20/02/2024·4 mins to read

Adapting to the proposed 39% trustee tax rate: options and risks

It is highly likely that, from 1 April 2024, the tax rate applying to “trustee income” of trusts will increase from 33% to 39%, in line with the top personal tax rate. 

The increase was included in a tax Bill introduced by the previous Labour Government, motivated in particular by a concern that high net worth individuals and families were using trusts to escape the 39% top personal rate. The Bill lapsed at election time, but has been reinstated. It seems that the National-led coalition Government intends to press ahead with the increase to the trustee rate (along with most other measures in the Bill).

To put the increase in context, first a little background on how income of typical New Zealand “complying” trusts is taxed (the rules being different for “foreign” or “non-complying” trusts):

  • Income earned by trustees in trust is taxed either as “trustee income” (currently at 33% or, likely from 1 April, at 39%) or as “beneficiary income” if distributed to a beneficiary within the relevant tax year or within certain timeframes following the end of the year. 
  • Beneficiary income is taxed at the beneficiary’s personal tax rate(s). This does not, however, apply to distributions to a minor beneficiary, being a beneficiary who is under 16 years at the trust’s balance date for the tax year. Distributions of income to a minor beneficiary are taxed as trustee income, at the trustee tax rate. This is to prevent distributions to minors being taxed at a lower rate, due to concerns that such distributions are more likely to be used to fund expenses of adults (eg parents) on higher tax rates.
  • If trust income is treated as trustee income and tax is paid by the trustees accordingly, a subsequent distribution of the tax paid (capitalised) income is generally not taxable to the recipient beneficiary.

In anticipation of the increase to the trustee rate, IRD has released a “general article” that is intended to provide high-level guidance on how, particularly from a tax avoidance perspective, it is likely to view some taxpayer transactions and structural changes that might be considered in response to the increase (see article “Proposed increase in the trustee tax rate to 39%” GA 24/01).

IRD discusses five different scenarios:

  1. A company is owned by a trust and pays out retained earnings as dividends before the tax rate increase and/or reduces its dividends from 1 April 2024:
    IRD considers this is unlikely to be tax avoidance, in the absence of any “artificial or contrived” features. An example given of where IRD might be concerned is the crediting of the trust’s shareholder current account with the company, so as to accelerate the payment of a dividend before 1 April, where there is doubt that the company could pay the credit balance if it was liquidated. 
    Takeaway: The dividend must be “real” (to use IRD’s terminology). Crediting shareholders’ current accounts where the company has sufficient net assets to back the crediting should be acceptable. 
  2. Trustee distributes income to a lower tax-rate beneficiary as “beneficiary income”: A distribution of beneficiary income to a beneficiary to ensure the income is taxed at a rate lower than the trustee tax rate, is generally acceptable to IRD. But it may not be acceptable where, “in reality”, the beneficiary is not entitled to the distribution or will not benefit from it. Where the amount is immediately resettled on the trust or the beneficiary is not informed about the distribution or cannot demand payment from the trustee, IRD may have concerns.
    It is also worth noting that the tax Bill intends to thwart distributions to a beneficiary of a trust that is a “close company”, being a company in which the shareholders are a trust or a small circle of individuals, where a settlor of the distributing trust has ‘natural love and affection’ for one or more such shareholders. In that case, similar to the existing minor beneficiary rule, the income will be taxed at the trustee tax rate, not the 28% corporate tax rate of the close company. 
    Takeaway: A distribution of beneficiary income must be “real”. Any arrangement under which the distribution is contributed back into the trust, or which does not actually benefit the beneficiary, should be carefully considered.
  3. Trust incorporates and owns a company to hold income-producing assets: Such a restructuring may be considered to “trap” income in the company, limiting the immediate tax burden to the 28% corporate tax rate. When the company later pays a fully-imputed dividend to the trust, an additional 11 cents in the dollar of tax will be paid if the trust treats the dividend as trustee income, but until that happens, there is a timing benefit. Using such a trap is said to be generally acceptable where the underlying income-earning assets are, for example, real property or portfolio financial assets. 
    However, IRD cautions that interposing a holding company between an existing operating company and a trust shareholder may raise tax avoidance concerns. IRD is referring to so-called “dividend stripping”. In its article Revenue Alert 18/01 it characterised a dividend strip as the sale of shares where some or all of the sale amount received is in substitution for a dividend likely to have been derived by the seller but for the sale of the shares. One way a dividend strip may occur is where a shareholder sells a company to a related company and the price is left as a debt owing, with subsequent company income, taxed at no more than the 28% corporate tax rate, passed to the original shareholder or another related party as non-taxable debt repayment, rather than as a dividend. 
    Takeaway: Dividend stripping is an IRD compliance focus, so care needs to be exercised in this area and expert advice obtained.
  4. Winding-up a trust: IRD says this is unlikely, without more, to be tax avoidance. 
    Takeaway: Consideration may be given to whether some trusts have any continuing utility given the increase in the trustee tax rate.
  5. Trustee invests in a PIE, rather than directly in shares, bonds or term deposits: Currently, the top Prescribed Investor Rate (PIR) for investors in PIEs, both individuals and trusts, is 28%, which is usually a final tax rate on income derived by the investor through a PIE. IRD indicates that it has no concern with a trust allocating investment into a PIE in order to access the 28% “capped” PIR rate. 
    However, we note that from a tax policy standpoint, the 28% top PIR is looking increasingly distortionary, and while to date there has been no indication that it may be reviewed, the hike in the trustee tax rate may make this more likely. 
    Takeaway: Watch this space. 

In summary, any restructuring in reaction to the 39% trustee tax rate needs to be carefully thought through. The tax disclosure obligations for most trusts were significantly broadened from FY2021-22, including new requirements for the filing of financial statements and provision of settlement and distribution information, so that IRD could monitor taxpayer behaviour following the top personal tax rate increasing to 39%. IRD can be expected also to use that information in future to review how trusts respond to an increased trustee tax rate.


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