Tax Effective Giving – Charitable Distributions Through Discretionary and Charitable Trusts
By Harriet Warlow-Shill
29 March 2018
A trust is an arrangement by which a trustee (individual or company) holds property ‘on trust’ for beneficiaries.
With a discretionary trust, the trustee determines which of the beneficiaries will receive trust income and the timing and nature of charitable distributions from the trust.
A charitable trust is a trust that operates for charitable purposes. In some instances, (depending on the terms of the trust) the trustee of a charitable trust can determine who should receive trust income, in line with the charitable purposes of the trust.
This article looks at using discretionary and charitable trusts as a tool to maximise charitable giving, through tax effective means.
Charitable distributions and taxing of trusts
Charitable trusts which are registered as charities with the Australian Charities and Not-for-Profits Commission are typically income tax exempt. The charitable trust itself is not taxed on income. Beneficiaries of trust distributions will be assessed for income tax on distributions received.
So long as a discretionary trust distributes all of its income before the end of each tax year, the trust will typically not be taxed on income (although in some circumstances a trustee may be taxed, such as where the trust distributes to minors or non-resident beneficiaries).
For more information on income tax exemptions click here.
Tax exempt beneficiaries
If trust income is taxed in the hands of a beneficiary, and the beneficiary is income tax exempt, no tax is paid on that income. This is the case, even if the beneficiary is not a tax deductible gift recipient (DGR). So long as the beneficiary is income tax exempt, no tax is paid on the trust income distributed to it.
In light of the above, to the extent that a discretionary trust or charitable trust gives to an income tax exempt entity (such as a charity or non-profit) the beneficiary will be entitled to keep the full gross or pre-tax amount of the distribution.
On this basis, (subject to certain conditions) income from property held in a discretionary trust or charitable trust is non-taxable where it is distributed to a charity or non-profit (which are income tax exempt entities). In this way, investing through a discretionary trust or charitable trust structure can allow for charitable gifting in pre-tax dollars whilst reducing tax assessable income.
A discretionary trust can only distribute to a beneficiary clearly identified in the trust deed. As such, where the beneficiary is a charity or non-profit organisation, the beneficiary should be added by name to the list of beneficiaries under the trust deed. Most discretionary trust deeds include a mechanism to add beneficiaries. Even so, when adding a beneficiary to a trust, you should seek legal advice, to ensure that the amendment does not trigger a resettlement of the trust (which may have stamp duty or capital gains tax consequences).
By contrast to discretionary trusts, charitable trusts are usually drafted in broad terms, allowing for distributions to be made to any beneficiary (named or unnamed) so long as the distribution is for a charitable purpose.
Discretionary trusts and charitable trusts can distribute funds to individuals or entities overseas (although this is subject to the terms of the trust deed).
A charitable trust is required to incur its expenditure and pursue its objectives principally in Australia. For this reason, a charitable trust must make the majority of its distributions to Australian beneficiaries. However, up to fifty per-cent of trust income may be distributed overseas.
A trustee of a discretionary trust is required to pay tax on distributions to non-resident beneficiaries. A non-resident beneficiary can claim a tax credit for the amount (or some of the amount) of tax paid by the trustee in respect of a distribution to the non-resident beneficiary. We advise you to seek accounting advice in this regard.
Charitable giving through discretionary trusts and charitable trusts maximises charitable distributions and reduces tax assessable income.
If you would like to establish or amend a trust for the purposes of charitable giving, please contact a member of our Charities and Not-for-Profit team.
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