Te wiki o te tāke; Shifting the top tax rate to 39% has energised the efforts of those affected to reorganise their affairs, just as they did the last time this was attempted. The IRD is watching more closely this time

This week we focus on trusts in particular new reporting requirements for trusts which have caused a stir together with a concerning court decision from Australia. Elsewhere, there is a harsh but not unexpected decision from the Taxation Review Authority regarding the taxation of arrears of weekly ACC compensation.

Last month, Inland Revenue released two papers relating to trusts, firstly, an issues paper on the reporting requirements for domestic trusts where disclosure is required under the Tax Administration Act 1994, tax and secondly, a detailed operational statement setting out the reporting requirements for domestic trusts.

Now, these prompted an article by Auckland barrister Anthony Grant, who specialises in trusts and estates. He was quite concerned about the papers and why this information was being gathered.  His article concluded;

“The information can be wanted only because the IRD and the present government want to tax people who lend money to trusts at less than market rates, people who get benefits from trusts, people who provide services to trust assets and people who have powers in relation to trusts, as they have never been taxed before.”

That's quite a quite a closing statement.

The source of the two Inland Revenue papers is legislation enacted when the Government increased the tax individual tax rate to 39%. The Government did not also increase the trustee tax rate, even though Inland Revenue recommendation was that it should, based on bitter experience of what happened between 2000 and 2010 when such a differential existed previously.

Instead, the Government made very clear statements that it would be watching the situation carefully, and if it did see what it regarded as unacceptable tax avoidance happening, it would move to increase the trust tax rate. In the meantime, it introduced a whole new set of disclosure rules to enable Inland Revenue to have a clear look at what transactions are going on involving trusts.

Now, this was a radical departure of from previous practise. One of the weaknesses of tax administration in New Zealand, in my view, is that we don't get to see a lot of detailed or very segmented tax statistics. If you go elsewhere in the world, tax authorities can produce very voluminous data relating to which sectors and persons are paying tax. Inland Revenue doesn't produce those sorts of data, although if you ask for it under the Official Information Act, you should be able to obtain much of what you're after.

That lack of tax data being made public reflects the moves made in the 1990s to ease tax administration under which most people were no longer required to file tax returns and the information to be included in most tax returns is quite limited.

The new legislation requires quite substantial amounts of information to be provided. It includes details of all settlements on a trust, which includes all transfers of value along with details identifying the entities or individuals making those settlements. Transfers of value include all things monetary and non-monetary and the provision of services below market value.  Details of all distributions, whether taxable or not, are required and including again, monetary or non-monetary together with details identifying recipients. There's a general question wanting information about details of who has the power to appoint or dismiss a trustee, add or remove a beneficiary or amend a trusted name and finally a catch all or any other information the Commissioner of Inland Revenue wishes.

This represents a large increase in compliance for trusts. It should be said that it does also reflect to some extent the impact of the new Trusts Act. Trustees can now expect to have more reporting requirements because beneficiaries now have rights of access to information about the trusts.

Trustees who may previously have been a little casual, to put it mildly, about record keeping will now need to sharpen their game not just for tax purposes, but basically to comply with the new Trusts Act. We don't actually know how many trusts there are in New Zealand, the best estimates are somewhere between 500 and 600,000, and it's one of those stats where per capita New Zealand is right up there.

The Government reporting requirements come into effect with those tax returns that have to be filed for the current year ending 31 March 2022. However, the legislation contains a provision that if Inland Revenue reviews a return and finds something of concern, it can request the same information for the previous eight income years, which means the first year could be for the year ended 31st March 2015.

As noted, the legislation represents a substantial increase in compliance costs. You should also look at it in the context of the controversial high wealth individual research project, which is going on at the moment. Both these initiatives address an area where arguably New Zealand taxpayers have not been providing a lot of information, and hence the Government and Inland Revenue are in the dark as to exactly the extent of wealth in the country.

And by the way, this is a worldwide trend. Although New Zealand managed to come through the global financial crisis very well, which has enabled us to manage the COVID 19 response pretty well, for the rest of the world the double whammy of the Global Financial Crisis and now the pandemic means that governments are under enormous fiscal pressure. There's a growing trend to request further information in relation to the wealthy and wealth taxes are being discussed elsewhere around the world. So this is actually part of a global trend here.

But that's not to undermine the importance of the issues raised here. These represent significant compliance costs, and they are quite concerning for trustees and beneficiaries about what were apparently quite legal transactions, such as advances to beneficiaries. Details of loan advances to beneficiaries are now required together with distribution of what we call term trustee income, which is tax paid income. This is particularly going to be relevant going forward because trustee income is exempt income for a New Zealand tax resident. Therefore, for someone who's taxed at the 39% top rate a distribution of trustee income is a way to essentially get tax free capital distributions from a trust. And this is what one of the areas these new provisions are looking to target.

The level of detail asked in relation to beneficiaries and what is expected of trustees is incredibly high. The new rules are expected to affect about 180,000 trusts, although there's a sort of a de minimis position for trusts which don't have annual income exceeding $30,000 and the total value of the assets is less than $2 million. That still leaves a substantial number of trusts will required to prepare quite detailed information for submission.

For example, all interest and non-interest-bearing loans from persons associated with the trust that is the settlors, trustees and beneficiaries. Then if trust property such as a house is enjoyed by a beneficiary for less than market value, the sum is to be recorded as a drawing in favour of the beneficiary. This one in particular is going to cause a bit of a stir as it’s quite a bold step. For many trusts, properties held by the trustees are essentially let rent free to the beneficiary on the basis that the beneficiary meets the upkeep, such as rates, maintenance etc, and the interest payments relating to any mortgage over the property.

Now we see a deemed income provision in relation to assets provided by a company, but there’s no such provision for trust purposes. These particular requirements are one reason why Antony Grant sounded the alarm. It would essentially impose a deemed rental or an imputed rental on property.  This is something which has been considered by several tax working groups, but not implemented by the Government.

Another matter which is going to be a headache for trustees and initially probably may not be entirely accurate, is the requirement to break down the equity of the trust between the corpus, which is the sum of all settlements that have been made on the trust less the distribution of corpus made to beneficiaries and trust capital, which is the sum of all taxable and non-taxable income retained and gains and losses made by the trust.

There's also to be an equity item in relation to drawings, which effectively mean the total amount of assets of value withdrawn from the trust by beneficiaries during the year, and then beneficiary current accounts are to be shown. Some of these well-managed trusts will already be doing, but the extension across the board to most trusts is going to cause increased compliance costs as I’ve said. The implications of what happens when the Inland Revenue digests all this information we'll have to wait and see.

Now, the officials’ issue paper is open for submissions until 15th November, and submissions on the operational statement are open until 30th November. So you might want to have a quick look at these papers and then consider making submissions.

Moving on, trusts with overseas trustees, beneficiaries or settlors can cause quite a lot of confusion. It's something I'm seeing increasingly particularly in relation to Australia, where the latest estimate is that maybe between four and five hundred thousand Kiwis live at the moment. And one of the issues that happens is that the trust taxation law differs from country to country. But and I see this quite a bit in relation to various jurisdictions people mistakenly assume that the rules are similar and don't pay attention to the fine detail.

Now, in relation to trusts and people moving to Australia, it's been well known for some time that if there's any trustee resident in Australia, then the trust is deemed to be resident in Australia and therefore subject to Australian tax rules.  And so steps are taken to ensure that no trustees move there or resign their trusteeships before doing so. But that doesn't always happen, and a case has just popped up in Australia, which although it involved a UK tax resident person it would have implications for New Zealanders.

Now, typically, distributions through a discretionary trust of current year income or capital gains are generally considered to retain those characteristics in the hands of the beneficiary. What that means for New Zealanders resident in Australian who qualify for the temporary resident’s tax exemption is if they get a distribution of foreign sourced income, that is income from outside Australia, it’s generally exempt from Australian tax. But a new decision from Australia, Greensill, makes it clear that this treatment doesn't necessarily apply to capital gains.

Now, in this case, what happened was the trust realised A$58 million on a capital gain from the sale of a UK management company. The gains were distributed to a beneficiary living in the UK and therefore non-resident for tax purposes in Australia. The shares that were disposed of did not represent taxable Australian property for capital gains purposes.

Ordinarily, a capital gain on non-taxable Australian property made by non-residents is disregarded for Australian tax purposes. But the full Federal Court of Australia ruled that in this case, because it was distributed to a non-resident beneficiary of a discretionary trust, there was no exemption available because of the way that the legislation was drafted in relation to how trusts deal with capital gains. Therefore, the Australian trustee was required to pay income tax on behalf of the non-resident beneficiary in respect of that $58 million capital gain.

And this is where we could have problems in New Zealand. For example, a New Zealand domestic trust with three trustees, two of whom are in New Zealand, and one is in Australia. The trust is deemed an Australian tax resident and if the trust tries to distribute the capital gain, such as the realisation of the sale of a property in New Zealand then following the Greensill decision, Australian capital gains tax is payable, and it would be at 45%. So this is a major decision.

People therefore need to be very careful to be check as to the status of the trustees and settlors of the trust. Basically, what you want to try and do is minimise any link between an Australian resident and a New Zealand trust. Otherwise, you'd be looking at a substantial capital gains bill.

What wasn't apparently argued in court was the question of whether double tax relief would be available under the double tax agreement between Australia and the UK.  This is unusual because I would have thought it would have been an issue that could have been applied in the Greensill decision, but apparently it wasn't argued.

So therefore, we may have to wait either for another tax case or for perhaps the Australian Tax Office to decide that's the Greensill decision is not really what they want and change the law. I think we might be waiting a long time for that.

Now moving on from trusts, the Taxation Review Authority (TRA) has confirmed that a taxpayer who received arrears of weekly compensation from Accident Compensation Corporation relating to an injury three years earlier was correctly taxed in the year in which she received payments. This is something that pops up quite regularly and I've discussed it previously.

In this case, the person was injured, made a claim for weekly compensation, and for three years there was a back and forth arguing about it. And eventually ACC paid a significant lump sum of arrears total of just over $180,000.  This payment was subject to pay as you earn as income in the year of receipt.  The taxpayer quite reasonably objected on the basis that her regular level of earnings was always quite low. Therefore, the tax that would have been payable if she had received the payments when she was entitled to do so would have been lower.

However, the law makes no adjustment for this, and it was taxed as a lump sum at higher rates.  She took her case to the to the TRA, which kicked it out on the basis the legislation provides no scope for relief. Now, this is a not uncommon problem. In fact, I wrote to ACC and asked, just how often does this happen, where arrears of ACC are paid in a subsequent income year?

And the data I got back in April said that in the year ended 30 June 2020, there were 14 166 such payments. And in each of the years ended 30 June 2017, 2018 and 2019 there were at least 1100 such cases. The average payment was around between $42,000 and $49,000 with the median pay-out around $21,000. But some very large payments were made. There's one in the year ended 31 June 2020 of over $1.1 million.

So this is quite a significant issue which I think is something that should be amended by legislation. It seems unfair for someone who's been injured or entitled to relief but doesn't get it when it should happen and then has to take action to get their entitlements with more added stresses. Finally, when a person does get paid. Inland Revenue comes in and takes a big cut of it. And by the way, this is going to be a bigger problem now that we have a 39% tax rate. So, I've made a submission to Parliament’s Finance and Expenditure Committee on this, requesting the issue be looked at and the legislation changed.

Speaking of submissions, a reminder that submissions to the Finance and Expenditure Committee regarding the Government's interest limitation proposals close next Tuesday, 9th November. So you've got until then to make submissions on that. I expect there will be quite a few submissions on the new rules. But as part of those submissions, you can actually draw the committee's attention to other matters, which is what I am doing in relation to the ACC matter.

Well, that's it for this week. I'm Terry Baucher and can find this podcast on my website www.baucher.tax or wherever you get your podcasts.  Thank you for listening and please send me your feedback and tell your friends and clients. Until next week kia pai te wiki, have a great week!

Terry Baucher is an Auckland-based tax specialist with 25 years experience. He works with individuals and entities who have complex tax issues. Prior to starting his own business, he spent six years with one of the "Big Four' accountancy firms including a period advising Australian businesses how to do business in New Zealand. You can contact him here.