Below is Chapter 1 of our ‘Trust Distributions Guide’ booklet. To read the other chapters of our booklet, click the links below:
- Chapter 2: Defining and Determining Trust Law Income
- Chapter 3: Making Effective Distributions
- Chapter 4: Timing, Authority and Validity of Distributions
- Chapter 5: Risk Management and Common Traps
- Chapter 6: Summary and How we can Help
The evolution of Trusts
Trusts developed over many centuries to recognise a special relationship between one person (the trustee) who holds assets on behalf of others (beneficiaries).
Although the trustee is the legal owner of the assets, the trustee is forbidden by its duties from using the assets except to benefit the beneficiaries. If not, the trustee would is in breach of trust.
It has also been established for centuries by the common law (the law developed by court cases) that trustees can earn income from the trust’s assets, which they can either hold onto or distribute to beneficiaries. This income is called trust law income.
The concept of trust law income is still essential because this is the only thing trustees can legally distribute to beneficiaries. If a trustee tries to distribute anything that is not trust law income (such as tax law ‘net income’), this will fail. The distinction between trust law income and other amounts is what this Guide is about.
Trusts and taxes
The income tax law has always had a tough time dealing with trusts, particularly discretionary trusts.
This is because, for most legal purposes, a trust is not a ‘thing’ in its own right. A trust is only a ‘relationship’ between a trustee and its beneficiaries. The trustee only holds assets and collects money on behalf of the beneficiaries.
In other words, a trust is a ‘pass-through’ relationship whereby the trustee holds asset and collects money each year for the benefit of others.
However, the income tax law is all about identifying specific people (humans or companies) that the law can say have derived income that year so it can assess them for income taxes.
If the tax law could not identify a trust as a taxpayer in its own right, then people could decide to hold their businesses or investments in a trust, and the income would not be taxed until it was (if ever) distributed by the trustee. This would be a huge source of tax avoidance if the tax law did not do something about it.
As a result, the tax law deals with trusts by deeming them to be a ‘thing’ (even though they aren’t). The tax law then treats trust as ‘taxpayers’ and also deems them to have received something like ‘taxable income’. Treating trusts in this way mostly works, but it is artificial, and ultimately creates a complex mess.
Creating a ‘taxable income’ concept for trusts
For a human or company taxpayer, the income tax law looks at your assessable income for a given year, and takes away any allowable deductions relating to that same year, to arrive at a net amount called your taxable income. Income taxes are then paid on your taxable income at your marginal tax rates (0-45% for humans, 25-30% for companies). This all reflects the process that income taxes should only be paid on the net amount (or profits) you have left over after expenses are paid.
None of this process works for trusts.
This is, again, because a trust is not a ‘thing’, so it may be difficult to say it earns any assessable income or incurs any deductions. However, for the reasons mentioned above, Parliament knew it needed to impose tax on the income of trusts to stop them being used to avoid tax altogether.
Taxing trusts on a net amount
Parliament dealt with this by creating a new concept called net income in Division 6 of the Income Tax Assessment Act 1936 (Cth) (the Tax Act 36). Section 95 of the Tax Act 36 defined net income like this:
in relation to a trust estate, means the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions…[with some exceptions for deductions relating to farm management deposit and tax losses].
For most purposes, this means net income is basically the same as taxable income that applies to other taxpayers. However, this hides a level of complexity that the net income concept does not deal with.
You will notice the deeming words in section 95 operate to make the concept of assessable income work for trusts, by deeming the assessable income to be received in the hands of the trustee as if the trustee were a taxpayer. This solution fixed the need for trust’s to be taxed on a net amount (now called net income), but it was clear this was an artificial concept entirely created by the Tax Act, with no basis in the common law which defined the nature and powers of trusts over centuries.
What is the foundation for the ‘deemed’ income concept?
A keen observer may argue that this still does not really fix the underlying problem, since it still requires there to be ‘assessable income of the trust estate’ and ‘deductions’ to then be allocated to the trustee and labelled net income.
It may be an academic argument, but it could be said that a trust estate (i.e. the trust) still does not have any assessable income because this is just a tax law concept not recognised by trust law. So, has the net income definition in section 95 actually done anything to solve this problem? The answer is: not on its own. The net income definition only works because of the later sections 97, 98, 99 and 99A which import ‘trust law income’ for the first time, to try make sense of things.
The ’net income’ vs trust law income conflict
Section 97 most commonly applies, because it is how beneficiaries are taxed on money they receive from trusts. Section 97(1) of the Tax Act 36 taxes beneficiaries in this way:
…where a beneficiary of a trust estate who is not under any legal disability is presently entitled to a share of the income of the trust estate:…
(a) the assessable income of the beneficiary shall include:…
(i) so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was a resident…
In other words, section 97(1) is saying that when a beneficiary is ‘presently entitled’ to a share of income of the trust estate then the beneficiary will be taxed on that share of the tax law net income of the trust estate for that year. Section 98, 99 and 99A use a similar method of comparing a ‘share’ of the income of the trust estate with tax law net income to divvy up the tax.
Suddenly, we have introduced something called ‘income of the trust estate’ which we have not properly defined yet! So, what is this?
Well, in the 2010 Bamford case the High Court clarified that the phrase ‘income of the trust estate’ in section 97(1) means trust law income (rather than a concept specific to tax law). Trust law income is a real thing that the Courts have defined and dealt with for centuries. In other words, section 97 is saying that a beneficiary is taxed on that ‘share’ of the trust’s tax law net income with reference to the ‘share’ of trust law income to which the beneficiary is entitled.
Section 97(1) effectively links tax law net income to trust law income.
Because Parliament had to create the new artificial concept of tax law net income, this needed to be reconciled with trust law income in some way. This is what the use of the word ‘share’ is doing in section 97(1).
First you look to see how much trust law income a beneficiary is getting (which is a real thing), and then for tax law purposes the same beneficiary is treated as receiving a corresponding ‘share’ of the tax law net income.
Because these sections use a comparison of ‘shares’ this led to further controversy about whether this should be by quantum ($100 net income = $100 trust law income), or by proportion (10% net income = 10% trust law income). The court in Bamford ultimately decided the proportional method was correct, which is discussed further below.
The rest of our Guide covers some of the issues you need to think about to navigate these rules to make effective trust distributions.
Whether you are a trustee, advisor, or beneficiary, our team can help you understand your rights and responsibilities and avoid costly mistakes. Call us on 1300 654 590 or email us to make your trust distributions smarter, safer, and more strategic.
The information contained in this post is current at the date of editing – 22 August 2025.
