Article

Implications of the 39% trustee tax rate

Tax Alert - June 2023

By Robyn Walker, 

The many New Zealanders who have a family trust were likely unhappy to learn that Budget 2023 has announced an increase in the trustee tax rate from 33% to 39% with effect from the 2024/25 tax year (generally 1 April 2024). For a Budget that was badged as having ‘no major tax changes’, this may feel like a major change for the 400,000 trusts registered in New Zealand. Trusts are commonly used for asset protection purposes, particularly for New Zealanders who are running some of New Zealand’s over 500,000 small businesses.

The change to the trustee tax rate follows the increase of the top personal tax rate to 39% from 1 April 2021 and the introduction of significant trust disclosure requirements, which trustees will have recently grappled with in filing 2021/22 tax returns. Support for the change comes in the following comment in the Budget Press Release: “Ministers made clear … that if analysis indicated high-income earners were circumventing the rate through greater use of trusts, the Government would move to address this issue. New information from Inland Revenue has shown an almost 50 percent spike in income subject to the trustee rate, from $11.4 billion in the 2020 tax year to $17.1 billion in the 2021 tax year.”

The Budget Press Release attempts to suggest that this change won’t materially impact most trusts, with the comment “[o]nly a small proportion of trusts will pay most of the additional tax. The top five percent of trusts with some taxable income in the 2021 tax year accounted for 78 percent of all trustee income ($13.3 billion out of $17.1 billion). This is estimated to raise approximately $350 million per year.”

The fact that the majority of trusts will not be paying “most of the tax” will be of little comfort to the significant number of trusts held by ‘regular New Zealanders’ with a marginal tax rate of 33% or lower.

Statistics provided by Inland Revenue indicate there are 120,000 trusts with trustee income between $1 and $180,000 (and 43,000 trusts with nil income), which had a mean level of trustee income of $21,000 in 2021. As an indication, the tax increase would be:

 

If the average trust will be paying an additional $1,260, collectively those 120,000 trusts face an extra tax burden of $151,200,000, all else being equal.

The details

The trustee tax rate change is included in the Taxation (Annual Rates for 2023-24, Multinational Tax, and Remedial Matters) Bill (‘the Bill’). The Bill has had its first reading and is now with the Finance and Expenditure Committee (‘FEC’) for consideration. The FEC has called for submissions by 30 June 2023.

In addition to changing the trustee tax rate to 39%, the Bill includes three additional trust changes:

  1. A twelve-month exemption from the 39% rate for deceased estates. During the 12-month period the estate will be taxed at the personal tax rate of the deceased person.
  2. Trusts settled for the care of a disabled person will be taxed at the disabled beneficiaries’ personal tax rate.
  3. Beneficiary income received by certain close company beneficiaries will not be taxed as beneficiary income in the company but will instead be treated as trustee income with tax paid at the trustee rate.

In an acknowledgement that the 39% tax rate may result in over-taxation when the beneficiaries of a trust have personal tax rates below 39%, the Commentary to the Bill notes there are options available for trustees, including allocating income to beneficiaries and for amounts to be held in a current account or resettled into the trust (we copy an example from the Commentary below). Despite the Inland Revenue example, we caution against trustees taking any actions which are circular in nature, or which are not genuine distributions in order to benefit from a lower tax rate – seek tax advice in these circumstances.

Example taken from Inland Revenue commentary to the Bill:

Amy (an air traffic controller) and Anthony (a builder with his own company) have settled some income-generating assets on a discretionary family trust for the benefit of themselves, their children (both minors under the age of 16) and future grandchildren. Amy, Anthony and their accountant are the trustees.

2024–25 income year

Anthony has personal income of $70,000 and Amy has personal income of $180,000. Their trust has income of $40,000.

If the income is retained as trustee income, it will be taxed at the proposed 39% trustee tax rate. Any income allocated to their children as beneficiary income will also be taxed at 39% under the minor beneficiary rule.

However, by allocating the income to Anthony as beneficiary income, it can be taxed at his personal tax rate. To meet the definition of beneficiary income, the trustees cannot change their mind about the allocation, so he has an absolute right to withdraw the funds. If Anthony does not want to withdraw the money, it can be credited to his current account, available to be called upon at any time.1

2025–26 income year

Bary, the older of Amy and Anthony’s children, has turned 16, so he is no longer a minor. Bary has no personal income. Anthony again has personal income of $70,000, and Amy has personal income of $180,000, while the trust has income of $50,000.

Since Bary is no longer a minor, he is not subject to the minor beneficiary rule. Income can be allocated to Bary as beneficiary income and taxed at his personal tax rates (e.g., up to $14,000 at 10.5%, over $14,000 and up to $48,000 at 17.5%).

If Bary does not want to withdraw the money, it can be credited to his current account, available to be called upon at any time, or a sub-trust arrangement can be set up so that Bary’s interest in a portion of the trust assets is recognised and protected.

1 A previous version of this fact sheet included an example of Anthony settling the beneficiary income back on the trust. This has been removed as there is some uncertainty under existing law about the tax treatment of such a settlement. This matter will be subject to further consultation.

The proposed change for close companies is designed to prevent trusts from distributing income to a closely connected company in order to have that income taxed at 28% rather than 39%. This new rule is set out in the proposed section HC 38 and states:

HC 38 Beneficiary income of certain close companies

When this section applies

(1) This section applies when a close company that is not a Māori authority or tax charity derives an amount of beneficiary income from a trust in an income year and a person for whom a settlor of the trust has natural love and affection holds, under sections YC 2 to YC 4 (which relate to interests held in a company), a voting interest or a market value interest in the close company.

Treatment of amount derived

(2) The amount is—

(a) excluded income of the close company under section CX 58B (Amounts derived by certain close companies from trusts); and

(b) treated as trustee income for the purposes of determining the rate of tax that applies, who pays the relevant tax, and who provides the return of income.

Relationship with other provisions

(3) This section—

(a) overrides sections HC 5, HC 18 to HC 20, HC 22, HC 23, and HC 32; and

(b) is overridden by section CW 10 (Dividend within New Zealand wholly-owned group).

What next

Given there was no public consultation on the change in trustee tax rate before the Budget announcement, it’s critical that trustees take the time now to consider what the impact of this change will be.

The Inland Revenue acknowledges that the inability to consult on this change before the Budget means that some exemptions which may be justified have not been included in the Bill – so now is the time to make a case to the FEC for any further carve-outs from the rules. The submission process also offers an opportunity to highlight any additional unintended consequences from the proposal.

It is our understanding that the Government intends for this Bill to follow a full FEC process and it is not intended that the Bill be rushed through in order for the legislation to be enacted before parliament dissolving for the election. As is standard in election years, when parliament dissolves for the election, all Bills technically lapse and need to be reinstated by the new Government. What happens on 14 October may determine the fate of this proposal.

Finally, its worth noting that this rate change applies only to trusts, which leaves companies and portfolio investment entities (PIEs) still taxed at a maximum rate of 28%. While company tax is arguably just an interim tax until profits are distributed to shareholders, investors in PIEs have a permanent tax benefit. Before considering immediately changing investment structures, taxpayers should be aware of the following comment from Inland Revenue: “Ministers have decided to progress increasing the trustee tax rate to 39% for the 2024-25 and latest income years (beginning on 1 April for most trusts) while considering PIE and company/shareholder misalignment issues on a longer timeframe.”

For more information please contact your usual Deloitte advisor.

June 2023 - Tax Alerts

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