Trust distributions and tax rate change

Using a trust to manage and protect a family’s business and personal assets has been a common practice in New Zealand. However, with the recent increase in the amount of information required to be supplied to Inland Revenue, and now the Government’s decision, as part of its 2023 Budget, to increase the trust tax rate from 33% to 39% from 1 April 2024, many will be rethinking their position, including the cost benefit of using a trust.

The alignment of the trust tax rate to the top personal marginal tax rate of 39% occurred due to the view that trusts were being used to circumvent the top personal tax rate. The Hon David Parker stated that the IRD’s High Wealth Individuals research revealed that “a substantial number of the super-wealthy funnel their income through trusts which minimises their tax bill. This change remedies that.”

One of the benefits of using a trust is their flexibility, however this has meant that in practice they are sometimes part of tax avoidance arrangements. This does not change their legitimacy, but they can become ‘tainted by association’. For example, a common scenario comprises a trust holding 100% of the shares in a company. A beneficiary of the Trust operates the company and pays themselves a salary. If the salary is intentionally set lower than market rates, with the remaining income of the company distributed to the trust in the form of a dividend, it could be deemed that a taxpayer has fixed the salary in an artificial manner to obtain a tax advantage and thereby is party to a tax avoidance arrangement.

Where taxable income derived by a trust is subsequently used to fund the lifestyle of beneficiaries the view could be taken that the funds paid to the beneficiaries should be treated as taxable beneficiary distributions.

If beneficiaries are reliant on dividend income that is derived by the trust, payment of the ‘dividends’ to the beneficiaries could be seen as comprising taxable beneficiary income, irrespective of the legal form of the payment. For example, if a trust owes a beneficiary $1m and a trust derives a dividend of $72,150 into its bank account and the same day that exact amount is paid to the lender – is it a loan repayment or the distribution of the dividend? If trustee resolutions reflect it is a loan repayment, would that be upheld in a review by Inland Revenue.

Prior to April 2021, when the top personal marginal tax rate and the trust rate were the same at 33%, there was no difference from a tax perspective and transactions were not subject to a high degree of review or scrutiny; and this may soon be the case again. However, in the interim, while the trust tax rate remains at 33%, the IRD will likely continue to scrutinise the use of trusts, particularly where a beneficiary is subject to the top 39% tax rate.

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