business does not provide the flexibility to philanthropists afforded by the further option of enabling trusts to provide an election that retains their ongoing discretion to give to charities. In our experience, to this day many business owners remain unaware of the way that discretionary trusts may be used in a tax-effective manner to enlarge their philanthropic contribution. Many still give out of already-taxed dollars that they have received from their discretionary trust. The renewed public focus on tax-effective giving through discretionary trusts afforded by the reforms presents an opportunity for charity networks to make their donors aware of this long-standing ability, and thus expand their current funding. To that end, whatever form the reforms ultimately take, charities would be well-advised to ensure that their donors are aware of the steps that must be taken in order to preserve their ability to donate in pre-tax dollars.
Treasury is seeking submissions on the reform. The consultation remains open until 18 September 2026.
[1] Australian Government, Minimum Tax on Discretionary Trusts Exposure Draft Legislation Explainer (03 September 2026) 2 available at https://consult.treasury.gov.au/c2026-799771
[2] Ibid 1.
[3] Ibid 2.
[4] Ibid 1.
[5] Exposure Draft Explanatory Memorandum, Treasury Laws Amendment Bill 2026 [1.27].
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