The Federal Government’s proposed crackdown on discretionary family trusts could create a far more severe tax outcome than many business owners, investors and family groups first expected.

Initial post-budget analysis suggested the proposed rules may result in an effective tax rate of around 51% on certain trust distributions, with some estimates suggesting the rate could rise as high as 63% in more complex scenarios. However, closer examination of the budget material has raised concerns that the ultimate tax cost for trusts using corporate beneficiaries, commonly known as “bucket companies”, could potentially be even higher.

In some cases, the total effective tax rate could approach 70%.

For families and business owners who use discretionary trusts as part of their wealth, investment, business or asset protection strategy, this is a significant development. The proposed changes could materially affect how income is distributed, how profits are retained, and whether existing family group structures remain appropriate.

Although the final legislation has not yet been released, the policy direction is clear: the Government is seeking to reduce the tax advantages associated with discretionary trust distributions, particularly where income is directed to companies rather than individual beneficiaries.

What is a bucket company?

A bucket company is a corporate beneficiary that receives income distributions from a discretionary trust.

In many family groups, a discretionary trust earns income from business profits, investment portfolios, property holdings, or other assets. The trustee then decides which beneficiaries will receive the trust income each financial year.

Where individual beneficiaries are already on high marginal tax rates, the trustee may distribute some income to a related company. This can allow the income to be taxed at the corporate tax rate rather than at the top individual marginal tax rate.

This approach has commonly been used to manage tax, retain profits within a family group, fund future investments, support business working capital, or build wealth over time.

For example, rather than distributing income to an individual who may be taxed at up to 47%, including the Medicare levy, a trust may distribute income to a company that is taxed at a lower corporate rate. The company may then retain those funds, invest them, or pay dividends at a later time.

This is why bucket companies have become a common feature in many family wealth structures.

Why the proposed changes matter

The proposed rules appear to be aimed at ensuring that discretionary trust distributions are subject to a minimum level of tax. However, the concern is that the way the rules may operate could go beyond a minimum tax rate and result in the same income being taxed more than once.

This is particularly important for trusts that distribute income to companies.

The issue is not simply that a higher tax rate may apply. The larger concern is that tax may be applied at the trustee level and then again at the company level, potentially without appropriate credits being passed through to recognise tax already paid.

That could create a double-taxation outcome.

For families who have used bucket companies for many years, this may require a fundamental review of their current arrangements.

How double taxation could arise

The key concern is whether a corporate beneficiary will receive credit for tax paid by the trustee.

Under the budget material, it appears that the trustee may be taxed on income distributed to a corporate beneficiary. However, the corporate beneficiary may still be assessed on the full amount of its entitlement.

This means that, in practical terms, the same trust income could be taxed twice.

For example, assume a discretionary trust distributes $100 of income to a bucket company.

Under a more conventional approach, the trust or the company would be taxed in a way that avoids duplicating tax on the same $100. However, the concern raised by tax specialists is that the proposed rules may impose tax at the trustee level on the $100 and then tax the bucket company again on the full $100 distribution.

If the trustee-level tax is 30% and the company is also taxed at 30% on the same amount, the combined tax impost could be 60%.

That is significantly higher than the 51% originally suggested by some early modelling.

The outcome becomes even more severe where the company later pays a dividend to an individual shareholder who is on the top marginal tax rate.

How the effective tax rate could approach 70%

The potential tax cost does not necessarily stop once the bucket company has paid tax.

If the company later pays a franked dividend to an individual, additional tax may be payable depending on that individual’s marginal tax rate and the availability of franking credits.

Where the final recipient is taxed at the top marginal tax rate of 47%, including the Medicare levy, the total tax collected across the trust, company and individual levels could potentially rise to just under 70%.

This would be an exceptionally high effective tax rate when compared with the current top individual marginal tax rate.

It would also significantly reduce the after-tax benefit of using a bucket company as part of a family group structure.

For example, where a family trust distributes income to a bucket company with the intention of retaining profits for investment, the proposed rules could substantially reduce the capital available for reinvestment. Over time, this may affect compounding returns, liquidity, debt repayment capacity, and broader wealth accumulation strategies.

Why family groups use discretionary trusts

Discretionary trusts are not used only for tax reasons. They are often central to broader financial planning and wealth structuring.

A family trust may be used to hold investment assets, operate a family business, manage intergenerational wealth, provide flexibility in income distribution, support estate planning objectives, and offer a degree of asset protection.

For business owners, discretionary trusts can also provide commercial flexibility. Income can be distributed in a way that reflects changing family circumstances, business needs, and investment priorities.

For example, one year a family may distribute income to an adult child who is studying or working part time. Another year, income may be distributed to a spouse or retained within a company for future investment. The flexibility of the structure is often one of its main attractions.

However, the proposed crackdown may reduce that flexibility, particularly where corporate beneficiaries are involved.

Who may be affected?

The proposed changes may affect a wide range of taxpayers, including:

• family business owners who operate through discretionary trusts;
• investors who hold shares, property or managed investments through family trusts;
• professional families using trusts as part of long-term wealth planning;
• high-income households that distribute income to corporate beneficiaries;
• groups with existing bucket companies and unpaid present entitlements;
• families using companies to retain profits for future investment;
• trustees who regularly distribute income to adult beneficiaries and corporate beneficiaries.

The impact will depend on the final legislation, the structure of the family group, the type of income being earned, the beneficiaries involved, and whether corporate beneficiaries are currently used.

Even families that do not currently distribute to a bucket company should pay attention, as the rules may affect future planning options.

Unpaid present entitlements may need review

One area that may require particular attention is unpaid present entitlements, commonly referred to as UPEs.

A UPE can arise where a trust distributes income to a beneficiary, such as a bucket company, but does not physically pay the cash to that beneficiary at the time. Instead, the amount remains owing.

Many family groups have historical UPEs sitting between trusts and corporate beneficiaries. These arrangements may have been established over many years as part of a broader tax and cash flow strategy.

If the proposed rules change the tax treatment of trust distributions to corporate beneficiaries, trustees and advisers may need to review how existing UPEs are managed, whether repayment arrangements are appropriate, and whether further distributions to corporate beneficiaries remain viable.

This review should also consider Division 7A implications, loan agreements, interest obligations, cash flow, and the company’s future dividend strategy.

The broader financial planning impact

The proposed trust changes are not merely a tax issue. They may affect broader financial planning decisions.

A higher tax rate on trust distributions may reduce the amount of after-tax income available for investment, superannuation contributions, debt reduction, family support, education funding, retirement planning, and business reinvestment.

For business owners, reduced after-tax cash flow may limit the ability to fund expansion, purchase equipment, employ staff, repay loans, or build reserves.

For investors, a higher effective tax rate may change the attractiveness of holding assets through a trust compared with other structures.

For families approaching retirement, the rules may affect how income is drawn from family entities and how wealth is transferred between generations.

For families with estate planning objectives, the changes may require a reassessment of how control, income and capital are passed to the next generation.

Should families restructure?

The possibility of a higher tax rate does not automatically mean every family trust should be restructured.

A trust may still be appropriate for asset protection, estate planning, succession planning and investment flexibility. In many cases, the non-tax benefits of a discretionary trust may remain valuable.

However, the tax assumptions supporting the structure may need to be revisited.

Any restructure should be approached carefully. Moving assets out of a trust or changing ownership structures may trigger capital gains tax, stamp duty, legal costs, refinancing issues, commercial risks, and unintended estate planning consequences.

For some families, the best approach may be to adjust annual distribution strategies. For others, it may involve changing how profits are retained, reconsidering the use of corporate beneficiaries, or introducing alternative structures for future investments.

The right answer will depend on the family’s objectives, asset base, income level, risk profile, and long-term plans.

Planning questions to ask now

Families using discretionary trusts should start reviewing their position before the legislation is finalised.

Important questions include:

• Does the trust currently distribute income to a bucket company?
• What amount has historically been distributed to corporate beneficiaries?
• Are there unpaid present entitlements between the trust and company?
• Are Division 7A loan arrangements properly documented and managed?
• How much tax would be payable if distributions to companies were no longer attractive?
• Would income be distributed to individuals instead?
• Are those individuals on high marginal tax rates?
• Does the company retain funds for investment, business cash flow or asset protection?
• What impact would a 60% or 70% effective tax rate have on the family’s wealth strategy?
• Is the current structure still aligned with estate planning and succession objectives?
• Would future investments be better held in a company, trust, superannuation fund, or individual names?
• Are there opportunities to use superannuation more effectively as part of the broader plan?

These questions should be considered as part of a coordinated review involving financial planning, tax, accounting and legal advice.

Superannuation may become more important

If the proposed rules reduce the effectiveness of discretionary trust and bucket company strategies, superannuation may become even more important in family wealth planning.

Superannuation remains a concessionally taxed environment, subject to contribution caps, preservation rules and balance limits. For eligible individuals, concessional contributions, non-concessional contributions, spouse contributions and downsizer contributions may all form part of a broader tax and retirement planning strategy.

However, superannuation is not a direct substitute for a family trust. It has different rules, access restrictions and estate planning considerations.

A well-structured plan may involve using trusts, companies, personal ownership and superannuation together, with each structure serving a specific purpose.

Asset protection and estate planning still matter

A key risk in responding to tax changes is focusing only on the tax rate and ignoring the broader purpose of the structure.

Many families use trusts because they want flexibility, control and protection.

For example, a family trust may help separate investment assets from business risk, provide flexibility where children have different financial circumstances, assist with succession planning, or support vulnerable beneficiaries.

Even where the tax advantages are reduced, these benefits may still justify retaining the structure.

The important point is that the structure should be reviewed in light of the new rules, rather than abandoned without proper analysis.

The final legislation will be critical

At this stage, uncertainty remains.

Budget papers provide a policy outline, but they are not the law. The final tax treatment will depend on the wording of the draft legislation and any amendments made after consultation.

The most important issue will be whether a corporate beneficiary is assessed on the full amount of the trust distribution without receiving a credit for tax paid by the trustee.

If that is the outcome, the rules could create a materially harsher tax result than many taxpayers originally expected.

Until the legislation is released, families should avoid making rushed decisions. However, they should not ignore the potential impact.

What should trustees do now?

Trustees should begin by understanding their current exposure.

This means reviewing the trust deed, recent distribution minutes, prior-year tax returns, corporate beneficiary arrangements, UPE balances, Division 7A loans, retained profits, and future income expectations.

Trustees should also consider whether their distribution strategy remains appropriate under different tax-rate scenarios.

For example, it may be useful to model the outcome if distributions to corporate beneficiaries are taxed at 51%, 60%, or close to 70%. This can help families understand the potential cash-flow impact and decide whether changes may be required.

The review should also consider the family’s broader goals, including retirement income, investment growth, business succession, debt reduction, asset protection and intergenerational wealth transfer.

Do not wait for year-end

Family trust distribution decisions are often made close to 30 June. However, these proposed changes may require earlier planning.

Trustees may need time to obtain tax advice, review trust deeds, update company records, manage UPEs, consider alternative structures and prepare revised distribution strategies.

Waiting until the end of the financial year may limit the available options.

Proactive planning is especially important for families with significant trust income, complex family groups, business assets, property holdings, or long-standing bucket company arrangements.

A coordinated advice approach is essential

The proposed changes highlight the importance of coordinated advice.

Tax rules, financial planning, legal structures and estate planning are closely connected. A decision that appears tax-effective in isolation may create problems elsewhere.

For example, changing the ownership of an asset may reduce future trust tax exposure but create capital gains tax, stamp duty, loss of asset protection, lending issues or estate planning complications.

Similarly, distributing income directly to individuals may simplify the structure but increase personal tax, affect cash flow, or change family wealth dynamics.

Families should ensure their accountant, financial adviser and solicitor are aligned before making major changes.

Key takeaway

The proposed crackdown on discretionary trusts and bucket companies could materially change the tax landscape for many family groups.

The greatest concern is the possibility that trust distributions to corporate beneficiaries could be taxed at the trustee level and then again at the company level, potentially producing an effective tax rate of around 60% before any later dividend is paid.

Where profits are ultimately distributed to an individual on the top marginal tax rate, the total effective tax rate could potentially approach 70%.

While the final outcome will depend on the draft legislation, the potential impact is significant enough that families should review their structures now.

For business owners, investors and high-net-worth families, this is an opportunity to reassess whether existing trust arrangements remain fit for purpose and whether broader wealth planning strategies need to be adjusted.

To discuss how these proposed changes may affect your family trust, business structure, investment strategy or broader financial plan, contact Cadre Capital Partners.