The New Zealand Tax Podcast. Terry Baucher reviews the current state of trusts with legal specialist Tammy McLeod

My guest this week is Tammy McLeod, Managing Director of North Shore based firm Davenports Law. Tammy is a trust and asset structuring specialist with over 25 years’ legal experience, specialising in the areas of personal asset planning, trust law and Property Relationships Act. Tammy leads the Davenports trust team and has been a principal in the firm since 2006. Kia ora Tammy. Welcome to the podcast. Thank you for joining us.

Tammy McLeod

Thank you so much for having me, Terry. It's a pleasure.

How has the new Trusts Act changed the trust landscape?

TB

Not at all. The Trust Act 2019 came into force on 30th January 2021, and it's caused quite a big upheaval in the trusts ecosystem. What have you seen as the main changes coming out of the implementation of the act?

Tammy McLeod

A couple of things. The first one is that there's been a major shift towards the rights of beneficiaries and knowledge of beneficiaries regarding trusts. So, I guess if you think about the shift that we've seen over the last ten, 15 years from employer to employee, employees have more rights, landlords/tenants. Now there seems to be a shift from trustees to beneficiaries, to the beneficiaries being entitled to ask for more information and holding trustees to account has really shifted the whole landscape. That's the first thing.

The second thing is I think that a lot of people are actually deciding whether they actually need a trust anymore. So particularly through the 2000s, we used to set trusts up left, right and centre because their accountant might see the need for a trust, or neighbours had a trust and it just seems to be the thing to do.

And a lot of people are now taking stock and seeing whether they still actually need a trust or whether it's something that they don't need any more given the extra compliance costs that have come about, in particular because of new changes to the law, not just the Trust Act, but also changes to the Income Tax Act and the way trusts report to the IRD.

TB

Yes, that's a good point, that last one. I've seen quite a bit of rethinking about what role the trust has in relation to income tax purposes with the increased disclosure requirements Inland Revenue asked for in the March 2022 and March 2023 years. And now we have, as you may be aware, the bill going through Parliament, which proposes increasing the trustee tax rate to 39%. 

A lot of interesting commentary is going around. Many trusts, the majority in fact, rarely distribute their income and have minimal income.  Once you aggregate that trusts income with those of the principal settlors, they're well short of the $180,000 threshold where the 39% tax rate kicks in. So, there's quite a rethinking going on in that. And that's certainly what I've been seeing.

 A lot went on in the nineties and early noughties, as you say, in terms of trust setting up. But right now, as that generation of business owners passes through into retirement, they're thinking about winding up trusts.

And then there's the other area where I get asked to help quite a bit. And that's where you've got beneficiaries or trustees overseas.  People think of trusts and think of tax. That's not really why we use trusts, is it? What’s the real purpose of trusts?

Why do people use trusts?

Tammy McLeod

No, and in fact what I was taught early on was to never mention tax in the first three things that you talked about the benefits of trusts, simply because that shouldn't be the only reason.

From a lawyer’s perspective, or from a legal perspective, I think asset protection to asset protection, still should be the number one driver. So, if you are in a position of risk, say the director of a company, own your own business and you could be at risk for because of your actions, then very, very simplistically put, because if your assets are in a trust, that could actually help protect in the event that you were sued for whatever reason, or something went wrong with your business.

And it does date back to the days of the Crusades when the knight would ride off to the Crusades and leave his estate in the hands of the neighbours to look after for his wife and family. Because if he didn't have someone holding that in trust, then it's likely that it could have been taken for taxes or just taken. So asset protection is still a big driver.

With relationship property, a trust is not the panacea to all ills when it comes to relationship property. But they certainly help with segmenting estates and ring-fencing assets that people might receive by way of inheritance from relationship property pools. And it's a really good way of protecting those assets.

Another reason is often people may want to treat their children differently. Under a trust, you can't claim against a trust in the same way that you can make a claim against an estate. So this is a really good way of estate planning, sort of outside the normal rules around will making and estates and how they’re distributed.

And then lastly, people that have assets might just want to keep it in trust for future generations. So think of a family holiday home as an example, or a family business that's wanting to be kept for future generations. There's a number of reasons why trusts can be very, very helpful with asset structuring.

TB

Yes, I've come across all of those scenarios and in some sad cases you actually have to ringfence the assets because either the beneficiary is incapable or is an addict sometimes.

The proposed 39% rate?

On trusts and the government's proposed 39% trustee tax rate rise, one of the points of debate that I saw raised in submissions to Parliament, it's a question of will trusts. Because they initially were saying, oh well, they will be taxed at 33% for the first 12 months, but that's way too short a period in my view. What in your view will be more likely period? More realistic?

Tammy McLeod

Well, I think that probably flagging the 12 months because in estate matters, usually everything's distributed within 12 months on the grounds of probate. But obviously there's often times where assets are held on trust under an estate for a much longer period of time, you've got minor beneficiaries is the usual rule.

But I would say that probably 85 to 90% of estates are distributed within the first 12 months. So, I think that's where they’ve got it from.

And another one of those perhaps tax rules where you wind up paying your advisors a whole lot more to sort out what should be something that is quite simple and quite straightforward. But it doesn't seem fair if you like, for assets or money that's being held on trust for a minor beneficiary to be taxed at 39 cents, it's highly unlikely a minor beneficiary would be paying 39 cents on the dollar.

TB

And then as I’ve occasionally come across, there's disputes over who's to get what which will delay winding up. Whenever these erupt the only people, in my view, who ever win are the lawyers and accountants.

Tammy McLeod

Without a doubt. Lawyers in particular.

Here, there, everywhere. Keeping tabs on where key people are

TB

As I said, one of the things I see quite a bit of is - we’ve got a very mobile population - people, beneficiaries, trustees, moving settlors, all moving around the place. What's your experience with this? How often do you encounter those scenarios?

Tammy McLeod

At the moment, all the time, as you say, particularly after we've been shut down in the country, I guess for two years plus, people are just moving all over the place. A lot of people are moving to live in Australia in particular and it's a real moving feast. There seems to be a lot of the next generation moving to Australia and other places.

And so that's something that trustees have to be hugely aware of and I think there's a real onus on trustees to ensure that they are aware of the movement of beneficiaries because it might have an impact on how they’re taxed in relation to the country that they're in. So for an example, an Australian tax resident beneficiary will be taxed on a distribution from a New Zealand trust, and so proper advice needs to be taken upfront.

And I think that's one benefit to having an independent professional trustee, is that they should be keeping on top of these issues and flagging these issues. And every time a distribution is made from a trust to a beneficiary, where that beneficiary is situated, should be considered.

Therefore, any trust that we are trustee of, we ensure that we have regular meetings and it's one of our agenda items, the location of some of the beneficiaries and making sure that you're on top of that and then planning for that. Because it's not even a distribution being made during the lifetime of the parents if they’re settlors and trustees of the trust. It's what happens if the children are to receive as beneficiaries of the trust assets upon both parents death So it might not be in the immediate picture, but it could be something in the future, it should be planned for.

TB

That's quite an issue. Particularly in Australia, there are two things. There are the beneficiaries who should qualify for the temporary residence exemption in some cases. That applies to exempt non-Australian sourced income so long as the beneficiary is not a citizen.

And that's something I think trustees now need to be aware of as people become Australian citizens, then those rules where previously a distribution from New Zealand trust or New Zealand income would not be taxable in Australia. The easier ability to become an Australian citizen changes everything.

And then of course the other one, and I'm sure you've seen this, is when a trustee wanders across to Australia and they don't tell you. I'm sure you've encountered that quite a few times.

Tammy McLeod

Many times. And I think it's one that we've been more aware of and there's been a lot more talk of. But I think the beneficiary one is really becoming an issue because as you say, the population is so mobile and one year you could be in Australia the next year, that could be in the UK, in Singapore, it's just people are moving around. All over the show.

TB

Distributions to persons in Australia who are not Australian citizens, are manageable. But the real headaches I keep encountering are distributions to people in say Britain, particularly Britain, or America, where the rules can be quite brutal. You can be looking at a 45% tax rate because we use discretionary trusts so much, that can be really quite disadvantageous.

Self-managed trusts – the risks

One of those things I see crop up, is that there is a certain proprietorial interest, “this is my trust”. Say the family set it up and were told you can self-manage this and then were sent away. A lot of those got set up during the 1990s..

How do you manage that? You come in, you find someone wants to do something, and then you find out that they've done a lot of things they shouldn't have done in trust law. But what's the what's the process there?

Tammy McLeod

My pet peeve is how you can manage your own trust. And one thing that really frustrates me is where a lot of professionals are now saying they don't want to be trustees, and so they're setting up trustee companies that only mom and dad are the only directors and shareholders, often saying that's a different entity for Mum and Dad. And I just think that's wrong.

To me, having an independent trustee is what really makes your trust robust. And so that's where you can put your hand on the heart and say, I can't sell this, a trustee has to think “I can't mortgage this property, I can't borrow this money or buy this business without my independent trustee knowing. It's not my decision anymore”.

And to me, that's the first line of defence of what actually is a trust. Funnily enough, it's not a legal requirement or one of the certainties of trusts. But from a robustness perspective, definitely having an independent trustee is important. And what has also happened over the last five years in particular, but maybe 5 to 10 years, is that the independent trustees are tending to become professional trustees.

So previously people would often use a family member, or a family friend. And I think the landscape has changed. Not only because of the risk to trustees, and so professional trustees understand the risk, know the risk and can insure against the risk.

I always say professional trustees care, but they don't care. The numbers on the page are just numbers to us. Whereas for a friend or family member to know how much money the trust is losing, how quickly it's paying down the debt, that can be too, too much.

So, my view is always have independent trustee, and ideally a professional independent trustee. And it also helps with the management as well. The things that we've just been talking about with Australian beneficiaries, if you've just got Ma and Pa as the only trustees, how can they keep on top of these issues without the input of a third independent person? So I'm hot on having a professional trustee.

Emerging issues?

TB

I mean, are you seeing as a result of two things - suppose that the greater rights for beneficiaries, as you mentioned in the start, but are you seeing more issues emerge from those Ma and Pa trusts set up 20, 30 years ago. Are they starting to boil over in difficult ways? What issues are those leading to?

Tammy McLeod

The major difficulty with those ones at the moment, and I'm sure there'll be more issues that come out over time, but the big thing at the moment is if Ma or Pa dies, or in particular loses capacity, or one’s died and the others lost capacity, who are the trustees now and how are they appointed? Who are they going to be? Often children fighting between themselves. So that can be an issue. And children trying to influence aging, elderly parents. Whereas if you do have the professional in there, A you've got a referee, and B you've got a platform for how these types of issues are to be managed.

TB

That last point you made about losing capacity is one that makes me very nervous. I talk with clients on this because I'm just encountering it in tragic circumstances. If a trustee loses capacity, am I right in thinking that that means that you probably have to go to court to get things done?

Tammy McLeod

No, not anymore. So under the new Trusts Act, that's another one of the changes, if a trustee loses capacity, then he or she is then deemed to be incapable of being a trustee going forwards and are immediately removed by virtue of the statute.

So that's new. Previously there were no rules around who could be a trustee. The other thing the new act has also done is put in place vesting rules. Previously you had to go to court, unless the trustee had said otherwise, to enable a new trustee to be registered on titles to properties and companies, shareholding registrars and so forth.

Whereas now under the new act is an automatic deeming or vesting of the trust assets on the capable trustees. The difficulty can be assessing what capable means.

And just to give an example, I talked to a client last week and one of the settlors is verging on the early stages of dementia and he's heavily involved in the family businesses. And the question was asked, at what point do we say that he's not capable?

There's this balance is he’s capable of being a trustee? At the moment he understands what he's doing. Can he make good decisions for the trustees going forward? How do we deem him to be incapacitated? And it might be different for him than it might be for someone else in a similar set of circumstances.

So, if you had an incapacitated, or bordering on incapacitated settlor, who doesn't have the sophistication of understanding business, etc., that might be a different level of capacity to be a trustee.

So this is a whole minefield. And lawyers have to ask some pretty hard questions and also talk quite robustly with family, doctors, geriatricians and the like particularly with an ageing population.

The risks with powers of attorney

If you think back about the comments that we've made around the lots of trusts being set up in the 1990s and early 2000s, some 20 years on we've got a whole raft of settlors and trustees heading towards their mid to late eighties and nineties. It’s a bubble that's moving through which is going to create lots of issues because the other thing to remember is that enduring powers of attorney don’t fit with trusts.

TB

 I was just about to ask you about that one.

Tammy McLeod

So your enduring power of attorney relates to your personal property, it doesn't relate to your powers as a trustee. There can be mechanisms within trust deeds which help with who has the power to appoint or remove trustees or a settlor who loses capacity. But it's not a given that the powers of attorney and the trustees have any connection at all, you need to go back to the source documents and see what’s there.

The future of trusts

TB

What do you see going forward with trusts? Do you see much change in this area?

Tammy McLeod

I see massive change and I’m seeing it already, probably in the last three or four years, rather. We’re still setting up a lot of trusts. But we’re winding up as many, if not more probably, than what we’ve been setting up. There are still great reasons, as we talked about earlier, for people to have trusts and most people are still putting in place asset structuring.

But I see there's a lot more dispute. A lot of the work that I'm now doing - I used to say that my legal practice is all about the good, positive things of setting up, good positive structures for people, for the future. And now a lot of it is actually how do we unwind the structure of these trustees not doing what I want them to do?

How do I make this beneficiary behave? There are disputes after Mum and Dad have died between beneficiaries as to what's to happen with the trust assets. It's disputes between trustees, disputes between beneficiaries.

So it's become a lot more fraught, bordering on litigation type issues. A lot more people separating, the impact on relationship property. That's how I sort of got more into that area was people separating, myriads of trusts which had to be unwound which were complicating factors.

What I do nowadays is more quasi litigation rather than setting up structures. And I guess that's interesting from a purely legal perspective as well as my practice matures. So that's interesting as well, but definitely very, very different to what it was five, ten years ago.

TB

As I said, the explosion of trusts and we don't actually know how many trusts we have in the country, and it's one of those per capita starts we probably shouldn't be too proud of.

With the administration of trusts you've mentioned trustees’ meetings. How critical are they in this process, particularly what you just talked about with the potential incapacity, etc., and the professional trustee?

Tammy McLeod

I think that companies, to give as an example, as opposed to trusts, are quite easy to manage in a way because the Companies Act 1993 is quite prescriptive about what you need to do to make sure that your company carries on as a company with the Annual Return and so forth.

Trusts aren’t like that. So even under the new act, there's no real prescription there. But that's your only evidence really, of having a trust, because trusts are this kind of ethereal being, I can't give you something and say, here, this is a trust for your record keeping.

So having those trustee meetings are imperative to go over the kinds of things that we've been talking about today. Where are the beneficiaries? What's the capacity of the trustees? Tax issues, etc.

Come hear Tammy present

And in fact, I'm presenting a seminar next week at the North Harbour stadium which got around 600 people registered for. And we're going to be covering things like this. So why do you need a trust is often the first question I get asked about in trustee meetings “Remind me again why I need this trust.”

I’ll be talking about things like capacity, powers of attorney, the changes to the act, disclosure of information to beneficiaries. So, I'll be covering all that at the seminar next week. Those are the sorts of things that we talk about at the annual trustee meetings.

TB

I'd agree trusts are quite ethereal. Sometimes you see on companies’ office documents that the ABC trust holds the shares in this. Which is not correct at all. It's the trustees that should be named as shareholders.

So, there's a lot of sloppy or untidy administration out there and it can lead to quite a number of issues. We've mentioned beneficiaries overseas. What I get very concerned about in tax is when settlors or trustees move overseas, particularly in the case of Australia if a trustee goes over there, the New Zealand property could become taxable subject to Australian capital gains tax, even if the gain is distributed to a New Zealand resident. So heaps of things going on.

I think that might be a good place to leave it there. If you've got this seminar coming up, I know I've seen you present, that will be well worth attending with 600 attendees. I'm sure you can squeeze a few more in.

My thanks very much to you, Tammy, for coming along and talking to us on this podcast. Good luck with the seminar next week.

Tammy McLeod

Fantastic. Thank you so much, Terry. I really appreciate it. We've been friends for a very long time, so it's nice to get a spot on the podcast.

TB

I can very highly recommend Tammy, she’s a highly experienced veteran of the trust field. You'll be in very good hands and the seminar will be well worth attending.

Well, that’s all for this week. I’m Terry Baucher and you 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 time, kia pai to rā. Have a great day.