Labor’s proposed overhaul of discretionary trusts is facing a fresh backlash after tax experts warned a new exemption designed to soften the government’s 30 per cent minimum tax could leave family trusts unable to accommodate children or grandchildren born after the new regime begins.
The controversy has been dubbed a “birth tax” by critics, although the description requires an important qualification: the draft legislation does not impose a tax simply because someone has a baby.
Instead, the concern arises from the way an alternative regime for existing discretionary trusts has been drafted.
Under Labor’s broader reforms, certain discretionary trusts will face a minimum tax rate of 30 per cent from July 1, 2028.
The government says the change is intended to reduce income splitting and better align the tax treatment of trust income with the tax paid by Australians earning wages.
But after businesses and tax advisers warned that restructuring family trusts into companies or fixed trusts could trigger substantial legal, administrative and state stamp duty costs, Treasury developed another option.
That option allows an eligible discretionary trust to effectively step outside the new minimum-tax regime by becoming what the draft legislation calls an Excluded Election Trust, or EET.
The catch is that the trust must nominate in advance who will receive its income and capital — and in what proportions.
Once those arrangements are made, the draft allows very limited scope to change them.
That is where newborn children have entered the debate.
How the new election would work
The exposure draft released by Treasury on September 3 says a trust making an EET election must nominate every beneficiary to whom the trustee intends to provide a share of both income and capital.
It must also specify each beneficiary’s percentage entitlement, with the nominated shares adding up to 100 per cent.
The same proportions generally have to continue in future years if the trust wants to preserve its exclusion from the 30 per cent minimum tax.
The election is only available to relevant trusts already in existence on July 1, 2028.
For a conventional trust operating on a July-to-June financial year, the election must be made during the 2028–29 income year. Once made, it can continue into future years provided the trust complies with the nomination.
On its face, the system exchanges one of the defining characteristics of a discretionary trust — the ability to change distributions as family and commercial circumstances evolve — for more favourable tax treatment.
The government says this is an alternative to physically restructuring the trust and is expected to avoid the stamp duty problems that could accompany transferring assets into a different structure.
For many businesses, that could be valuable.
But tax professionals have now focused on what happens when the family itself changes.
Death and divorce are covered. Birth is not.
Treasury’s explanatory material says that once an EET nomination is made it generally cannot be varied.
Only two specified circumstances allow changes to nominated individual beneficiaries.
One is the death of an existing beneficiary. In that situation, the deceased person’s allocated share can in certain circumstances be redirected to eligible beneficiaries of their estate.
The second involves a relationship breakdown between nominated beneficiaries, where relevant court orders, agreements or awards alter their interests.
There is no corresponding provision expressly allowing a new child or grandchild to be added simply because they were born after the family’s beneficiary arrangements were fixed.
That omission has prompted tax advisers to argue that some families could effectively be “frozen” according to their circumstances when they entered the election.
CPA Australia tax lead Jenny Wong has warned that family trusts are often established specifically to hold businesses and other assets across generations.
The issue is therefore much broader than short-term income splitting. Trusts can form part of succession arrangements expected to operate for decades, during which marriages, births, deaths and major changes in family circumstances are inevitable.
Australian Industry Group chief executive Innes Willox has also criticised a design that provides flexibility for death and relationship breakdown while apparently failing to make similar accommodation for new births.
The concern is particularly acute for younger business owners who may establish or operate family structures before having all their children.
A couple could make an EET nomination when they have one child, for example, and later have another child whom they want to include equally in the family’s long-term arrangements.
Under the current exposure draft, that apparently simple family change could collide with the conditions attached to the tax election.
Where the 47 per cent figure comes from
The most striking part of the criticism concerns what happens if an EET stops following its nominated distributions.
Treasury’s explanatory materials say that if the trustee does not give nominated beneficiaries the income and capital shares specified in the election, the election can be automatically revoked.
The consequences for that income year are severe.
Beneficiaries who had been made presently entitled to trust income are treated for tax purposes as though that entitlement had not occurred.
The trustee then becomes liable for tax on all of the trust’s net income for that year at the top marginal tax rate plus the Medicare levy.
Under current individual tax settings, that combination is 47 per cent.
In later income years, the trust would fall back into the proposed 30 per cent minimum-tax regime.
This is the mechanism behind the “birth tax” headline.
But it is crucial to distinguish the mechanism from the political label.
A family does not receive a 47 per cent tax bill merely because a baby is born.
The problem arises if a trust that has chosen the EET concession later wants to distribute income or capital to a new family member in a way that departs from its locked nomination and causes the election to be revoked.
A family could instead leave the new child outside those trust distributions, abandon the election prospectively where permitted, accept the minimum 30 per cent regime, or consider another structure.
Those alternatives are why describing the proposal as a literal tax on having children would overstate what the draft legislation does.
What critics are identifying is a potentially significant penalty for changing long-term family arrangements after selecting the government’s concession.
Why Labor is changing trust taxation
The Albanese government argues the broader reform is about tax fairness rather than targeting family businesses.
Treasury says Australia has more than one million trusts, around 840,000 of which are discretionary trusts, and their use has grown considerably over the past two decades.
The government’s analysis says discretionary structures can allow trustees to allocate income among beneficiaries on different marginal tax rates, reducing the total tax paid by a family group.
Treasury estimates families using discretionary trusts paid an average tax rate about four percentage points lower in 2022–23 than families on comparable incomes without such trusts.
It also says more than 90 per cent of private trust wealth is held by the wealthiest 10 per cent of households.
The government therefore plans to impose the 30 per cent minimum tax at trustee level, with non-corporate beneficiaries receiving non-refundable credits for tax already paid by the trustee.
The 2026–27 Budget estimated the measure would raise about $4.5 billion over the forward estimates.
Treasurer Jim Chalmers argues that revenue can help finance tax relief for workers while reducing an advantage that is not available to ordinary employees earning their income directly through wages.
The government has repeatedly emphasised that the measure will not affect every trust.
Fixed trusts, widely held trusts, complying superannuation funds, charitable trusts, special disability trusts and other specified structures are excluded.
Primary production income and certain income relating to vulnerable minors are also among the exclusions.
After criticism following the May Budget, the government expanded the exemption for genuine testamentary trusts, including future discretionary testamentary trusts subject to conditions.
It says fewer than 10 per cent of Australia’s 2.7 million active small businesses will be affected by the discretionary trust reforms in any given year.
The election was supposed to solve another problem
The EET mechanism itself emerged because the original proposal created difficulties for businesses that wanted to escape the minimum tax by restructuring.
Treasury has promised expanded Commonwealth rollover relief for three years from July 1, 2027, allowing affected taxpayers to move assets from discretionary trusts into other structures without immediately triggering certain federal income tax consequences.
But Commonwealth relief cannot automatically eliminate every state tax, commercial or contractual cost.
CPA Australia warned earlier in the consultation process that restructuring could involve far more than changing a tax return.
Depending on the business, it could require changes to leases, contracts, licences, ownership arrangements and financing, as well as potentially exposing taxpayers to state stamp duty.
The fixed-distribution election was therefore welcomed as a genuine improvement because it could allow a trust to remain legally intact while being treated differently for the minimum-tax rules.
Now the argument has shifted to the price of using that concession.
If beneficiaries and percentages have to remain fixed for decades except following death or relationship breakdown, many families may question whether avoiding the 30 per cent minimum tax is worth sacrificing the flexibility for which the trust was originally established.
This is still draft legislation
The latest controversy is occurring before the rules have been finalised.
Treasury’s exposure draft is currently open for consultation, with submissions due on September 18.
That matters because the absence of a birth-related variation in the current text could still be addressed before legislation reaches its final form.
The government has already altered parts of its tax package following consultation, including its treatment of testamentary trusts and the creation of the EET option itself.
The Coalition has seized on the latest issue, with Shadow Treasurer Tim Wilson describing it as another tax “landmine” and promising political resistance to Labor’s trust regime.
Those comments are part of the political contest over the government’s tax package, not an independent assessment of how the eventual law will operate.
The more important test will be whether Treasury accepts the technical concern identified by practitioners and changes the beneficiary rules before the legislation is settled.
For families using trusts, the distinction is substantial.
A genuine tax imposed simply because a baby was born would be one thing. That is not what Labor has drafted.
But a concession that requires a family to predict decades in advance who its beneficiaries will be — while imposing major tax consequences if those arrangements later change — raises a real policy question of its own.
The government created the election to give families and businesses greater flexibility.
Tax experts are now asking whether, in solving one problem, the draft has created another.
