Fixed Trusts: The Commercial Law Pitfalls Before the 2028 Switch

From 1 July 2028 the trustee of a discretionary trust will pay a minimum 30 per cent tax on the trust’s taxable income. The exemption list is short and explicit: fixed trusts, widely held trusts (including fixed testamentary trusts), complying superannuation funds, special disability trusts, deceased estates and charitable trusts. The Government has paired the new tax with three years of expanded rollover relief from 1 July 2027 to allow restructure out of discretionary trusts into either a company or a fixed trust.

Every adviser with a discretionary trust client is about to be asked the same question: can we move into a fixed trust before the new tax bites? Most of the public discussion of that question is tax-driven. This article is not. It is a commercial law article about what fixed trusts actually are, what the deed has to do to qualify (and to keep qualifying), and the drafting traps that catch advisers who treat a fixed trust as a discretionary trust with a different label.

Tax characterisation follows the legal substance of the trust. A trust deed that is internally inconsistent with the requirements of a fixed trust at law will fail the tax characterisation, regardless of what the cover page says.

What “fixed” actually means

A trust is fixed in the legal sense when each beneficiary has a vested and indefeasible interest in the income and capital of the trust. Vested means the right has accrued (not merely contingent). Indefeasible means the right cannot be defeated, divested or reduced by any subsequent act, election or power of any person, including the trustee.

Schedule 2F to the Income Tax Assessment Act 1936 (Cth) codifies this for tax purposes: a beneficiary has a fixed entitlement to a share of the income or capital of the trust where the beneficiary has a vested and indefeasible interest in that share. Section 272-65 provides the same test for the corresponding loss attribution context.

The Commissioner’s discretion in section 272-5(3) to treat a beneficiary as having a fixed entitlement notwithstanding a defeasance power exists, and is given practical content by Practical Compliance Guideline PCG 2016/16. The PCG is what most advisers rely on to establish fixed trust status in practice. It is also the source of the most common drafting failures we see, because advisers read the PCG as a tax document and miss its consequences for the trust deed itself.

The drafting pitfalls

1. The variation clause that quietly destroys fixedness

Almost every trust deed contains a variation clause. In a discretionary trust, the trustee or the appointor typically has broad power to vary the deed by execution of a deed of amendment. That power is appropriate because discretionary trusts are inherently flexible.

In a fixed trust the same power is fatal. If the trustee or appointor can vary the entitlement of any unit holder (including by changing the share, class or terms attaching to units), the interests of unit holders are not indefeasible. They are defeasible by an exercise of the variation power. The trust is not fixed at law, regardless of what the unit register currently says.

The drafting fix is to scope the variation power narrowly: it must not permit any variation that affects the rights of unit holders to income, capital, voting, redemption or class without unanimous unit holder consent (and even then, with care). Many off-the-shelf fixed trust deeds do not get this right. They use a variation clause adapted from a discretionary deed with no specific carve-outs for unit holder rights.

2. Trustee discretion over income or capital

Fixed trusts often retain trustee discretion in places that look operationally sensible but destroy the fixed characterisation. Examples include trustee power to:

• decide which receipts are income and which are capital;
• apply income to expenses, depreciation reserves or maintenance reserves in the trustee’s discretion;
• accumulate income rather than distribute it;
• distribute capital to one unit holder ahead of others, or to vary the time or manner of capital distribution;
• issue further units of a different class, with different rights.

Each of these powers, exercised by the trustee, can change the economic substance of a unit holder’s entitlement. Each of them therefore makes the entitlement defeasible at the trustee’s discretion. A fixed trust deed needs to either remove these powers entirely, or make their exercise mandatory rather than discretionary (for example, accumulation can be mandatory and tracked through unit holder capital accounts on a pro rata basis).

3. Confusing the PCG safe harbour with the statutory test

The statutory test for a fixed trust in section 272-5(1) is whether a beneficiary has a vested and indefeasible interest in a share of the income or capital of the trust. That test does not require a single class of units. A trust deed can validly create A class units that hold the fixed entitlement to income and B class units that hold the fixed entitlement to capital, and still satisfy section 272-5, provided each entitlement is itself vested and indefeasible.

What requires a single class is the PCG 2016/16 Category 6 safe harbour. That safe harbour is designed for simple fixed trusts. A multi-class structure is in substance a hybrid and falls outside Category 6. The trust may still be a fixed trust at law and for section 272-5 purposes, but the trustee cannot rely on the PCG safe harbour to self-assess and will need to either obtain a private ruling or accept the risk of an ATO challenge to the fixed characterisation.

The drafting question is therefore which path the parties want. If the deed must qualify under the PCG safe harbour (the usual position for private fixed trusts wanting administrative comfort), it must provide for a single class of units sharing equally in income and capital. If the parties need a multi-class structure for commercial reasons, the deed can still be drafted as a fixed trust at law, but the parties need to accept the additional ATO engagement (ruling or otherwise) that comes with that choice.

4. Defeasance hidden in trustee powers

Defeasance does not have to be in a single clause. It is the cumulative effect of trustee powers that, individually, look administrative but together allow the trustee to defeat or diminish unit holder entitlements. Common hidden defeasance powers include:

• power to compulsorily redeem units at a value the trustee determines;
• power to alter the rights attaching to units by trustee resolution;
• power to consolidate or subdivide units in a manner that affects relative entitlements;
• power to suspend or defer distributions indefinitely;
• power to set off amounts owed by a unit holder against distributions in a way that effectively reallocates them.

Each of these has commercial justifications, but each of them is a defeasance power for fixed trust purposes. The deed must either remove the power, or condition its exercise on unanimous unit holder consent, or design it so that the effect on relative entitlements is neutral (for example, compulsory redemption at NAV with proceeds paid to the unit holder).

5. Issue and redemption mechanics

PCG 2016/16 (Category 6 safe harbour) requires that units be issued and redeemed at net asset value, calculated on a consistent and transparent basis. Many off-the-shelf deeds provide for issue or redemption at a price the trustee determines, or at face value, or at a value agreed between the trustee and the relevant unit holder. None of these satisfies the NAV requirement.

The drafting fix is mechanical: the deed must contain an explicit NAV calculation methodology, must require independent valuation of non-liquid assets at defined intervals, and must constrain the trustee to apply that methodology consistently. The deed should also identify who certifies NAV (typically the trust auditor or a licensed valuer), and the frequency.

PCG 2016/16: what protection it gives you and what it does not

PCG 2016/16 sets out six categories of trust that the ATO will accept as fixed for tax purposes without requiring a private ruling. The category most relevant for private fixed trusts is Category 6, which applies where the trust deed itself contains the structural features the ATO regards as necessary to support fixed characterisation. The structural conditions for Category 6 are:

• a single class of units, sharing equally in income and capital;
• fixed entitlements to all of the income and all of the capital of the trust;
• no power in the trustee or any other person to defeat, diminish or vary a unit holder’s entitlement;
• units issued and redeemed at net asset value, calculated on a consistent basis;
• no power in the trustee to accumulate income to the detriment of distribution rights, or to allocate income or capital disproportionately; and
• variation of the deed permitted only by unanimous consent of unit holders.

The legal analysis required for any candidate fixed trust deed has two questions in this order. First, does the deed give every beneficiary a vested and indefeasible interest in income and capital, with no discretionary power vested in anyone to defeat or vary that interest? If yes, the trust is fixed in substance, satisfies section 272-5(1) on its terms, and falls within the Category 6 safe harbour without further work. Second, if the answer is no (because the deed includes some defeasance power that the parties want to retain for commercial reasons), the PCG safe harbour has work to do. The drafting then becomes about meeting one of the PCG categories on its terms, or accepting that the trust is a hybrid that needs to be ruled on case by case.

The corollary for drafting is that the PCG and the statutory test are not the same instrument. The PCG provides administrative comfort that the Commissioner will not challenge a self-assessed fixed characterisation where the structural features are present. The statutory test in section 272-5 is what actually makes the trust fixed at law. A deed that satisfies the PCG also satisfies the statutory test in substance, but a deed that satisfies the statutory test does not necessarily satisfy the PCG. For a private fixed trust the practical objective is to satisfy both at the same time, which means drafting to the PCG Category 6 conditions.

Saunders v Vautier risk

A fundamental commercial law issue for fixed trusts is the rule in Saunders v Vautier (1841). If all unit holders are of full legal capacity and together hold all beneficial interests in the trust, they can compel the trustee to terminate the trust and distribute the trust property to them. The rule applies notwithstanding contrary provisions in the trust deed.

For private fixed trusts with a small number of unit holders, the rule is not a theoretical concern. It is a live risk that one or more unit holders may use a Saunders v Vautier argument either to extract capital from the trust early, or to threaten termination as a negotiating lever against the trustee or other unit holders.

There are partial drafting responses: ensure that unit holders never collectively hold the entire beneficial interest (for example, by including a perpetually deferred general beneficiary class with a remote contingent entitlement); use trustee class rights that are not strictly unit holder interests; or design the unit register so that there is always at least one unit holder who is not of full legal capacity (a minor, a deceased estate). Each carries its own commercial and tax risk. None completely defeats the rule. Advisers should be candid with clients that the rule cannot be wholly contracted out of.

Trustee duties to fixed unit holders

The trustee of a fixed trust owes duties to unit holders that differ in important respects from those owed by the trustee of a discretionary trust. The relevant duties include:

• a duty of fairness as between unit holders, particularly in the exercise of any retained discretion (for example, timing of distributions, allocation of expenses);
• a duty to act in the best interests of the unit holders collectively, not the trustee or any related party;
• a duty to administer the trust in accordance with its terms, with no implied authority to deviate;
• a duty to account, to provide reasonable information to unit holders on request, and to maintain proper books and records;
• a duty to avoid conflict of interest, which becomes particularly acute where the trustee or its related parties are themselves unit holders or have other interests in the trust assets.

These duties are not new. They are familiar from the law of unit trusts and managed investment schemes. What is new is the volume of trusts that will need to comply with them from 1 July 2028 onwards. A trustee company that has been running a family discretionary trust since 1985 will, after restructuring into a fixed trust, find itself owing a new and more demanding set of duties to the same family members it has always served. The operational reality of how that trustee runs the trust needs to change accordingly.

Practical drafting recommendations

When advising on a fixed trust deed in the period 2026 to 2028, we recommend the following:

• Start from a deed drafted specifically as a fixed trust. Do not adapt a discretionary trust deed. The two are different documents at the structural level and a conversion exercise is more likely to introduce defects than start fresh.
• Scope every trustee power against the fixed trust requirements. If a power could be exercised in a way that defeats or diminishes a unit holder’s entitlement, redraft, condition or remove it.
• Build in the PCG 2016/16 mechanics by design, not as add-ons. The no-defeat covenant, single class declaration, NAV mechanics and variation limits should be load-bearing parts of the deed.
• Document the issue and redemption methodology in detail. NAV needs to be calculated on a defined basis with defined inputs, by a defined person, at defined intervals.
• Address Saunders v Vautier directly in the structure (not just the deed). Decide who the residual or contingent beneficiary is, and document the rationale.
• Anticipate the operational changes the trustee will need to make. A fixed trust trustee is closer to a custodian than to a discretionary trust trustee. The deed should provide for the books, the certifications, the distributions and the unit register on that basis.
• Treat the deed as a living document. PCG 2016/16 conditions can be breached inadvertently between years. A periodic legal review by external counsel is sensible, particularly in the first three years after restructure.

Closing

The 30 per cent minimum tax on discretionary trusts will reshape Australian private wealth structuring in a way that has not happened since the introduction of CGT. The rollover relief window from 1 July 2027 will be busy. Most clients restructuring into fixed trusts will do so on adviser-driven advice, using template deeds that have not previously been stress-tested against PCG 2016/16 or against the commercial law tests for vested and indefeasible interests.

The deeds that are drafted well will hold up. The deeds that are drafted as discretionary trusts in fixed trust clothing will not, and the cost of getting it wrong will be a 30 per cent trustee tax on income that the parties thought they had structured around.

Cadena Legal advises on the drafting and ongoing administration of fixed trusts for private wealth, family business and investment fund clients. If you are reviewing a deed in advance of the 2027 to 2028 transition, we are happy to assist.