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Family Trusts and the Great Kiwi Bach

Mar 21, 2022
Garreth Collard from EpsomTax.com

Family trusts and the great Kiwi bach: both have a long history in New Zealand.  For many of the estimated 180,000+ trusts in New Zealand, compliance was something you did once or twice in your lifetime with the lawyer… “what’s his name? It’s been so long; do you remember who we used last time dear?”  

Typically, the trustees are Mum and Dad, and that’s it: no independent or professional trustee. And that’s been okay for a long time – not best practice, but arguably tolerable for most people. Until the last decade or so, when the Ministry of Social Development “clicked” that many people applying for a hardship subsidy to enter a rest home had a trust, and that the trust probably had assets, and the value of those assets – principally the land – had risen exponentially.   

Later, with publication of the Panama Papers (in 2016) and the Pandora Papers (2021), the role of trusts in obscuring ownership of wealth became clearer, and subsequently there have been moves in New Zealand to force transparency of trust ownership and activities… which brings us to, your trust and your bach. 

Trusts in New Zealand typically fall into two main categories: trading and non-trading. For most trusts are non-trading and simply own the family home and perhaps a holiday home.  Most of these trusts have no IRD number and have never had financial statements drawn up, much less a balance sheet – that’s a one-page listing of assets e.g. buildings, and liabilities e.g. loans, that the trust has. Well, all that is about to change, thanks to two developments: 

  1. Trusts Act 2019 
  1. Taxation (Income Tax Rate and Other Amendments) Act 2020 

Let’s discuss each of these and their impact on you and your family trust - and your holiday home! 

Trusts Act 2019 

This act introduced some mandatory duties for trustees, information-keeping requirements, and greater transparency for trusts. For example, trustees must now keep core trust documents e.g trust deeds and any variations, any documents relating to purchases or sales of trust property, valuations, records of trustee decisions, resolutions, meeting minutes, accounting and financial statements, letters of wishes etc etc. Trustees must also make ‘basic trust information’ available to all beneficiaries and provide ‘trust information’ to beneficiaries who request it e.g. beneficiaries now have a right to demand certain information about the trust such as advising a beneficiary that they are a beneficiary, and even how much money they will receive.  

Why might this be an issue? Firstly, trustees have never had to tell beneficiaries that they are a trust beneficiary. Likewise, trustees have never had to disclose to a beneficiary they are owed the amount of funds recorded in their beneficiary current account. This has got some families worried about a sense of entitlement that could arise because of a niece or grandson finding out they will inherit a million or two in property. Not only that, but when a young relative finds out they are owed a sizeable sum on their beneficiary current account, then repayment can be demanded. 

The second issue has to do with the IRD view. Beneficiary current account distributions are often made “on paper” but without any actual money being paid out. Rather, it shows as an amount owed to the beneficiary.  IRD may question whether there has been a proper distribution of income to the beneficiary if said account has existed for a long time, which can cause tax problems. 

The third issue is that a beneficiary may inadvertently become a settlor of the trust. If the trust owes the beneficiary more than $25,000, and interest has not been paid to the beneficiary at the appropriate rates, then this beneficiary is now treated as a settlor of the trust. This could cause tax problems, especially if said beneficiary lives overseas.  It might also mean the trust is denied the use of a main home exclusion when selling property caught by the Brightline Test, or it could even become tainted as an “associated person” under the Income Tax Act – meaning that the sale of property which previously was not taxable, now is. 

Taxation (Income Tax Rate and Other Amendments) Act 2020 

This act was passed under urgency in December 2020, and with it, two big changes to the reporting requirements in the Tax Administration Act 1994.  

Firstly, the IRD Commissioner now has vast new powers to collect any information that they deem relevant. You might have heard about IRD contacting approximately 400 high net-worth individuals in late 2021 for detailed information about their trusts and wealth. 

Secondly, domestic trusts which have assessable income – essentially any trust that receives income, whether passive or active - will have a lot more information to report to IRD from the 2021/22 financial year onwards.  This includes information such as: 

  • A profit and loss statement e.g. income vs expenses 
  • A balance sheet (see above definition) 
  • The amount and nature of any settlements made on the trust during the year 
  • Any services provided to the trust at less than market value 
  • Identifying each settlor who has made a settlement on the trust during the year OR any settlor whose details have not previously been supplied to the Commissioner; note that the IRD definition of “settlor” is much wider than the legal definition 
  • Details of any distributions made by the trustees during the year 
  • Identifying each beneficiary who received a distribution from the trust during the year 
  • Identifying anyone with powers of appointment, or powers to amend the trust deed, and so on! 

Trustees do well to note that the IRD can now demand this information for any tax year right back to the start of April 2014. 

Effect 

How will this affect your trust? If it is a “small trust” i.e. has no more than $30,000 of income and the expenses likewise don’t exceed that figure, and the trust’s assets are under $2 million, then it will have to prepare and file financial statements and tax returns with IRD each year. For trusts that are not “small” more extensive reporting will be needed.  

Let’s look at an example: Your trust owns a holiday home. You get your brother-in-law to help you build a deck. He doesn’t charge for this.  As this is a service provided to the trust at less than market value, IRD will treat this as a settlement on the trust (requiring forgiveness of the implied debt created) and the market value of the service will be recorded as interest on the beneficiaries’ current account. 

Later, you let your sister and her family stay in the bach.  She is a beneficiary of the trust. They don’t pay any money to the trust for the use of the home – after all, they are family.  However, IRD will now see this as a drawing in favour of the beneficiary. 

There may not be any immediate taxable effect of this. But as things go along, then taxable income may arise as a result of IRD’s “new view.” 

But, what if your trust does not own a bach? It has no IRD number, just owns the family home – that’s it? IRD advise that all trusts will require an IRD number – whether trading or not – from FY22 onwards (that’s the year that is about to end on 31 March 2022). The trust would then complete a non-active declaration, meaning annual tax returns will not be required. Failure to do so will mean that the trust will be deemed a non-complying trust. Taxable distributions from non-complying trusts are taxed at the rate of 45%. We suggest you engage promptly with your lawyer and accountant regarding this. 

Final comments 

One thing is for sure, trusts – like most other structures – are becoming more complicated and expensive to maintain. They still have their place in many spheres and situations, and we do expect to see some matters thrashed out in the courts and become case law, as various trustees push back against these recent developments.  Nonetheless, now is a good time to engage with both your lawyer and accountant to review your trust and whether it is fit for purpose.  Remember, your trust is likely protecting the most valuable assets you own, so the relatively minor fees involved are an investment in your portfolio and your future.  

Of course, if you would like an independent review of your trust financial status, please feel free to contact our Executive Director, Garreth Collard, for a consultation

This article was produced by EpsomTax.com and is not intended as personalised financial advice. All numbers are meant as examples and not indicative of any property in particular..  

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