With the release of the high-wealth individuals research project and the ongoing narrative around the use of trusts (even though they have yet to complete the analysis of the first year’s data from the new trust disclosure rules), it became obvious in recent times that the Government was looking to increase the trust tax rate, but is it fair?
While the Government information around trusts indicates 5% of the trusts in New Zealand pay 78% of the trustee income, the trustee rate increase still affects all trusts.
Based on the Government’s own numbers, in order to tax the 9000 trusts that earn the 78% of trustee income (the obvious targets of this new rule), it has increased the tax cost for all 177,000 trusts in New Zealand. In the interests of the tax system being fair and progressive, one must question if this is the right outcome.
While the Government acknowledged that trusts established for disabled beneficiaries could be taxed at marginal rates, the real question is should the Government have instead considered a tiered rate for all trusts?
Its base assumption must be that the trust tax rate should be 39% because all beneficiaries would have been taxed at that rate, otherwise the trust rate at 39% would result in over-taxation — a clearly false proposition.
Under the current proposal, if anyone has settled a trust, tax will be imposed on trustee income at a flat rate unless they choose to distribute that income.
Assuming the trust was not established for tax purposes, then they are ultimately penalised with a higher rate of tax by retaining the income for, say, asset protection purposes. This is a significant over-reach, in our view, to solve a relatively narrow perceived problem.
However, if tax was imposed on trustee income at 33% up to $180,000 and trustee income in excess of this was taxed at 39%, then a large proportion of the smaller trusts would not have been impacted.
For those trusts earning significant income (clearly the stated target for the trust rate increase), they may have paid slightly less tax than a flat rate of 39% imposes, but they would still incur 39% for a proportion of their trustee income.
Although still imperfect and likely to capture some family (and beneficiaries indirectly) who probably should not be the target, this would also better align with the principles included in the recently introduced Tax Principles Reporting Bill, that the tax system should be fair and result in the wealthy paying a larger amount of tax in absolute terms.
For those taxpayers who have shares in a privately held company in their trust, consideration will need to be given to whether that company distributes any of its retained profits.
When the top marginal tax rate changed, many private companies chose to distribute earnings to shareholders prior to the change in rate.
The Inland Revenue Department then questioned whether this was tax avoidance. Having said that, these reserves could have been distributed with the same tax impact at any time prior given the relative marginal tax rates. These amounts were previously reinvested in the business by the shareholders.
As many business owners hold shares in private companies through their trusts, many will consider that it would be prudent to distribute profits prior to the increase in the trustee rate. But this begs the question as to whether this is tax avoidance. Does the company have to physically pay the amounts, or can a shareholder reinvest in the business or just retain the funds in this structure?
There are many valid commercial and asset-planning reasons to establish a trust, whether it be to ring-fence assets from risk or to protect them for future generations.
In recent years we have seen the introduction of more comprehensive trust disclosures and now the increase in tax rate to 39%. This will result in many asking if they should still have trusts.
When reviewing whether a trust is required, it is important to understand why the trust was established and the settlor’s intentions for the assets contained within the trust. It may be that the trust contains a family holiday home and the settlor’s intentions are for this to be available to future generations.
While they cannot guarantee that the trustees will decide to sell at a future point in time, holding such a property through a trust is a much better option to creating fractional/joint ownership.
We suggest that every trustee and beneficiary of a trust whereby this provision would result in over-taxation — which is middle New Zealand — make their concern about this sledgehammer approach known to the Government.
— Jarod Chisholm is a tax advisory senior partner at Findex. The views and opinions expressed in this article are those of the author and do not necessarily reflect the thought or position of Findex NZ.
