Trusts under the microscope: Key taxation issues to watch in 2025

With the company tax return deadlines behind us, the spotlight turns to trust taxation as a key area of focus for the Australian Taxation Office (ATO). Trusts remain a popular structure for asset protection and income distribution, but they also present unique challenges due to evolving interpretations of tax laws. Here's an overview of the ATO's current approach and what trustees and beneficiaries need to know to stay compliant.

Trust Distributions and Division 7A

The ATO has been applying Division 7A rules to distributions from trusts to companies since 2009, treating them as dividends taxable under company rules. While this practice has gone largely unchallenged, a recent Federal Court case may impact how these distributions are treated in the future.

What this means for Trustees:

• Review trust structures: Trusts that distribute income to associated companies should ensure compliance with Division 7A requirements.
• Monitor legal outcomes: The outcome of the Federal Court case could bring significant changes to how these distributions are taxed. Trustees should stay informed and be ready to adapt their practices.

Alignment of income and cash distributions

The ATO is closely examining situations where there is a mismatch between income distributions from trusts and cash payments to beneficiaries. A common scenario involves:

• Income allocated to adult children as beneficiaries.
• Cash payments used for family expenses or other non-beneficiary purposes.

Key risks:

The ATO may assess tax liabilities under existing trust rules if discrepancies between income and cash flows are not properly documented.

Recommendations for Trustees:

• Detailed record-keeping: Maintain clear records of all distributions and payments, specifying amounts spent on behalf of beneficiaries.
• Direct payments: Make payments directly to the beneficiaries’ bank accounts wherever possible to avoid potential scrutiny.
• Document family expenses: If trust funds are used for general family expenses, ensure these transactions are well-documented and supported by clear agreements.

Emerging areas of concern

The ATO’s approach to trusts includes the potential for retrospective application of rules, creating uncertainty for trustees. Key areas to watch include:

• New interpretations: The ATO may “retrofit” existing rules to apply to trusts in ways that were not previously enforced.
• Changes to legislation: While the government has been slow to reform trust tax rules, trustees should anticipate updates that could impact trust management and taxation.

How to stay ahead

Trustees and beneficiaries can take proactive steps to ensure compliance:

1. Regular reviews: Work with a qualified tax advisor to review trust structures and practices annually.
2. Compliance checks: Ensure all distributions and payments align with current tax laws and ATO guidance.
3. Stay informed: Monitor legislative changes and legal outcomes, particularly those that could affect how trusts are taxed.

With heightened ATO scrutiny on trusts, maintaining accurate records and aligning trust management practices with regulatory expectations is critical. By staying informed and proactive, trustees can reduce the risk of compliance issues and ensure their trusts operate smoothly in 2025 and beyond.