The proposed EET regime: a powerful tax constraint, not a substitute for discretion

At first glance, the newly proposed ‘excluded election trust’ (EET) regime might appear to replace the trustee’s discretion with a mandatory distribution formula, but the position is more nuanced. The proposed rules may make departure from the nomination costly, but they do not relieve the trustee of its fiduciary obligations.
The practical question for trustees will be: does the EET nomination dictate how trust distributions must be made, or is it merely one important factor the trustee must consider when exercising its discretion each year?

The trustee must make a genuine and informed decision

Even where a trustee’s discretion is expressed to be “absolute” or “unfettered”, it must be exercised in good faith, upon real and genuine consideration, and for the purposes for which it was conferred.1 The trustee must make an informed and independent decision based on the circumstances at the time, rather than mechanically applying a predetermined policy or acting at another person’s direction.

In Owies v JJE Nominees Pty Ltd [2022] VSCA 142 (Owies), the Court confirmed that a trustee must be properly informed. The enquiries required to be made by the trustee will depend on the trust’s nature and purpose, its beneficiary class and the terms of the relevant power. The trustee need not investigate the circumstances of every possible beneficiary but must have sufficient current information about those with a realistic claim to consideration.2

In Owies, the trustee repeatedly applied a settled distribution formula without directly enquiring into the circumstances of two primary beneficiaries. This supported the conclusion that it had not genuinely considered the how the distribution was to be each year. Owies does not require equal or needs-based distributions, but it does require an informed and independent decision. An EET nomination may therefore strongly influence the trustee’s decision to distribute income but should not be applied mechanically as a substitute for it.

The proposed 30% minimum tax

From 1 July 2028, it is proposed under the exposure draft to impose a minimum 30% tax at the trustee level on relevant net income of discretionary trusts.3 Certain trusts and income would be excluded, including fixed trusts, qualifying primary production and testamentary trust income, and amounts subject to non-resident withholding tax.

Non-corporate beneficiaries would generally receive a corresponding non-refundable tax offset for minimum tax paid on their distribution. Corporate beneficiaries would not receive a tax offset, potentially resulting in tax at both the trustee and company levels without an offset for the company.4

The reforms will materially affect the tax consequences of distribution decisions, but not the source or purpose of the trustee’s powers. As recent case law illustrates, tax consequences are relevant, but a lower-tax outcome does not, by itself, determine how a trustee should exercise its discretion.

How would the EET election work?

The EET exposure draft offers an alternative for certain trusts in existence on 1 July 2028. The trustee may elect for the trust to become an EET, meaning that it is taken not to be a minimum tax trust while the election remains in force.5 The election must also be accompanied by a nomination specifying:

• each beneficiary who may be made presently entitled to a share of income and capital;
• each beneficiary’s fixed share of trust income and capital (with each beneficiary’s share of income and capital being equal).

The cumulative total of each beneficiary share must equal 100% and the nomination generally cannot be varied. Limited changes are contemplated following the death of a nominated beneficiary or a qualifying relationship breakdown. The trustee may revoke the election prospectively, but it cannot make another EET election if an earlier election has been revoked.

Does the nomination compel the trustee?

If the trustee decides the EET election is to be in force for an income year, the trustee “must” confer present entitlements to trust income and capital in accordance with the EET nomination.6

On one view, this provision might be interpreted as a requirement that the trustee only make distributions consistent with the EET nomination. The better view is that the provision identifies what the trustee must do if it decides to preserve and rely on the EET treatment for the relevant year. It does not compel the trustee, irrespective of the trust deed and its fiduciary duties, to make the nominated distributions.

If the trustee decides not to confer entitlements in accordance with the EET nomination, the proposed legislation does not provide a mechanism requiring the trustee to perform the nomination. Instead, the consequence is automatic revocation of the EET election. The law attaches consequences to the decision without displacing the decision itself.

Distribution in accordance with the nomination is a condition of retaining the concessional EET treatment, not an independent source of the trustee’s power to distribute. The trustee’s power must still be found in the trust deed, and its exercise must still satisfy the trustee’s equitable obligations.

An informed decision remains necessary

The EET nomination will be a highly influential factor in the trustee’s decision to distribute income in a given year. Departure may cause the election to be automatically revoked, prevent another election from being made and expose the trust (and ultimately its beneficiaries) to particularly adverse tax treatment in the revocation year.

Where automatic revocation occurs, proposed section 102UYG may treat beneficiaries as never having been presently entitled to relevant income or capital for that year. Division 6 of the Income Tax Assessment Act 1936 (Cth) would then apply under modified rules that may result in the trustee being assessed on the affected income as undistributed trust income at the highest marginal tax rate.

Those consequences may make compliance with the nomination commercially compelling in most years. But the trustee should still consider whether the nomination:

• is authorised by the deed and consistent with the purposes of the distribution power;
• remains appropriate having regard to current beneficiary and trust circumstances; and
• is preferable when the tax consequences of departure are properly weighed.

A trustee should not assume that making the EET election once permits it to apply the nominated percentages mechanically forever. That approach risks reproducing the central problem in Owies: treating a settled formula as a substitute for the continuing exercise of discretion.

Equally, Owies does not require the trustee to depart from the nomination merely because beneficiaries’ circumstances change. The trustee may properly conclude, after genuine consideration, that the nomination remains appropriate and that the substantial tax consequences of departing from it weigh strongly in favour of compliance.

Practical steps for trustees

Trustees considering an EET election should take the following steps:

• Confirm that the nominated income and capital appointments would be authorised by the deed. Consider the primary beneficiaries, default entitlements, purposes of the trust and any restrictions on its powers before making the EET nomination.
• Obtain current information about the principal beneficiaries, review the trust’s financial position and consider whether following the nomination remains a proper exercise of the relevant powers. Minutes should record, within reason, the information and factors considered by the trustee.
• The trustee should assess not only the expected minimum tax savings, but also the loss of future flexibility. It should consider how the nomination would operate if a beneficiary’s health, financial position, personal relationships or capacity materially changes.