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Trust Issues: Testamentary Trusts and the New Era of Tax

When the Australian Government introduced sweeping changes to the taxation of trusts as part of their controversial budget earlier this year, attention quickly turned to whether testamentary trusts would be drawn into the net of the new regime.

The reforms included two proposed 30% minimum taxes: one targeting discretionary trust income and the other targeting capital gains. If applied to testamentary trusts, these measures could have significantly disrupted both testamentary trust planning and the pre-death structuring of estates.

Fortunately, testamentary trusts have largely escaped the new tax regime, but not without strings attached. To qualify as exempt from the tax changes, a testamentary trust must satisfy strict conditions designed to distinguish genuine testamentary trusts from arrangements engineered to obtain favourable tax treatment.

That is where the uncertainty lies. The boundary between legitimate estate planning and tax-driven structuring is not always clear, particularly while questions remain about how the Commissioner will interpret and administer the proposed laws. Of particular concern, testamentary trusts established on or after 1 July 2028 may lose the exclusion if their beneficiary classes extend to companies or existing family trusts. Existing wills containing broad beneficiary definitions may therefore require review before the testator’s death.

This article examines the two proposed 30% minimum taxes, the testamentary trust exemptions and the potential friction between the new rules and established estate-planning strategies.

 How it works: 30% Tax on Trust Income

The Treasury Laws Amendment (Tax Reform No. 3) Bill 2026 (Cth) (the 30% Trust Tax Bill) was introduced on 14 October 2026. The proposed reforms introduce a 30% minimum tax on relevant discretionary trust income from 1 July 2028. Genuine testamentary trust income will generally be excluded, but the exemption comes with important restrictions on asset sources, beneficiary classes and avoidance arrangements.

According to the 30% Trust Tax Bill, tax would be payable by the trustee, calculated on the trust’s taxable net income that falls within the minimum tax rules. Where the trustee already pays tax on that income, the new tax would operate as a top-up to 30%, rather than an additional 30% charge.

Eligible non-corporate beneficiaries would continue to include their share of trust income in their tax returns and receive a non-refundable tax offset reflecting the minimum tax. Higher-taxed beneficiaries may therefore pay further tax, while beneficiaries with insufficient tax liability would not receive a refund of the unused offset.

Importantly, corporate beneficiaries will not receive the offset and will remain subject to ordinary company tax on their distributions.

Estate Planning Ramifications of the new Trust Income Rules

Under the 30% Trust Tax Bill, testamentary trusts will be exempt from the minimum 30% tax on trust distributions if that meet the requirements of being a “genuine testamentary trust”.

To be considered a genuine testamentary trust:

  • the income must be sourced from the estate, or the reinvestment of funds sourced from the estate;
  • where the testamentary trust is established after 1 July 2028, all of the beneficiaries of the testamentary trust must be individuals or exempt entities; and
  • the income of the trust must not be derived directly or indirectly under a scheme entered into or carried out for the purpose, or for purposes that include the purpose, of gaining access to the exemption.

Drafting a testamentary trust to include companies as potential beneficiaries is a reasonably common strategy in estate planning. Generally, such arrangements are drafted so that related companies are included as potential recipients of trust income, pending the trustee’s discretion.

This is generally drafted to provide flexibility for a deceased’s family – allowing income or capital to be distributed into whichever vehicle or entity that provides financial structure for a deceased’s estate.

This is a major concern for estate planning. Because a testamentary trust is established on the testator’s death rather than when the Will is executed, the proposed commencement rule may affect Wills signed years earlier. Existing Wills that permit distributions to companies, family trusts or other ineligible entities should therefore be reviewed and amended to address these changes.

Capital Gains

The Treasury Laws Amendment (Tax Reform No. 1) Bill 2026 (CGT Bill) was introduced in October 2026. Under this bill, a minimum tax rate of 30% is also imposed on capital gains.

Once again, however, a specific exemption has been included for “genuine testamentary trusts”. In this context, a testamentary trust will be exempt from the minimum 30% CGT so long as:

  • the capital gain is made on assets sourced from the estate, or the reinvestment of funds sourced from the estate; and
  • the capital gains must not be derived directly or indirectly under a scheme entered into or carried out for the purpose, or for purposes that include the purpose, of gaining access to the exemption.

The source of funds

 To gain access to both exemptions, the assessable income must originate from:

  • assets transferred from the deceased estate, including superannuation death benefits paid to the estate;
  • qualifying accumulations and reinvestments of those assets; and
  • replacement assets acquired through genuine arm’s-length transactions.

The rules do not apply income derived from assets and funds subsequently injected into the trust post-death.

Nor does it extend to a beneficiary’s later personal sale of an asset received from the trust.

The exemption concerns qualifying gains arising through the trust, not an enduring exemption attached to inherited property.

Further, if two spouses separately establish testamentary trust wills for their children, it will not be possible to “combine” those two testamentary trusts into one. This is still a common estate planning strategy, however, so any such provisions in testamentary trust wills need to be carefully reviewed.

When is a testamentary trust not “genuine”?

Both minimum taxes deny the testamentary trust exemption where income is derived under a scheme with a purpose of securing that exemption.

They specifically target schemes that cause property to become part of the deceased’s estate pre-death with a purpose of obtaining access to the testamentary trust exemptions.

The policy direction of both Bills is clear: preferential treatment is intended to remain available for genuine testamentary arrangements, but not where assets or structures are deliberately manipulated to bring income or capital gains within the testamentary trust concessions.

However, two concerning issues arise for estate planners:

  • gaining access to the exemption just needs to be a purpose, not the sole or dominant purpose – even if there are genuine estate reasons for testamentary trusts, if tax benefits are also sought, the exemptions may be denied; and
  • proving intention following the death of the testator can be problematic in tax cases, particularly where the testator has not documented their reasons for establishing testamentary trusts – or where documents such as letters of wishes focus heavily on the tax benefits of testamentary trusts.

The Conflict with Estate Planning Strategies

 The above integrity rules effectively serve as a disqualifier for testamentary trusts seeking to claim an exemption. If the assets and income of the testamentary trust don’t meet the standards of both rules, the law effectively sees them as identical to any other discretionary trust (and thus, equally as taxable).

There is no explicit requirement for any supposed scheme under either integrity rule to take place after death, meaning that the Commissioner may seek to question restructures or changes in asset ownership in the time period prior to a taxpayer’s death.

The draft legislation and accompanying explanatory memorandum makes it clear that the integrity rules are directed at “contrived schemes”. It also expressly states that the rules should not apply merely because steps are taken to increase the value of an estate left to beneficiaries.

The explanatory memorandum distinguishes contrived arrangements from genuine estate and succession planning, as considering tax consequences when choosing how to achieve a substantive succession objective will usually be incidental. This should not, however, be interpreted as an unconditional safe harbour.

There are a number of legitimate estate planning strategies that ultimately have the effect of transferring assets into an estate that would not otherwise have naturally formed part of a testamentary trust.

In these circumstances, despite the legitimate nature and aim of these strategies, the Commissioner could potentially argue:

  • the assets only became estate assets because of a scheme; and/or
  • a purpose of the scheme was to obtain access to the testamentary trust exemptions.

The following considers common testamentary trust and estate arrangements that may interact uneasily with the proposed integrity rules.

Superannuation

 A common estate planning strategy involves withdrawing funds from superannuation shortly before death. If a member of a superannuation fund passes away leaving their death benefits to a person who does not qualify as a spouse or a dependant, then death benefit tax applies.

By withdrawing the funds while alive and retaining the cash personally before death, the assets will ultimately pass through the estate (and into a testamentary trust structure if established), potentially avoiding death benefits tax on the deceased’s superannuation.

However, viewed through the lens of the new integrity rules, withdrawing super before death could be seen as a deliberate scheme to place assets into the estate so that future investment gains or income qualify for the testamentary trust exemptions, not just as a means of managing death benefits tax liabilities.

Even if the primary purpose of the transfer was to mitigate the death benefits tax, the Commissioner may form the view that another purpose of the transfer was to for the super assets to gain access to the concession.

 Liquidating family trust assets before death

 Another common strategy is undertaken where an aging client controls a family discretionary trust.

Instead of allowing trust assets to remain in the trust structure after death, the trust may be wound down and assets distributed or sold. The proceeds are then held personally by the client and ultimately pass through the estate into testamentary trusts established under their Will.

The motivation is often administrative simplicity. Families may wish to eliminate complexities associated with appointor succession, trustee replacement and multigenerational discretionary trust administration. The imposition of the impending minimum 30% tax on discretionary trusts may provide a further incentive to unwind those structures.

As discussed above, if assets are intentionally removed from an inter vivos trust and placed into the deceased’s personal ownership shortly before death, a question could arise as to whether part of the purpose was to ensure those assets formed part of the estate and thereby gained access to the exemption.

And again – such purpose need only be more than incidental. Whether such an arrangement would be regarded as a legitimate exercise or a disqualifying scheme will turn largely on the Commissioner’s assessment of the intention behind the restructure.

The key issue would therefore be evidentiary: whether access to the testamentary trust exemptions was more than an incidental purpose of the restructure. Contemporaneous evidence identifying succession, governance and administrative objectives prepared and signed by the testator may may become especially important in this context.

Surviving spouses renouncing benefits under a will

 A further scenario arises where spouses have mirror wills creating testamentary trusts for children or descendants.

Following the first spouse’s death, the surviving spouse may be entitled to inherit assets personally but elects to renounce or disclaim that entitlement so the assets pass directly to testamentary trusts established for the next generation. Again, such arrangements may genuinely be motivated by asset protection and genuine succession planning.

Unlike the previous examples, the assets already form part of the deceased estate. There is no immediate restructuring before or after death. The integrity rules are focused on ‘contrived arrangements’ that artificially or deliberately move assets into an estate to ‘cash in’ on the concession.

Despite this, the integrity measures also apply to any arrangement that has the purpose of gaining access to the exemptions. As such, if one of the purposes behind the renunciation is to gain concessional tax treatment, the strategy may fall foul of the rules.

Conclusion

The new tax reforms and proposed integrity rules are not the death knell for testamentary trusts that many estate planning practitioners feared. However, they do mark a clear shift in focus from structure to purpose, and therein lies the murky uncertainty.

Strategies such as pre-death superannuation withdrawals, deathbed asset transfers, the unwinding of family trusts and post-death renunciations all serve perfectly legitimate estate planning objectives. The difficulty is that some, if not all, of these same strategies may also have the effect of bringing assets within a testamentary trust exemptions that would not otherwise have been available – potentially bringing these strategies into conflict with the proposed integrity rules.

That is why clarity and gathering evidence will be critical. Advisers and taxpayers need a reliable and definitive stance on where the line will be drawn between ordinary, commercially sensible succession planning and arrangements that are sufficiently tax-driven to offend the integrity rules. Until that line is more clearly articulated, caution should be exercised when recommending or implementing strategies that move, redirect or preserve assets for the benefit of a testamentary trust.

Additionally, if the draft legislation is not amended, existing Wills and testamentary trust provisions should be reviewed and, where appropriate, redrafted so as to eliminate corporate and trust beneficiaries. Otherwise, these testamentary trusts face the risk of losing access to the exemption altogether.

For now, the key takeaway is that testamentary trusts have not and likely will not lose their place in estate planning.

However, estate planners must turn their minds from structure to intention, from strategy to purpose, and consider that the future tax treatment of a testamentary trust will depend on how, why and when the relevant assets came to sit within it.

Benjamin Kett
Solicitor

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Dividend Access Shares: An Ongoing Dividend Stripping Risk

What is dividend stripping?

Dividend stripping is an anti-avoidance concept designed to prevent arrangements that allow shareholders to extract the economic value of a company’s accumulated profits in a tax-advantaged form, rather than receiving those profits as taxable dividends.

Traditionally, dividend stripping involves a company with substantial undistributed profits transferring shares to another entity, which subsequently receives a dividend representing those profits. The original shareholder receives consideration reflecting the value of the profits, while the arrangement seeks to avoid the tax that would otherwise arise from distributing those profits directly to the shareholder.

Section 177E of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936) specifically addresses dividend stripping. It applies to schemes that are by way of, or in the nature of, dividend stripping, as well as schemes that have substantially the same effect. The provision is particularly relevant to corporate restructures and arrangements involving special classes of shares that provide access to accumulated profits.

The imputation consequences of dividend stripping are also addressed by sections 207-145 and 207-155 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997).

Dividend stripping and the courts

The traditional characteristics of dividend stripping were identified in Patcorp Investments Ltd v Federal Commissioner of Taxation (1976) 140 CLR 247 and subsequently considered in Federal Commissioner of Taxation v Consolidated Press Holdings Ltd (2001) 207 CLR 235.

Broadly, a traditional dividend-stripping arrangement involves the following features:

  • a company has substantial accumulated profits that could otherwise be distributed as dividends;
  • shares in the company are sold or allotted to another person or entity;
  • the company distributes its accumulated profits to the purchaser or new shareholder by way of a dividend;
  • the recipient is able to receive the dividend without bearing the tax that would otherwise arise, including through the availability of favourable tax treatment or franking benefits;
  • the original shareholder receives a capital sum or other economic benefit reflecting the value of the accumulated profits; and
  • the arrangement has the effect of avoiding tax that would otherwise apply to the distribution of those profits.

The central concern is that the economic value of accumulated profits is extracted while the transaction is structured to produce a more favourable tax outcome than an ordinary dividend paid to the original shareholder.

These principles remain relevant when assessing modern corporate restructures. However, section 177E also captures schemes that have substantially the effect of dividend stripping, raising questions about how far the provision extends beyond traditional arrangements.

That issue is particularly relevant to dividend access shares and has featured in the more recent litigation in Merchant.

Dividend access shares and the ATO’s position

Dividend access shares are a particular area of concern for the Australian Taxation Office (ATO). In Taxation Determination TD 2014/1, the ATO considered an arrangement involving a private company with significant accumulated profits that issued a special class of shares to an entity associated with the original shareholder.

The special shares carried dividend entitlements but had limited rights beyond receiving dividends. The company subsequently paid a substantial fully franked dividend to the holder of those shares, with further transactions resulting in the original shareholder or their associates obtaining the economic benefit of the company’s profits in a tax-free or substantially tax-free form.

The ATO concluded that the particular arrangement described in the determination constituted a scheme by way of, or in the nature of, dividend stripping where the relevant tax-avoidance purpose existed.

Features that may raise concerns include the issue of shares for nominal consideration, limited voting or capital rights, discretionary dividend entitlements, and the payment of substantial dividends to an entity associated with the original shareholder.

However, the use of different share classes or dividend rights does not, of itself, constitute dividend stripping.

The application of section 177E depends on the facts and circumstances of the arrangement, including its commercial and economic substance.

Franking credit implications

In addition to the potential application of section 177E of the ITAA 1936, dividend-stripping arrangements may have consequences under the imputation provisions of the ITAA 1997.

Sections 207-145 and 207-155 address the treatment of franked distributions made as part of a dividend-stripping operation. Where these provisions apply, the recipient may be denied the benefit of the franking credits attached to the distribution.

Accordingly, advisers should consider not only whether a dividend access share arrangement may constitute dividend stripping under section 177E, but also whether the associated franking benefits may be denied.

The analysis does not necessarily end when the shares are issued

The application of section 177E is not necessarily confined to the income year in which dividend access shares are issued.

Section 177A of the ITAA 1936 defines a “scheme” broadly to include an arrangement, plan, proposal, action, course of action or course of conduct. Accordingly, the relevant scheme may encompass a series of transactions extending beyond the initial issue of the shares.

For example, a company may issue B Class shares in one income year but make no distribution at that time. In a later year, the company may distribute a substantial proportion of its accumulated profits to the B Class shareholder.

The circumstances surrounding that later distribution may differ materially from those existing when the shares were originally issued. The subsequent use of the shares, the extent of the profits distributed and the ultimate destination of the dividend proceeds may therefore be relevant to determining whether the broader arrangement is by way of, or in the nature of, dividend stripping, or has substantially that effect.

This does not mean that every subsequent dividend necessarily constitutes a separate scheme or that every dividend paid on a special class of shares attracts section 177E. Rather, the relevant scheme must be identified by reference to the particular facts, and the arrangement must be considered as a whole.

The original commercial purpose for issuing the shares remains relevant, but it is not necessarily determinative of the treatment of subsequent distributions.

An arrangement initially implemented as part of a commercial restructure may require further consideration if the shares are later used to direct substantial accumulated profits to an associated entity in circumstances that produce the economic result contemplated by a dividend-stripping arrangement.

The developing position: Merchant

The scope of section 177E, particularly the limb dealing with schemes that have substantially the effect of dividend stripping, is also being considered in Commissioner of Taxation v Merchant & Anor; Merchant & Anor v Commissioner of Taxation.

In the dividend-stripping aspect of the dispute, related companies forgave substantial debts immediately before the debtor company was sold. The Commissioner argued that the debt forgiveness reduced the accumulated profits of the creditor companies while increasing the value of the debtor company, thereby having substantially the effect of dividend stripping.

The Full Federal Court found in favour of the Commissioner on the section 177E issue concerning the debt-forgiveness arrangements. The subsequent High Court appeal raises an important question: must a scheme substantially avoid tax on a substantial portion of a company’s accumulated profits to have substantially the effect of dividend stripping, or can the provision apply more broadly?

The issue is significant because it concerns the extent to which section 177E can apply to arrangements that do not follow the traditional model of transferring shares and distributing accumulated profits to a purchaser.

Although Merchant does not concern dividend access shares directly, its consideration of the scope of section 177E is relevant to advisers assessing alternative methods of extracting or reallocating the economic value of company profits.

What does this mean for advisers?

For advisers implementing corporate restructures or dividend access share arrangements, the analysis should not be treated as a once-and-for-all exercise completed when the shares are issued.

Where dividend access shares remain on issue over multiple income years, advisers should revisit the arrangement as subsequent distributions are made, particularly where substantial accumulated profits are directed to an associated entity. The analysis should take into account the circumstances surrounding each distribution and the broader arrangement of which it forms part, rather than treating the issue of the shares as determinative of the tax outcome.

Kara Bentley
Associate

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Minimum 30% Trust Tax Minefield

On Thursday 3 September, Treasury released the Exposure Drafts on the proposed minimum 30% tax on discretionary trust distributions.

The draft legislation pack covers three topics:

  • the mechanisms for imposing the 30% minimum tax;
  • the new proposed CGT rollover; and
  • an “electable regime” whereby a discretionary trust can opt out of the minimum tax by effectively electing to confine all future distributions to specific individuals.

A summary of the proposed changes is set out below.

30% Minimum Tax

From 1 July 2028, discretionary trusts will be subject to a minimum 30% tax on trust distributions.

The trustee of the discretionary trust will be liable to pay the 30% tax – individual beneficiaries will then receive a non-refundable tax offset for the tax paid by the trustee in respect of their distribution.

The result is:

  • no advantage will be obtained by distributing to beneficiaries on effective tax rates below 30%; and
  • beneficiaries on effective tax rates exceeding 30% will be required to pay “top up tax” on their trust distributions.

Application of Franking Credits

The draft legislation finally confirms the treatment of franking credits where part of the trust income includes franked dividends.

Specifically, the trustee of the discretionary trust will be able to utilise franking credits to reduce the trustee’s liability for the minimum tax. This results in:

  • where the trust receives a fully franked dividend at a 30% imputation rate, no additional tax liability will arise for the trust; or
  • where the trust receives a fully franked dividend at a 25% imputation rate, the trustee will be liable for 5% “top up tax”.

Once applied by the trustee, the franking credits are cancelled out. This means that they will not be passed on to the beneficiaries who receive the distribution – resulting in no ability for beneficiaries to receive franking credit refunds. The beneficiaries will only be entitled to the non-refundable offsets attaching to the minimum 30% tax.

Significantly, if the trustee has excess franking credits left over, the trustee will be entitled to a refund of the excess franking credits.

The Death of the Bucket Company

A company in receipt of a trust distribution will not be entitled to:

  • franking credit offsets; or
  • offsets for the minimum tax paid by the trust.

This will effectively result in “double taxation”, as:

  • the trust will pay the minimum 30% tax on the trust income; then
  • the company will pay tax at its own rate (25% or 30%) on the trust income distributed to it.

While the company will be liable for additional tax on the trust distribution, it will receive an entry into its franking account for the amount of tax paid by the company.

The result for a trust operating a business is the following:

A trading discretionary trust with income of $100,000 distributes all income to a company.

The trust pays the minimum tax of $30,000.

The company receives a distribution of $100,000, and is liable to tax on that $100,000 of $25,000.

The company receives:

  • $70,000 cash from the trust (being the $100,000 less the tax paid by the trust);
  • an unpaid present entitlement of $30,000 from the trust – since the tax offset is not passed on to the company, the trust must source the funds from elsewhere to discharge this UPE.

After the company discharges its own tax liability, it has $45,000 cash plus a UPE of $30,000.

The effective tax paid on the trust income is 55%.

Where the trust income instead comprises dividends received from a trading entity, the result is the following:

A trading company makes a profit of $120,000 and pays tax of $30,000 (at a 25% tax rate).

The company pays a fully franked dividend to a shareholder trust of $90,000 (plus $30,000 franking credits).

The trust’s minimum tax liability is $36,000 but it receives a franking offset of $30,000, resulting in additional tax payable of $6,000 by the trustee.

If the trust distributes the $90,000 dividend to a corporate beneficiary, the corporate beneficiary will be subject to 30% tax on that dividend (including on the franking credits given the streaming rules), resulting in a tax liability of $36,000.

The corporate beneficiary receives:

  • $84,000 cash from the company; and
  • an unpaid present entitlement of $6,000 from the trust – since the tax offset is not passed on, the trust must source the funds to discharge this UPE from other sources.

After the company discharges its own tax liability, it has $48,000 cash and a UPE of $6,000. The only entry into its franking account is for the company’s own tax liability of $36,000.

The effective tax paid on the profits of $120,000 is 60%.

Who’s not subject to the tax?

The following kinds of trusts will not be subject to the minimum tax:

  • fixed trusts;
  • special disability trusts;
  • deceased estates; and
  • complying superannuation funds (note: this means that a non-complying fund will be subject to the minimum tax).

The draft proposes to amend the definition of a “fixed trust” to be a trust where:

  • the trust’s beneficiaries have fixed entitlements to all of the income and capital of the trust; or
  • there are no material discretionary elements affecting the entitlements or rights of the trust’s beneficiaries.

Testamentary Trusts

Testamentary trusts will also be excluded from the regime but only under specific circumstances.

Consistent with section 102AG (excepted trust income) treatment, testamentary trust income in any year will not be subject to the minimum tax provided that the source of the income is:

  • from the deceased estate;
  • from natural accretions to the testamentary trust; or
  • from the disposal and reinvestment of assets of the testamentary trust.

If the trust is “established on or after 1 July 2028” (which presumably is determined by the date of death, not the date of the will), then the beneficiary receiving the trust income must be an individual or tax exempt entity.

Further, these rules are subject to integrity measures that require the trust to be a “genuine testamentary trust”. A trust will fail this genuine testamentary trust requirement if the Commissioner is satisfied that the testamentary trust’s income was derived directly or indirectly from a scheme entered into or carried out for the purpose of, or for purposes including the purpose of, gaining access to the testamentary trust exemption.

New Rollover

The draft legislation also includes the proposed new CGT rollover.

The new Subdivision 126-C rollover will be available to any trust subject to the minimum tax where:

  • all of the assets of the trust are transferred out of the trust;
  • the transferee is:
    • individuals; or
    • a company or fixed trust, provided that the entity does not have material discretionary elements – including no rights to issue shares or units of different classes unless those powers can’t be exercised to vary existing rights or interests or significantly affect the value of existing rights or units;
  • the restructure occurs between 1 July 2027 and 30 June 2030;
  • the transferor and transferee choose to apply the rollover;
  • continuity of ownership requirements are satisfied; and
  • the transferor and transferee meet certain residency requirements.

No turnover requirements apply to the rollover, making it available to all discretionary trusts.

Any taxpayer (and the underlying owners) that uses the new rollover will be subject to a 4-year amendment window.

The continuity of ownership requirements provide that all persons who have a direct or indirect interest in the transferee just after the restructure must have been:

  • beneficiaries of the trust; and
  • a member of the “family group” for family trust election purposes.

Where the rollover is available, it will apply to switch off all direct income tax consequences, including CGT, balancing adjustment events and trading stock events. Family trust distributions tax is also specifically disregarded.

The impact of the rollover is that:

  • the transferee entity inherits the existing CGT cost base of CGT assets (though the interplay between this and the deferred gain rules recently introduced are unclear);
  • trading stock is acquired at cost price; and
  • depreciating assets are acquired at their existing written down value.

Finally, the new rollover preserves the acquisition dates for the purposes of determining eligibility for the 15-year exemption.

Opt-Out Regime

The draft legislation also contains a surprising mechanism that allows a trust to opt out of the minimum 30% tax by making an “excluded election trust election” or EET election.

The making of an EET election requires the trustee to nominate:

  • the names of the beneficiaries who will receive all future income and capital distributions from the trusts; and
  • the share of trust income and capital that those beneficiaries will receive.

If distributions are made in any year other than to the nominated beneficiaries, penalty tax will be charged at a flat rate of 47% in that year. The election will then be deemed to be permanently revoked.

Once made, the election can never be varied – changes in who benefits from trust distributions will only be allowed in the case of death or marriage breakdown. However, to be varied on a marriage breakdown, both of the beneficiaries must have been specified in the nomination.

A trust can choose to revoke the EET election, however if it does:

  • penalty tax will be charged at a flat rate of 47% in the year it is revoked;
  • the trustee can never make a new EET election; and
  • in all future years, the trust will be subject to the minimum 30% tax.

The election can be made partially in favour of a company, provided that the company was incorporated on or before 1 July 2028 and does not have any “material discretionary elements”. This would effectively require the shares on issue to be ordinary shares only, held by individuals.

The intended effect of the EET election option is to allow trusts the ability to fall outside the minimum trust tax regime, but in a way that doesn’t give rise to state-based duty implications. However, significant concerns have already been raised about this proposed regime since:

  • making such an election could be construed as a fetter on a trustee’s discretion, giving rise to potential trust law breaches and future claims by beneficiaries who have not been properly considered; and
  • many state revenue offices have already indicated that making such elections may in fact still give rise to duty implications.

Next Steps

The Exposure Drafts are open for consultation until 18 September 2026.

Concerned advisers and taxpayers are encouraged to lodge their submissions directly to Treasury.

The Federal Government has indicated that it intends to pass the new legislation prior to Christmas this year.

Natalie Cameron
Legal Practice Director

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WHEN DO SUBCONTRACTOR ARRANGEMENTS ATTRACT PAYROLL TAX?

The New South Wales Court of Appeal has confirmed that the payroll tax employment agency provisions can apply to outsourced cleaning arrangements even where the client has limited control over the individual workers performing the services.

In SKG Cleaning Services Pty Ltd v Chief Commissioner of State Revenue [2026] NSWCA 122, the Court held that the critical question is not simply whether a client controls who performs the work or how the work is performed. Rather, the inquiry focuses on the connection between the services provided and the ordinary activities of the client’s business.

The decision is particularly relevant to businesses that engage contractors or subcontractors to perform services that would ordinarily be undertaken by their own employees.

Background

The appellants, including SKG Cleaning Services Pty Ltd and entities associated with Ezko Property Services, operated businesses providing cleaning services to commercial and government clients in New South Wales.

The cleaning services were performed using a combination of the appellants’ own employees and subcontractors. The relevant client contracts ranged from short-form standard contracts to more detailed agreements with larger clients.

The contracts generally specified the nature, location and frequency of the cleaning services. For example, contracts required services such as emptying bins, wiping benches, cleaning sinks, vacuuming and mopping, with some services to be performed daily, weekly or fortnightly.

The Chief Commissioner assessed the appellants for payroll tax on the basis that the relevant contracts were employment agency contracts under section 37 of the Payroll Tax Act 2007 (NSW).

Where the employment agency provisions apply, the employment agent is taken to be the employer and payments made to the service provider are treated as wages for payroll tax purposes. The Queensland legislation contains substantially similar employment agency provisions, although the corresponding provisions are found in sections 13G to 13K of the Payroll Tax Act 1971 (Qld).

The appellants challenged the assessments, arguing, among other things, that the relevant contracts were not employment agency contracts because the clients did not have sufficient control over the individual cleaners or the manner in which the cleaning work was performed.

The Supreme Court rejected that argument. The appellants then appealed to the Court of Appeal.

The issue on appeal

The central issue was whether contracts under which cleaning services were provided to clients constituted employment agency contracts.

The appellants argued that a significant degree of client control over the workers or the manner in which they performed their work was necessary before a contract could be characterised as an employment agency contract.

In particular, they argued that the relevant contracts merely described what cleaning was required and when it was to be performed. They did not give the clients significant control over who performed the work or how the work was carried out.

The Court rejected that approach.

The Court of Appeal’s decision

The Court of Appeal unanimously dismissed the appeal and confirmed that the expression “for a client” in the employment agency provisions requires consideration of whether the services are provided “in and for” the client’s business.

The relevant question is therefore the connection between:

  • the ordinary activities of the client’s business; and
  • the services provided under the contract.

The Court emphasised that the degree of control exercised by the client over the service provider is relevant, but it is not determinative.

As a result, the absence of detailed control over individual workers does not, of itself, take a contract outside the employment agency provisions.

Control is relevant, but not the test

The appellants’ argument placed considerable emphasis on the traditional concept of control associated with an employment relationship.

The Court considered that approach too narrow.

The fact that a client does not determine which particular cleaner attends a site, or precisely how that cleaner performs the work, does not mean that the services are not being provided in and for the client’s business.

Instead, the Court’s analysis focused on the nature of the services themselves and their connection with the client’s ordinary business activities.

This is consistent with the earlier authorities concerning the employment agency provisions, including UNSW Global Pty Ltd v Chief Commissioner of State Revenue, Chief Commissioner of State Revenue v E Group Security Pty Ltd and Chief Commissioner of State Revenue v Integrated Trolley Management Pty Ltd.

The Court’s approach confirms that whether a contract is an employment agency contract is ultimately a question of fact and degree, having regard to the terms of the contract and the circumstances in which it operates.

Why were the cleaning contracts caught?

The relevant cleaning services were:

  • regular and continuous;
  • performed at the clients’ business premises; and
  • services that would ordinarily be expected to be undertaken in the operation of businesses of that type.

The Court considered that, in the ordinary course, if the cleaning services were not supplied through the appellants, the clients would be expected to have their own employees perform that work.

That connection was sufficient to bring the arrangements within the employment agency provisions.

Importantly, the Court did not consider it necessary for cleaning to be part of the client’s core revenue-generating business.

For example, a retail business does not ordinarily operate a cleaning business. However, regular cleaning of its premises may nevertheless form part of the ordinary activities required to operate that business.

Accordingly, the fact that cleaning was ancillary to the clients’ core businesses did not prevent the employment agency provisions from applying.

Are all cleaning arrangements caught?

The decision does not establish that every contract for cleaning services will necessarily be an employment agency contract.

The Court recognised that some services may be sufficiently specialised or infrequently required that they would not ordinarily be expected to be performed by the client’s own employees.

The distinction is therefore between services that form part of the ordinary and ongoing activities of a business and services that are sufficiently separate, specialised or infrequent that they would not normally be undertaken by the client’s employees.

For example, a business that regularly engages cleaners to clean its premises may be within the employment agency provisions. By contrast, a business that engages a specialist contractor on an occasional basis to perform a highly specialised cleaning task may have a stronger argument that the services are not sufficiently connected with its ordinary business activities.

The importance of the contract

The decision also highlights the importance of the terms of the relevant contract and the evidence available to establish how the arrangement operates in practice.

Although the appellants argued that some contracts contained little or no indication of client control, the Court noted that some contracts nevertheless contained provisions dealing with matters such as:

  • standards of work;
  • worker suitability;
  • background checks;
  • security requirements;
  • the client’s ability to object to particular workers; and
  • reasonable directions.

Those provisions reinforced the conclusion that the contracts were employment agency contracts.

The case also demonstrates the evidentiary difficulties that can arise where contractual documentation is incomplete. A taxpayer seeking to challenge a payroll tax assessment bears the onus of establishing the matters necessary to demonstrate that the assessment is excessive.

Accordingly, businesses should retain complete copies of their contractor and subcontractor agreements, together with records demonstrating how those arrangements operate in practice.

Kara Bentley
Senior Associate

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Proposed Negative Gearing and CGT Reforms: Tranche 2

Capital Gains Tax and Negative Gearing Reforms – What does Tranche 2 mean?

Treasury has released the second tranche of draft legislation implementing the Government’s capital gains tax (CGT) and negative gearing reforms.

The first tranche established the broad framework for the reforms from 1 July 2027. The Tranche 2 legislation addresses some of the issues identified in the original legislation and expands on how the new rules will apply in more complex situations.

The measures remain in draft and are subject to consultation, with the consultation period closing on 21 August 2026.

A summary of some of the key changes is set out below.

Property Changes

New residential dwellings

A new definition of “new residential dwelling” has been introduced for the CGT rules.

Broadly, a new residential dwelling includes:

  • new homes built on land without an existing dwelling;
  • additional dwellings that increase the number of homes on the land (provided the dwellings are capable of being separately titled);
  • non-residential buildings converted into residential dwellings; and
  • dwellings that were “new” for the seller and are acquired within 24 months of the first certificate of occupancy.

The proposed 24-month acquisition period is particularly notable, as it provides a longer period than the 12-month period originally contemplated.

Qualifying new residential dwellings will generally be able to continue accessing negative gearing, and their owners can generally choose between the existing 50% CGT discount and the new indexation-based regime.

Importantly, the special CGT treatment is not simply a blanket exemption for any property described as “new”. The proposed rules contain detailed requirements concerning the dwelling’s history and whether it falls within the statutory definition.

Further exemptions from negative gearing restrictions

Tranche 2 also proposes that the negative gearing restrictions will not apply while a residential dwelling is used for certain types of housing, including:

  • NDIS specialist disability accommodation;
  • eligible community housing used to provide affordable housing;
  • public housing provided through a government agency or local government body; and
  • dwellings forming part of an active build-to-rent development.

These exemptions are directed at housing arrangements that provide broader social or housing policy benefits and will be subject to the detailed eligibility requirements in the draft legislation.

Property transfers on death or relationship breakdown

Tranche 2 proposes to preserve existing tax treatment for property ownership changes following death or relationship breakdown.

In certain circumstances, a surviving spouse, existing co-owner or person receiving property following a qualifying relationship breakdown may retain the previous tax treatment.

This will be particularly relevant to estate planning and relationship property settlements involving negatively geared investment properties.

Changes to CGT

Exemptions for deceased estates and certain testamentary trusts

The proposed changes would exempt certain trusts and estates from the 30% minimum tax on capital gains, including:

  • testamentary trusts – trusts established under a person’s will;
  • deceased estates – property of a deceased person while the estate is being administered; and
  • special disability trusts – trusts established for the care and accommodation needs of a person with a severe disability.

The exemption is intended to apply to gains genuinely arising from the deceased estate. Integrity rules can deny the exemption where arrangements are entered into to obtain the benefit of the exemption, including arrangements involving property being acquired by a deceased person for the purpose of accessing the concession.

The draft also contains specific anti-avoidance provisions dealing with schemes involving property of deceased estates.

Apportionment between the old and new CGT rules

One of the more technically significant aspects of Tranche 2 is the proposed method for determining the portion of a capital gain that accrued before 1 July 2027 and the portion that accrued from 1 July 2027.

For assets held across the transition date, the gain will generally need to be split between the old CGT regime and the new indexation regime using a value determined as at 30 June 2027.

Taxpayers will generally have the option of relying on a market valuation at the transition date or, for real property and certain other assets without a readily ascertainable market value, using the proposed statutory apportioning method.

The alternative apportioning method

The proposed apportioning method is particularly noteworthy because it avoids the need for a formal valuation in some circumstances, but it is also considerably more complicated than a simple straight-line apportionment.

Broadly, the proposed method works backwards from the eventual capital proceeds and uses the asset’s growth rate over the relevant ownership period to estimate the asset’s value immediately before 1 July 2027. The resulting amount is then used to determine the portion of the gain attributable to the pre-1 July 2027 period.

The method involves a nine-step calculation, including determining the relevant growth rate, applying that growth rate over the relevant periods and working backwards to determine the estimated 30 June 2027 value.

This is particularly important because a simple division of the gain based on the number of days held before and after 1 July 2027 will not necessarily produce the same result.

For example, an asset held for ten years with half of its ownership period occurring before 1 July 2027 will not necessarily have 50% of its capital gain allocated to the old CGT rules. A compounding growth methodology can produce a materially different result, particularly where the asset has experienced significant growth.

For taxpayers with assets that are difficult to value including certain business assets, real property and other illiquid assets, the choice between obtaining a valuation and relying on the prescribed apportioning method could therefore have significant tax and compliance consequences.

Deferred gains

Another important issue addressed by Tranche 2 is the treatment of deferred capital gains.

A deferred gain is a capital gain that is calculated at an earlier point but not taxed until a later event, such as when the asset is sold.

The first tranche introduced a deemed sale and reacquisition mechanism for certain assets owned as at 1 July 2027. Tranche 2 contains further rules intended to ensure that a technical CGT event does not cause a deferred gain to be taxed prematurely where the underlying asset has not actually been realised.

In particular, the Tranche 2 legislation seeks to ensure that deferred capital gains are not inadvertently taxed in circumstances where the taxpayer does not actually dispose of the CGT asset in question. The draft therefore excludes certain capital gains from giving rise to a tax liability on the deferred capital gain.

Further, the draft legislation ensures that the deemed disposal and reacquisition is ignored for the purposes of determining eligibility for certain exemptions – most significantly, this mechanism ensures that the period for determining access to the 15-year exemption is not disrupted by the deemed disposal and reacquisition on 1 July 2027.

While the draft legislation does not yet address the remaining tax rollovers, the Explanatory Memorandum provides in this respect that:

Similar issues arise for roll-overs and similar types of concessions where a gain or loss is disregarded and the cost base of the asset or a replacement asset is modified. These include the relationship breakdown roll-over in Subdivision 126-A and the concession for transfer of the assets of a deceased estate to a beneficiary.

The intention of the Government is that CGT events for which the gain or loss is disregarded as a result of a roll-over or similar concession will not cause an individual to make a deferred gain or loss.

However, additional complexities arise for deferred gains and losses in the context of roll-overs and similar concessions, especially where the asset to which the deferred gain relates is transferred to another entity or replaced as a result of the roll-overs. These complexities have meant that the amendments to address this issue are not included in this tranche of legislation. Instead, these amendments are intended to progress in a future tranche of legislation.

What remains unresolved?

Despite the additional detail provided by Tranche 2, a number of important issues remain unresolved.

The exposure drafts specifically acknowledge that the following issues remain unresolved but will be addressed in further tranches of amendments:

  • the CGT treatment of rollovers and similar concessions (including the concession for beneficiaries receiving assets from deceased estates);
  • how the reforms apply to foreign, mixed and temporary residents;
  • the interaction between the CGT reforms and value shifting rules;
  • how the regime will apply to consolidated groups, listed investment companies, employee share schemes, demergers and options;
  • the interaction between the deemed sale and reacquisition of CGT assets held before 1 July 2027 and the rules requiring the determination of cost base at a point before an asset is realised.

What should taxpayers do now?

The Tranche 2 measures are still draft and consultation is underway. Treasury’s current consultation period closes on 21 August 2026.

For taxpayers holding significant investment assets, particularly residential property, assets held through trusts or AMITs, or assets acquired as part of a restructure, it will be important to consider the proposed rules well before 1 July 2027.

In particular, taxpayers should ensure that acquisition dates, cost base records, ownership periods and residency information are properly documented, as these records may become increasingly important when determining the portion of a capital gain subject to the existing CGT rules versus the new CGT rules.

Kara Bentley
Senior Associate

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Proposed Rollover Relief for Discretionary Trusts

The Federal Government has recently released a consultation paper on one of the most significant proposed changes to the taxation of discretionary trusts in decades.

As part of its broader tax reform package, the Government proposes introducing a minimum 30% tax on discretionary trust income from 1 July 2028. To facilitate restructuring ahead of those changes, the Government has also announced expanded rollover relief, available for a three-year period from 1 July 2027. This will allow eligible taxpayers to restructure out of discretionary trusts without triggering immediate income tax consequences, including capital gains tax (CGT).

While the legislation has not yet been released, these proposed changes are likely to have a significant impact on many privately owned businesses that currently operate through discretionary trust structures.

Why are these changes being introduced?

The proposed rollover relief is a direct response to the Government’s proposed minimum tax on discretionary trusts.

Under the proposed regime:

  • trustees of discretionary trusts will continue to determine which beneficiaries are presently entitled to trust income each year;
  • beneficiaries will continue to include their share of trust income in their own tax returns; however
  • the trustee will be required to pay 30% tax on the trust’s taxable income (unless a higher rate already applies).

Individual and other non-corporate beneficiaries will receive a non-refundable tax offset for the tax paid by the trustee, reducing their own tax liability. However, the effect of the changes is that trust income will generally be subject to a minimum tax rate of 30%, regardless of the beneficiaries’ lower marginal tax rates.

What about bucket companies?

One important integrity measure to mention is the treatment of corporate beneficiaries.

Under the proposal, corporate beneficiaries will not receive credits for the tax paid by the trustee. This means tax may be payable at both the trustee and corporate-beneficiary levels.

This is designed to prevent taxpayers from avoiding the minimum tax by distributing trust income to a “bucket company”. As a result, one of the most common tax planning strategies currently used by discretionary trusts may no longer provide the same tax advantages under the new regime.

The proposed rollover relief

Recognising that many businesses may wish to move away from discretionary trust structures following these changes, the Government has announced that expanded rollover relief will be available for three years from 1 July 2027.

The proposed rollover is intended to allow taxpayers to restructure from a discretionary trust into another entity, such as a company or a fixed trust, without triggering direct income tax consequences, including CGT.

Importantly, the new rollover will be based on the existing Small Business Restructure Rollover (Subdivision 328-G of the Income Tax Assessment Act 1997), but with several significant enhancements.

Unlike the existing Small Business Restructure Rollover, the proposed relief would:

  • not be limited to small business entities;
  • not require a “genuine restructure” of an ongoing business;
  • be available to discretionary trusts within the scope of the minimum tax regardless of their size;
  • apply to active business assets, revenue assets and assets used to produce passive income, substantially expanding the types of assets that may be transferred under the rollover;
  • not require continuity of identical legal ownership following the restructure; and
  • accommodate changes in legal ownership through companies, partnerships or other entities, provided the ultimate economic ownership remains within the same family unit.

This represents a significant expansion of the existing Small Business Restructure Rollover, which is generally limited to active assets used in a business and is only available to entities satisfying the small business eligibility requirements. By contrast, the proposed rollover is intended to facilitate the transfer of virtually all categories of assets held by a discretionary trust, including passive investment assets, while removing the existing size limitations.

Although the proposed rollover is broader than the existing relief, it is expected to be subject to eligibility conditions and integrity rules.

The detailed legislation is yet to be released and the precise mechanics, eligibility criteria and integrity provisions should be considered once draft legislation becomes available.

Why might businesses restructure?

For many business owners, operating through a discretionary trust has historically provided flexibility to distribute income among beneficiaries in a tax-effective manner.

If the proposed minimum tax proceeds, some businesses may decide that another structure is more appropriate.

For example, a company may offer several advantages, including:

  • access to the 25% corporate tax rate (where eligible);
  • access to the dividend imputation system;
  • greater flexibility in retaining profits for future business growth; and
  • easier introduction of new investors or shareholders.

Similarly, some groups may consider moving to a fixed trust where appropriate, noting that the proposed minimum tax would not apply to fixed trusts.

What does this mean for you?

While the proposed rollover relief is a welcome change, there are still many issues that will need to be considered before deciding whether a restructure is appropriate, including:

  • whether a company, fixed trust or another structure better suits your long-term commercial objectives;
  • the potential impact on asset protection and succession planning;
  • financing arrangements and banking requirements;
  • state taxes, including whether any transfer duty relief will be available; and
  • the detailed eligibility requirements for the proposed rollover relief once legislation is released.

Importantly, not every discretionary trust should or will need to restructure. Trusts continue to provide significant commercial advantages beyond tax, including:

  • asset protection;
  • succession planning; and
  • flexibility in ownership arrangements.

The proposed rollover relief simply provides an opportunity for businesses to review whether their existing structure remains the most appropriate in light of the proposed tax changes.

What should you do now?

Although the minimum tax is not proposed to commence until 1 July 2028, now is an appropriate time for businesses operating through discretionary trusts to begin reviewing their structures.

The consultation process is currently underway, and the final legislation may differ from the proposals. Nevertheless, business owners should understand how the reforms may affect them and begin considering whether restructuring may be beneficial.

We expect further detail regarding the rollover relief and the operation of the new minimum tax once legislation is introduced. Until then, any restructuring should be undertaken carefully, with consideration given to the broader legal, commercial and taxation implications, not just the proposed trust tax changes.

Kara Bentley
Senior Associate

 

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