By Tammy McLeod*
Trusts are still one of the most flexible ownership vehicles that we have in New Zealand. They generally offer huge flexibility as to how investment income can be taxed and tax efficiency is something that is possible under New Zealand law.
Any income that a trust receives (whether that be from closely held companies, investment properties, investment portfolios, term deposits etc) can be taxed in two ways - either the trustees pay tax at 33% or the trustees can allocate income to the beneficiaries at the beneficiaries’ personal tax rates.
Under the Income Tax Act, trustees have 12 months from the balance date of the trust (which most often is 31 March for New Zealand trusts) to decide whether to pay tax at the trustee rate of 33% or, allocate income to beneficiaries. If income is allocated to beneficiaries, then that income is then declared by the beneficiaries as part of their income and they have to pay the tax (although the trustees remain responsible for payment of the tax). Up until 2010 the Income Tax Act only gave trustees six months from balance date to decide how to tax income, which meant that in most cases, trust financial statements had to be prepared before 30 September. However, in 2010, the law was amended to give trustees up to twelve months to decide. Many trust deeds however, still refer to that decision having to be made six months from balance date and so those trust deeds should be amended, if possible, to give the trustees an extension of time in which to have the financial statements prepared.
In the event that the trustees do decide to allocate income to beneficiaries then the beneficiaries must then declare that income in their personal tax returns together with any other income that they earn. The trustees of course must refer back to the trust deed to ensure that they have the ability to allocate income to beneficiaries and must check whether that power is discretionary.
Most trusts set up in New Zealand in the last twenty years are discretionary trusts and the trustees will have full discretion at to which beneficiaries are allocated income. However, older trusts may have fixed income beneficiaries or there may not be any ability to pay out income at all.
Trustees must make sure that they understand the terms of the trust deed to see what they can and cannot do, rather than relying on their accountant to ascertain the correct tax treatment of income.
If trustees do choose to allocate income to beneficiaries and are able to allocate it to any beneficiaries, income will most often be allocated to beneficiaries who are earning below $70,000. In many cases this will mean children or grandchildren over the age of 16 or non-working spouses.
In the case of children or grandchildren it is often the case that while the income is allocated to get the most tax efficient treatment, the trustees may not want to, or may not be in a position to, actually pay the income to the beneficiary - in which case the income is merely allocated and sits as a liability on the trust’s balance sheet, owed by the trust to the beneficiary.
Now that the new Trusts Act 2019 has come into force this may cause a problem for many trustees.
This is because beneficiaries over the age of 18 can now ask the trustees for copies of core documents relating to the trust and also financial information pertaining to the trust. The rationale for this is that the main obligation of the trustees is to act in the best interests of the beneficiaries. One of the only ways of enforcing this is for there to be transparency and for the beneficiaries to have a good understanding of the trust assets and liabilities.
Beneficiaries who previously didn’t realise that they had had income allocated to them but not paid, may be able to see that the trust owes them substantial amounts of money and they may ask for that to be paid. The trust may not have the ready cash to pay these amounts and often the allocation of income to beneficiaries is done for tax effectiveness rather than a desire to actually pay the income to the beneficiaries.
This could leave trustees in a difficult position and as we approach the end of another tax year, trustees should be looking carefully at beneficiary current accounts and deciding how to deal with them.
Tammy McLeod is the managing director at Davenports Law, specialising in the areas of personal asset planning, trust law and Property (Relationships) Act.
4 Comments
My understanding is that these new trust laws also mean that the trustees e.g. Mum and Dad cannot benefit from the trust. Only the beneficiaries. So for people who have historical trusts where Mum and Dad receive benefits from the trust, whether cash or assets, they will need to change the trust set up, if thats possible, or set up a new trust where the kids and them are all beneficiaries therefore all benefit. The trustees would need to be independent people e.g. friends, or professionals who will not benefit.
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