Discretionary trusts — often called family trusts — are among the most widely used structures for small to medium businesses in Australia. They offer flexibility in distributing income to beneficiaries and can be effective tax planning vehicles. They also create bookkeeping complexity that catches many practitioners off-guard.
If your client operates through a discretionary trust, you need to understand how distributions work, what records the trustee must keep, and how the trust's accounts interact with the beneficiaries' individual returns. This guide covers the essentials.
How Discretionary Trusts Work
A discretionary trust has three key parties: the settlor (who establishes the trust), the trustee (who holds and manages the assets), and the beneficiaries (who may receive distributions at the trustee's discretion). A corporate trustee is common for asset protection reasons.
The trust itself is not a taxpayer in the way a company is. Instead, the trust's net income is distributed to beneficiaries each year, and those beneficiaries pay tax on their share at their personal marginal rate (or company rate if the beneficiary is a company). If the trustee fails to distribute all the trust's income by 30 June, the undistributed amount is assessed to the trustee at the top marginal rate — currently 47%. This is one of the most important EOFY deadlines for trust clients.
Trust Distributions and Resolutions
The mechanism for allocating income to beneficiaries is a trustee resolution — a formal decision made before 30 June each year that specifies how much of the trust's net income each beneficiary will receive.
The resolution must be made before midnight on 30 June. Courts have been consistent that resolutions made after this time (even 1 July) are ineffective. This means the bookkeeper and accountant need the trust's financial position to be substantially finalised before EOFY.
In the accounts, the distribution creates a liability from the trust to each beneficiary — an "amount owing to beneficiaries" entry. When the cash is actually paid to the beneficiary (which may happen over weeks or months after 30 June), the liability is extinguished. The timing of the actual payment matters less than the resolution date.
Coding Trust Distributions in the Accounts
The year-end trust distribution is recorded as follows:
30 June entry:
- Debit: Retained earnings / Trust distributable income
- Credit: Beneficiary loan account (one account per beneficiary)
This creates the liability. When cash is paid:
- Debit: Beneficiary loan account
- Credit: Bank
If a beneficiary's loan account shows a debit balance (i.e., they've taken more cash out than their distribution entitles them to), that's a loan from the trust to the beneficiary — which may trigger Division 7A obligations if the trustee is a company, or other issues. Flag this to the accountant immediately.
Bucket Company Structures
Many discretionary trusts make distributions to a corporate beneficiary — often called a "bucket company" — which pays tax on the distribution at the corporate rate (currently 25% for base rate entities) rather than the higher individual marginal rate. The after-tax amount is then retained in the company for future investment.
The bucket company arrangement works well when beneficiaries are in high personal tax brackets and the trust generates significant income. The bookkeeping implications:
- The bucket company must have its own separate set of accounts
- The distribution from the trust creates a loan from the trust to the company (if not paid in cash promptly)
- Division 7A applies when the bucket company lends money back to the individual beneficiaries — there must be a complying loan agreement at the ATO benchmark rate
- Unpaid trust distributions to the bucket company must generally be paid within the time required under trust law and tax rules
Interposed Entity Transactions and Division 7A
Division 7A is a persistent risk in trust structures. The most common scenarios:
- Trust distributes to a bucket company; the company then informally pays the funds to the individual shareholder/trustee without a complying loan agreement — deemed dividend
- Trust distributes to a corporate trustee, which is also a company beneficiary — complex layering creates compliance risk
- Trustee (corporate) lends money to a beneficiary who is also a shareholder of the corporate trustee — Division 7A triggered
Your role is to identify these flows when they appear in the transaction records and escalate to the accountant. Don't attempt to resolve Division 7A issues without qualified tax advice.
The Trust Tax Return vs Individual Returns
Trusts lodge their own tax return (the Trust Tax Return) but pay no tax at the trust level if all income is distributed. The individual beneficiaries include their share of the trust's net income in their personal returns, at their own marginal rate.
This means the trust's year-end accounts must reconcile with the individual tax returns. If the trust shows $200,000 of distributable income and the tax return shows distributions to three beneficiaries of $60,000, $70,000, and $70,000 — all three numbers must be supportable from the trust's accounts.
Keep trust accounts and individual accounts entirely separate. Never consolidate them for convenience — the ATO and auditors look at each entity independently.
Practical Checklist Before 30 June
- Ensure the trustee resolution is drafted with the accountant well before 30 June
- Confirm the trust's net income figure is reliable enough to support the resolution amounts
- Check for any beneficiary loan account debit balances (potential Division 7A or excess distribution issues)
- Ensure corporate beneficiary (if any) has its own separate, up-to-date accounts
- Confirm all prior-year distributions have been formally recorded
Discretionary trusts reward careful bookkeeping. When the records are clean and the resolutions are properly documented, the year-end compliance is straightforward. When they're not, you're looking at potential tax penalties, deemed dividends, and a great deal of professional stress.