Using a trust to manage and protect a family’s business and personal assets is common practice in New Zealand. However, the tax rules applicable to trusts also differ to that applicable to individuals and companies. With the top personal tax rate increasing to 39% from 1 April 2021 while the trust tax rate has remained at 33%, the differential benefits retaining income in a Trust to be taxed at 33%.
However, the nature of the trust’s activity, the assets held, the beneficiaries involved, and the costs incurred by the trust on behalf of its beneficiaries still need to be carefully managed. A common scenario is a trust being the sole shareholder of 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 artificially 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, IRD could take the view that the funds paid to the beneficiaries should be treated as taxable beneficiary distributions. 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. Through this time, both trustees and their advisors may have taken a relaxed approach to how transactions were accounted for and documented. With income tax returns for the 31 March 2022 year now filed (by 31 March 2023), scrutiny by Inland Revenue is expected to increase, particularly if a beneficiary is subject to the top 39% tax rate.
If beneficiaries are reliant on dividend income that is derived by the trust, could Inland Revenue assert payment of the ‘dividends’ to the beneficiaries comprises 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, will that suffice in the event of a review by Inland Revenue? What if there are no resolutions, what then? What if there is no loan to repay?
Issues like this have not been the subject of material scrutiny in recent years because the tax rates were aligned at 33%. But with the rates no longer aligned, care and due consideration must be applied to ensure tax outcomes are as expected and not open to challenge.
