New draft interpretation statement clarifies when foreign sourced distributions may be subject to tax as foreign trust distributions.
Tax Alert - October 2019
By Joanne McCrae & Mike Cai
On 31 July 2019 Inland Revenue’s new draft interpretation statement, PUB00345: Income tax - distributions from foreign trusts (“draft statement”) was released for public consultation. The draft statement brings together the proverbial certainties of death and taxes, but while attempting to provide greater certainty, it shows the complexity of the tax treatment of foreign inheritances and foreign trust distributions.
Why is this uncertain?
It is a commonly held presumption that inheritances received by New Zealand tax residents can be received tax free in New Zealand. However, a New Zealand resident for tax purposes is generally liable to income tax on income derived from worldwide sources. One such source is foreign estate/trust distributions. The draft statement explains that a transfer of property from overseas needs to be considered to determine whether it represents a simple inheritance, gift or bequest or whether it constitutes a distribution from a foreign trust. Where a foreign arrangement bears the hallmarks of a trust under New Zealand law, then distributions may be taxable foreign trust distributions.
While not all foreign trust distributions will be taxable, the draft statement notes that the ordering rules (rules designed to prevent the making of tax-free distributions ahead of taxable distributions) may still apply such that intended capital distributions become taxable. There is an exception for distributions from non-discretionary trusts arising under a will or after intestacy. Where there is a trust in place for which this exception does not apply, the taxpayer is required to evidence through adequate documentation the source of the funds that have been distributed, applying the ordering rules. While the Commissioner acknowledges that obtaining such information may prove difficult in practice for the domestic beneficiary of a foreign trust, the draft statement maintains that where taxpayers cannot point to evidence allowing the proper application of the ordering rules, the entire distribution is likely to be considered taxable.
The first step will be for the recipient to determine whether there is a trust arising in respect of the property being distributed. The draft statement considers this should be determined under New Zealand tax law. This removes the uncertainty that may arise where the transfer is from a country (such as a civil law jurisdiction) that does not have a legal concept of a trust. The statement determines that a trust will exist where there is an equitable obligation imposed on the person holding the property to deal with it in a certain way for the benefit of certain beneficiaries. If the distribution has been subject to such an obligation, there may be a trust in place.
What does this mean for the taxpayer?
In our view this is unhelpful, as the onus of proof is placed squarely on the New Zealand beneficiary to firstly determine there is a trust and its characteristics, but then to obtain information that is not entirely within their control to confirm it should not be subject to tax in New Zealand. This will more likely catch those that are unaware, than those genuinely seeking to misapply the rules.
One example of the perils of being caught unaware is outlined in the draft statement. It concerns the treatment of a distribution from a trust in Canada which was established upon the death of Cindy’s parents. The terms of the will provide for discretionary trusts to be established for the benefit of Cindy and her family. The trustees agree to make a distribution to Cindy’s daughter to pay for university fees and funds it by selling some shares in New Zealand. However as it is a foreign trust (albeit set up under a will), the ordering rules will need to be applied. In the event Cindy cannot obtain adequate records, the distribution will likely be treated as taxable.
What is the risk of this and how can this be overcome?
The draft statement notably points out that with the introduction of Common Reporting Standard and Automatic Exchange of Information arrangements, Inland Revenue is likely to have more information than ever about amounts transferred to New Zealand tax residents from offshore. Once a trust is in place, it may become too difficult to retrospectively address issues or correct poor record keeping. Accordingly, we would recommend that New Zealand beneficiaries of inheritances pre-empt potential tax issues by seeking New Zealand specific tax advice early, as these rules are complex and the consequences can be significant.
For further information, please contact Joanne McCrae, Ian Fay or your usual Deloitte advisor.
October 2019 Tax Alert contents
· Business Tax changes announced
· Habitual buying and selling of land – what is a regular pattern?
· Protecting the tax base at a limited compliance cost
· Is Australia re-thinking the scope of their corporate residence rules?
· New draft interpretation statement clarifies when foreign sourced distributions may be subject to tax as foreign trust distributions
· Glencore case – A transfer pricing win for taxpayer