Properly taxing discretionary trusts has highlighted another problem the Government needs to solve

Who can you donate to, and then receive a tax deduction for that donation?

There should be a simple answer to this question, but the Government’s consultation on its minimum tax on discretionary trusts has highlighted that Australia’s regulation of tax-deductible donations is in shambles.

Currently, when a discretionary trust distributes money to a tax-exempt entity, no tax is paid on that money. It is one of the ways trusts can reduce their taxable income. There are around 300,000 tax-exempt entities in Australia that discretionary trusts can choose to give to without paying tax. These can include religious entities, sporting clubs, and peak industry bodies, alongside registered charities.

However, if, like most Australians, you don’t run your finances through a discretionary trust, you can only get a tax deduction for donating to a select number of registered charities: the 30,000 or so that have Deductible Gift Recipient (DGR) status. There are significantly fewer registered charities than tax-exempt entities, and even fewer DGR-endorsed charities, with a minority of Australia’s 65,000 registered charities able to accept tax-deductible donations.

DGR endorsement allows charities to receive tax-deductible donations from the public, and grants from philanthropic giving funds. It would make sense for the Government to limit tax deductibility of gifts from discretionary trusts to those made to DGR-endorsed charities. This would meet the Government’s objective of taxing the income of discretionary trusts more like workers’ income.

But that ignores the elephant in the room. The DGR system is fundamentally unfair, overly complex, and not fit for purpose. There is no rhyme or reason for why some charities can get DGR status, and others are excluded. The DGR system has developed in an ad hoc manner that is not reflective of modern charitable work.

For example, charities helping communities build resilience and prepare for climate disasters are excluded from DGR status, but those helping people recover from bushfires or floods can access tax-deductible donations. Other modern charitable work excluded from the DGR system includes reconciliation activities, the promotion and enhancement of democracy, and public interest journalism.

So, what to do?

The Government is coming under pressure, including from religious groups, to keep the status quo and let discretionary trusts continue giving to hundreds of thousands of tax-exempt organisations without having to pay tax, while leaving the rest of us limited in our options.

But there is a better solution: expand and simplify the DGR system along with limiting all tax-deductible donations, including those from discretionary trusts, to DGR-endorsed charities.

The Productivity Commission set out a clear pathway in its 2024 report on philanthropy for reforming the DGR system to make it fairer, simpler, and more fit for purpose. Its recommendation for reform is based on three principles:

• The charitable activity being supported by a tax-deductible donation is in the public interest;
• government support via a tax concession is appropriate; and
• there is minimal risk of a private benefit to the donor.

In applying those principles, the Productivity Commission concluded that the majority of registered charities should be supported by DGR status, with some key exceptions. As opposed to the current situation, where a minority of charities can access DGR status.

The Government has yet to take any action on the DGR recommendations from the report it commissioned, but implementing its minimum tax on trusts provides an excellent opportunity.

A minimum tax rate for discretionary trusts is an equity measure. So is reforming the DGR system. The present system does not provide for an appropriately fair, equitable, and accountable framework for the tax deductibility of donations regardless of their source. Unlocking DGR so that most registered charities can access tax-deductible donations from individuals, discretionary trusts, and philanthropic giving funds will provide consistency and integrity to the system governing tax-deductible donations.

It will also encourage Australians to invest in their local communities. At a time when social divisions are deepening, and the climate crisis is impacting us all, charities undertaking the work of building social capital, connection, and resilience are being denied a lifeline to do more of the work their community and governments are asking them to do.

We are urging the Federal Government to use the opportunity provided by implementing a minimum tax rate for discretionary trusts to also finally fix the broken DGR system and back the charities strengthening the communities Australia relies on.