SMEs to be hit hardest by new trust tax reforms

Discretionary trusts are widely used across Australia because they offer flexibility and asset protection for business owners operating in inherently risky environments. 

So, why would small businesses be impacted the most? 

At the moment, small businesses are often seen as the greatest beneficiaries of discretionary trusts, as they offer flexibility in distributing profits to family members in lower tax brackets, help shield business assets from personal liabilities, and allow for a 50 per cent discount on CGT.

But under the proposed reforms, many of these businesses may face a higher effective tax burden purely because of the structure they use to operate safely and efficiently.

Trustees will effectively pay a flat 30 per cent tax upfront on distributions. While beneficiaries receive corresponding tax credits, those credits are non-refundable. 

For high-income earners already paying tax above 30 per cent, the practical impact may be limited. 

However, Bartels said that for everyday SMEs that rely on discretionary trusts for flexibility, succession planning, and asset protection, the reforms could materially increase the overall tax burden and affect cash flow, despite no change in underlying business profitability. 

“For many small business families, the concern is not just about tax – it’s about cash flow,” he said. 

“Businesses could end up paying materially more tax despite earning the same income.”

Analysis from Halo Advisory suggested the reforms have the potential to force many SMEs to reconsider long-standing business structures designed around asset protection and succession planning.

“Operating through a trust structure has often been about protecting the family home or separating business risk from personal assets,” Bartels said. 

“The challenge now is that maintaining those protections may come with a significantly higher ongoing tax cost.” 

If a husband-and-wife business operating through a discretionary family trust generated $200,000 in annual profit, under the current regulations, distributing profits evenly may result in an effective family tax rate of approximately 22 per cent. 

However, under the proposed changes, the situation is seemingly more unfortunate as the family’s tax burden may increase substantially because excess tax credits cannot be refunded, resulting in a direct reduction in household cash flow. 

For many SMEs already managing rising wages, Bartel said that supply chain costs, insurance increases, interest rate pressure, and losing an additional $10,000–$20,000 in annual liquidity could materially affect hiring decisions, reinvestment plans, and long-term business stability. 

Accordingly, many business owners are depicting the reforms not as a tax impartiality measure, but moreso as a structural reset for the SME sector. 

As such, for many SMEs, restructuring will be more than just a basic practice; it could fundamentally change how their businesses operate in the long term. 

These concerns are leading to many critiques and particular business owners questioning, what does the future look like for small businesses? 

Many small business owners are not large-scale tax minimisers and are simply trying to build sustainable businesses that employ staff. 

Such reforms not only impose an additional burden on these SMEs in terms of cash flow, but also, when small businesses lose liquidity, reduce investment, hiring, and overall business growth. 

Regardless of whether these reforms proceed in their current form or evolve through consultation, Bartels said, business owners should begin assessing their structures now.