New Trust Annual Requirements

In December 2020 the legislation enacting the new 39% tax rate was passed. Within the same bill, somewhat overshadowed by the rate change, was the introduction of a new “annual return” requirement for trusts.

Not to be confused with the new Trustee Act that came into effect at the end of last month which requires certain disclosures to be made to beneficiaries, the annual return requirement included in the December 2020 bill imposes the disclosure of various trust information to Inland Revenue on an annual basis.

As enacted, the annual return for trusts will comprise:

  • an income statement and balance sheet;
  • details of any settlements made on the trust during the year;
  • the name, date of birth, country of tax residence and IRD number of any person who makes a settlement on the trust in the year, whose details have not previously been provided;
  • details on every distribution made by the trust during the year, including capital distributions, as well as details on the recipient beneficiaries; and
  • details of any person who has the power to appoint and remove trustees and beneficiaries of a trust.

The requirement will not apply to non-active, charitable or Maori authority trusts and foreign trusts that are already filing disclosures with Inland Revenue.

Although the legislation applies for the 2022 income year onward, there is a provision which allows
Inland Revenue to request the same annual return information for any period between the 2015 and 2021 income years.

Inland Revenue is likely to use the information to monitor the extent to which income is being taxed to trusts at 33%, that would have been taxed at 39% if derived by individuals. That information could then be used as a basis for the Government to either increase the trust tax rate or increase the extent that beneficiary distributions are taxed to individuals.

The information could also be used by Inland Revenue to specifically check other areas of compliance. For example:

  • Imputation streaming rules require dividends received by a trust that are then distributed to a trust’s beneficiaries to be spread proportionately across those beneficiaries, otherwise imputation credits may be forfeited.
  • Taxable income can be triggered if a trust receives the benefit of a debt forgiveness and a subsequent distribution is made to a corporate beneficiary.
  • Application of the land taxing rules can depend on whether parties are associated. The level of disclosure will enable Inland Revenue to readily determine who a trust is associated to.

As time passes and the amount of information held by Inland Revenue increases, they could proactively identify errors in a trust’s tax position. Especially if a trust has moved from one accountant to another and Inland Revenue has a clearer picture of past transactions than the new accountant has.

New Years aspirations

For many, a new year signals the start of a fresh beginning allowing goals and motivation to be reset. We typically try to leave the downsides of the prior year in the past and reassess our aspirations for the year to come. However, given the year that was 2020 and the ongoing impact of Covid-19, both locally and globally, there are various aspects of 2020 which have inevitably carried into 2021. Whilst some of these lingering effects prove to be challenging, they are not necessarily all negative.

2020 was undoubtedly a time of great uncertainty for NZ businesses. However, it was also a year in which there was a notable increase in the number of new businesses registering with the Companies Office. Data shows that at the end of December, there were 669,000 companies on record, with 58,000 registered during the year; up from 49,000 during the prior year. It is thought that the increase can in part be put down to Covid-19 related redundancies and the transformation of “side hustles” into viable businesses – something that Christchurch led project, Start Me Up is backing.

Launched earlier this year, Start Me Up is looking for business ideas from Christchurch, Ashburton and Selwyn residents whose employment was adversely impacted by Covid-19. Run in conjunction with ChristchurchNZ and the Ministry of Social Development (MSD), the two-part programme aims to teach budding entrepreneurs how to start their own business. The first part of the programme is a five-week online course designed to teach the fundamentals of building a successful business. The second part of the programme offers 25 successful applicants the chance to further develop their business idea through in-person workshops with mentors. To be eligible to apply, applicants must currently be unemployed and receiving a benefit from MSD.

The Government also recently announced the launch of its Small Business Digital Boost programme, which seeks to support small NZ business owners to realise the potential of digitising their business. The partnership between the Ministry of Business, Innovation and Employment (MBIE), The Mind Lab and Indigo will provide government-funded digital skills training and support. In the age of the internet (and Covid-19), the ability to successfully utilise digital tools offers small businesses the opportunity to better compete in today’s economic environment. The programme is the first of several that will be rolled out as part of the Government’s vision for New Zealand to become a “thriving digital nation”.

A shake up in the job market also looks likely with new findings revealed by Horizon Research indicating that nearly 385,000 adults will look to change their job in the coming year.

Although it is not clear if or how many of these will look to pursue their own business ideas, the support for entrepreneurs looks stronger than ever. If there was a time for a New Year’s resolution and change, maybe this is it.

Employee Accommodation

The treatment of employee accommodation (and taxable allowances) can be confusing. In 2015 the rules around employer-provided accommodation were subject to a reform, with the changes intended to provide greater clarity and cohesion for employers to understand their tax obligations. Previously, a net benefit approach was acceptable, where accommodation provided to an employee was not taxable if the employee maintained a home in another location. Following the reform, the starting point is that accommodation provided to employees is taxable unless one of the exemptions apply (e.g. temporary, out-of-town secondment, work-related conference). But how should it be taxed?

Firstly, PAYE typically applies to the provision of a cash allowance paid to an employee. While FBT usually applies to a non-cash benefit (such as the use of a car). However, the provision of accommodation comprises taxable income and is subject to PAYE, rather than FBT.

The amount of taxable income is the market rental value of the employee accommodation, less any contribution to the cost by the employee.

There are a number of Inland Revenue publications available to assist employers with determining the market rental value. For example, Commissioner’s Statement CS 16/02 sets out the Commissioner’s opinion on factors that can and cannot be taken into account; and CS 18/01 suggests market value reductions in the form of percentages specifically for boarding school employers. The overarching theme of the guidance is that employers have flexibility when determining the market rental value as long as a reasonable process is followed, and sufficient
evidence is maintained to support the values used. For example, an independent valuation could be obtained by a registered valuer, or an analysis of comparable rental properties could be undertaken. Further, an employer is able to apply their own reduction percentages that they consider to be appropriate for any given accommodation type.

Although such guidance is useful, there is little Inland Revenue guidance regarding how to calculate the PAYE itself, which can lead to confusion.

The PAYE liability varies depending on whether the employee or employer pays the PAYE. If the employee’s net income in the hand does not change with or without the addition of the taxable accommodation amount, then the employer is likely to be paying the PAYE. In this situation the market value of the accommodation should be grossed up and PAYE calculated based on the grossed-up amount. For example, assuming a 33% tax rate, a $300 market rental value would be grossed up to $448 to calculate a corresponding PAYE liability of $148.

If the employee receives less in the hand with the addition of the accommodation, the employee is funding the PAYE out of their salary or wage and the taxable amount is the market value of the accommodation itself. For example, a $300 market value would result in a $99 PAYE liability and the employee would receive $99 less in the hand.

Ideally, who is liable for the PAYE should be captured within the employment agreement, so that both parties know what to expect and are not caught out.

Employee Benefits for Millennials

Say what you want about millennials, there is no denying their presence in the workforce. According to Statistics New Zealand, millennials currently represent the largest age group in the workforce. Millennials are also attributed with having become problematic to attract, develop and retain – perhaps in part due to their unique preferences when it comes to employment benefits.

Generally, a work / life balance has always been among the top priorities for millennials, and while this remains true, the desire for work-life integration has emerged. Instead of disconnecting from work completely, millennials welcome the idea of mixing work and play, viewing social activities with co-workers as a resounding perk of employment. This is likely connected to millennials preferred work style, where they are less likely to work longer hours than other generations and embrace flexible ways of working. It is evident that millennials want flexibility and reject the premise that working long hours and being visible is the primary way to demonstrate value. Millennials are known to work well with clear instructions and targets, hence believe the where and how a job gets completed becomes less relevant.

Nevertheless, they are a generation that is committed to their personal learning and development. Research conducted by PwC revealed that 35% of respondents were attracted to employers who offered first class training and development programmes, with the most valued training opportunity being the ability to work with strong coaches and mentors. The study further revealed that millennials crave feedback, with only 1% of respondents saying feedback was not important. Millennials tend to favour frequent feedback sessions and value immediate on the job coaching. Whilst it may be difficult for older managers to navigate this expectation, millennials view the feedback cycle as integral to understanding how their role fits into the wider organisational strategy.

Millennials also lead the way in their desire to work for a company that reflects their own values. The Deloitte Global Millennial Survey 2020 revealed that 56% of respondents had previously ruled out working for an organisation because of its values, and 82% agreed that they were more likely to stay in a job if their personal values aligned. But what exactly do millennials value in an organisation? Putting employees first, having a strong foundation of trust and integrity, practicing customer care, and being environmentally and socially responsible are among the top ranking.

In order to motivate millennials, it is important that businesses understand what they can do to attract and retain them. Whether that be allowing them to work more autonomously, or encouraging learning and development, the reality is the turnover rate among millennials is still likely to be higher than other generations, in large part due to their willingness to quickly move on from organisations that do not meet their ever-changing expectations.

 

New Trustee Disclosure Obligations

In 2013 the law commission was asked to review the Trustees Act 1956 and NZ Trust law generally. Following this initial review, nearly eight years later, the long-awaited “Trusts Act 2019” will finally come into effect on 31 January 2021, replacing the entire 1956 Act.

One of the most significant changes in the new Act that is generating interest from trustees and practitioners alike is the introduction of beneficiary disclosure requirements on trustees. This becomes sensitive if it means disclosing a trust’s financial information, or to what extent some beneficiaries have benefitted more than others. However, the problem is what level of information should be disclosed and to whom?

Under the new Act, there are two layers to the disclosure obligations:

A “presumption” exists that Trustees will make available “basic trust information” to every beneficiary.

A beneficiary may request additional “trust information”.

Basic trust information comprises:

  • the fact the person is a beneficiary of the trust,
  • the name and contact details of the trustees,
  • any changes to the trustees as they occur,
  • their right to request a copy of the trust deed, and
  • their right to request trust information.

“Trust information” has a wide definition and includes information regarding trust property. Although, it specifically excludes “reasons for trustees’ decisions”. It is reasonable to assume ‘trust information’ includes financial information, but how detailed that information has to be is unclear, e.g. does it include amounts distributed to other beneficiaries? Given the new rules are intended to ensure beneficiaries have sufficient information to enforce the terms of the trust deed, it is presumed the answer is yes.

Before making “basic trust information” or “trust information” available to beneficiaries the trustees have to consider numerous factors, including:

  • the personal or commercial confidentiality of the information,
  • the age and circumstances of the beneficiary,
  • the practicality of giving the information, and
  • the effect on the beneficiary and family relationships of providing the information.

After taking all factors into consideration, the trustees can decide to withhold information from beneficiaries if they “reasonably” consider the information should not be provided.

The wording of the new Act is causing uncertainty and unease with existing Trustees as to what exactly their new obligations are and the risk of acting unreasonably. At one end of the scale, risk averse trustees are considering trust resettlements to establish new Trusts with a reduced number of beneficiaries, to preserve confidentiality or reduce the risk of litigation by beneficiaries. At the other end of the scale, trustees are awaiting case law to set the precedent on how to “reasonably consider” the factors above.

Although the legislation needs to be applied correctly (which in itself is uncertain), each situation is different based on the nature of family and beneficiary relationships, which makes it difficult to determine the best course of action.

Election Outcome and Tax Policies

After Labour’s victory in the 2020 General Election, their proposed tax policy changes are now likely to be implemented.

Labour has ruled out a capital gains tax and an increase in fuel taxes but is prepared to introduce a Digital Services Tax to target multinational digital businesses who have taken advantage of tax structuring options. Labour’s historical coalition partner, the Green Party, have notably been campaigning for a wealth tax, which Labour has repeatedly ruled out. Given that Labour has won enough seats to govern alone, the possibility of a wealth tax seems unlikely.

Labour’s election campaign promised no income tax changes for 98% of New Zealanders, however a new top marginal income tax rate of 39% for individuals earning over $180,000 will be implemented – expecting to raise $550 million of revenue a year.

For some of us this provides a sense of déjà vu, as we remember when we previously had a 39% tax rate from the 2001 to 2009 financial years. We saw disputes in the courts regarding the requirement to pay fair market salaries, legislation requiring income to be attributed to individuals and various policy statements from Inland Revenue.

As differences in tax rates widen, it impacts behaviour by incentivising tax planning to minimise application of top tax rates. Currently, there is little difference between the top income tax rates, 33% for trusts and individuals and 28% for companies.

It also leads to further inequity within the tax system because it is typically employees who are unable to alter how they are taxed, whilst business owners have greater flexibility to alter how their income is taxed.

For example, a distribution of accumulated income from a trust that has already been taxed at 33% may be distributed tax-free to a beneficiary who has a marginal tax rate of 39%. Individuals with investment income may also be further incentivised to invest in Portfolio Investment Entities instead of shares, where the top tax rate is capped at 28%. Conversations are likely occurring right now regarding whether shares in companies should be moved from personal ownership into trusts – and whether this is tax avoidance?

Companies will also face further costs with a 39% tax rate. Companies that currently pay fully imputed dividends at 28% are also required to withhold tax at 5% in order to reach the 33% marginal income tax rate. This withholding tax liability is likely to increase to 11%, which may place constraints on company cash flow or prevent dividends from being paid altogether. This will place further pressure on tax administration to keep accurate, up-to-date records as individuals on lower marginal tax rates may be entitled to tax refunds comprising the additional tax withheld.

Ultimately, this policy provides an opportunity for individuals to explore their different options to ensure efficient tax planning. However, utmost care should be taken when restructuring one’s affairs, in order to avoid undesirable consequences such as the breach of shareholder continuity resulting in the loss of imputation credits or tax losses, or potentially undertaking a tax avoidance arrangement.

Categories Tax