Are family trusts still worthwhile?
Trusts have always been enormously popular investment vehicles for Kiwis, as evidenced by some 400,000 registered NZ trusts. However, this number of trusts, along with our appetite is set to diminish. Why is this, and have you re-visited your use of trusts?
Wave of trust law changes
This Government has introduced far reaching changes to trust law and trust taxation. It is a materially different playing field than it has been for forty years.
We have seen:
- changes under the new Trusts Act (January 2021) codifying existing duties and setting down new responsibilities for trustees;
- the introduction of significant trust disclosure requirements to the IRD in the last tax year; and
- an increase in the rate of tax for trustee income from 33% to 39% planned from 1 April 2024.
Increase in tax rate applying to trustee income
The increase in the tax rate for income accumulated in a trust puts the trust rate in line with the top individual marginal rate and is intended to prevent taxpayers from avoiding tax on income at that rate (i.e., by failing to distribute to a higher rate beneficiary who pays tax at 39%). On the increase in the tax rate for trustee income, the government’s Budget 2023 explained this will not affect most trusts given only a small proportion of trusts will end up paying most of the forecast additional $350 million in tax. On the basis of the 2021 tax year, nearly 80 percent of all trustee income ($13.3 billion out of $17.1 billion) was accounted for by just 5 percent of trusts. We dispute the restricted impact; under the Government’s newly introduced draft legislation, this tax rate change to chase down 5 percent of trusts, will potentially impact all trusts held by ordinary New Zealand families and individuals, many having a marginal tax rate of 33% or lower.
The Government’s justification for this blanket approach, resulting in the over-taxation of approximately 95% of trusts at 39% is trustees with lower rate beneficiaries will merely need to distribute the annual trust income to those beneficiaries, thereby promoting a compliance rich programme of distribution (to those lower rate beneficiaries) and resettlement (where those beneficiaries are so inclined) increasing compliance cost for no good reason. This Government justification ignores the commercial and family interests of trustees administering trusts and may also be explicitly contrary to trust deed requirements dealing with the timing of beneficiary distributions.
This increase in the trustee tax rate is right out of the [then] Revenue Minister David Parker’s personal playbook. It is yet to be seen whether legislative process and select committee hearings will at all water down the Revenue Minister’s 39% tax rate crusade, but we think any judicious tempering is most unlikely.
It is also telling no draw back of the disclosure requirements is telegraphed, despite the introduction of these measures being publicised as a counter-measure to the 33% differential existing at introduction between trusts and individuals. It seems Tax Policy will have your cake and eat it too!
It is now more important than ever for trustees and settlors to step back and re-examine the trusts they have, especially those long-standing trust arrangements
The above wave of changes call into question whether family trusts are still worthwhile, triggering a number of considerations such as those following. You will have additional personal matters impacting the future of your trusts.
- When did you last re-visit your trusts? Are your trusts fit-for-purpose given all these changes?
- Should you be rationalising (winding up, refreshing or resettling) your trusts? Is your trust deed fit-for-purpose under the new Act? Are your intentions clear? Are your trustees and beneficiaries adequately protected?
- What are the specific impacts for your trusts and trustees? Do these undermine your reason for having a trust?
- Are the trustees of your trusts still suitable and relevant; do they still want to be trustees with added responsibilities? Should you consider a corporate trustee?
- What is the risk IRD will request back-year financial and non-financial information for your trusts?
- Will the new 39% tax rate create problems for trustees in deciding to retain income or distribute to beneficiaries? Are distributions to lower rate beneficiaries possible or advisable? Is resettlement of those distributions possible, and how will the resulting ‘reclassification’ of beneficiaries as settlors of your trusts impact the operation of the trust? How does this fit within the trust deed?
- Are you across the new beneficiary disclosure rules and what these may mean for vulnerable beneficiaries or relationships?
- Should trustees look to make large pre-tax-rate change distributions? How will this be viewed by IRD?
- How should trustees approach future distributions?
Many of the reasons why trusts were set up remain relevant, but this is all subject to your current and future circumstances
The advantages for using trusts continue to revolve around asset planning and protection, as well as flexibility. These include:
- creditor protection: assets held in a family trust are typically protected from personal creditor claims against beneficiaries;
- succession planning / inter-generational assets: trusts are excellent vehicles to hold (and protect) valuable and/or family specific assets to pass through family members; common examples would be farms, bespoke businesses, family homes, holiday homes and property;
- purpose specific objectives: a common example is income of a trust being held and set aside for the education advancement of children and grandchildren beneficiaries;
- protecting property against marriage failure: while “trust-busting” cases question the effectiveness of trust held assets against a settlor’s marriage breakdown, the settlors can ensure generational assets are unavailable to children’s partners who separate or leave the union, while still providing for grandchildren.
- low tax-rate beneficiaries: IRD’s own coverage recognises trusts remain effective income splitting vehicles; income accumulating in your trust can still be distributed to beneficiaries on lower tax rates of 10.5% or 17.5% or 30%, (this will not apply to “minor beneficiaries” under 16 years of age where distributions over $1,000 are taxed instead at the trustee rate (heading to 39%)).
How might we support you?
At VCFO Milne Maingay many of our directors are trustees of client and other family trusts; we are dealing with these matters currently in varied circumstances. We have a team of expert advisors in trust taxation, trust administration and trustee accountability who are actively involved in carrying out trust reviews, simplifications and changes.
The bottom line is we are reviewing client trust arrangements more and more. Let us know if you have a trust that may no longer fit your needs, or are unsure about your current trust arrangements, and together we can work out what might best suit you and your future aspirations.