How trust distributions work and common pitfalls

Each financial year, the trustee of a discretionary trust must decide how to distribute the trust’s income among the beneficiaries by 30 June (or any earlier date the deed requires). This decision is documented in a trustee resolution, which must be made and recorded by the end of the financial year. One exception: a beneficiary can be made specifically entitled to a capital gain up to two months after year end (by 31 August), but franked distributions must be streamed by 30 June. If no resolution is made, the default provisions of the trust deed apply, and in some deeds, the consequences of failing to make a resolution can be severe.

The trustee’s resolution must clearly specify which beneficiaries are to receive income and in what proportions. It should also address the character of the income being distributed, for example, whether capital gains or franked dividends are being streamed to specific beneficiaries. The streaming of capital gains and franked distributions is permitted under Subdivisions 115-C and 207-B of the ITAA 1997, but only if the trust deed gives the trustee the power and a beneficiary is made specifically entitled.

A common pitfall is making the distribution resolution after 30 June. The ATO has consistently taken the position that a resolution made after the end of the financial year is ineffective, meaning the trustee may be personally assessed on the trust’s taxable income at the top marginal rate plus Medicare levy (currently 47%). This makes the timing of the resolution critical.

Another common issue is distributing to beneficiaries who do not have capacity to receive the distribution, for example, distributing to a minor under 18 (which triggers penalty tax rates under Division 6AA), distributing to a non-resident (which may trigger withholding tax obligations), or distributing to a beneficiary who has not been properly included in the class of beneficiaries defined by the trust deed.

The ATO is also focused on section 100A. If a beneficiary is made entitled to income but the benefit is in substance provided to someone else under an arrangement (for example funds passed back to parents or kept by the trust), the entitlement can be disregarded and the trustee taxed at the top rate. The ATO’s views are in TR 2022/4 and PCG 2022/2, and distributions to adult children and corporate beneficiaries should be reviewed against them.

The trustee should work with the trust’s tax adviser to plan distributions before 30 June each year. The distribution resolution should be prepared, reviewed, and signed before the deadline. CoSec Partners can prepare template distribution resolutions as part of our corporate secretarial services.