As part of the Budget earlier this year, the Government surprised us with an announcement that it would raise the tax rate on Trusts from 33% to 39%, effective from 1 April 2024. For a Budget which was badged as having ‘no major tax changes’, this felt like a major change for the 400,000 Trusts registered in New Zealand.

This change brings the trustee tax rate into alignment with the highest personal income tax rate; and in line with Australia, Canada, the United Kingdom, and the United States who all align their trustee tax rates with top personal tax rates.

The rationale was a spike in the amount of income being put through Trusts, rising by $5.7b, or almost 50% from $11.4 in the 2020 tax year to $17.1b in 2021. The Government expects to raise a further $350m in tax per year following this change.

Will this change impact all Trusts?
Many Trusts will be used solely to own a family home and possibly a bach, so will be inactive for tax purposes and not affected at all.

The target for this increased Trust tax rate is wealthy individuals who invest, earn and retain wealth within Trusts which currently pay a flat 33% tax on income generated.

In the middle are many family Trusts that generate income from money invested in bank deposits, fixed interest, shares, and property investments. For those trusts that distribute the income to beneficiaries on lower tax rates, there will be no change. However, those that reinvest earnings within the Trust are likely to suffer collateral damage and will end up paying the higher tax rate.

Each year, accountants review income generated by Trusts and beneficiaries to determine how best to treat the income – either a) allocate it to beneficiaries and pay tax at their personal rates, or b) retain it within the Trust and pay tax at the trustees tax rate.

In making this decision, accountants and trustees consider various factors including:

• actual distributions made during the last year
• payments expected in the year ahead
• tax credits available
• expenses or losses to be claimed, as well as
• the best treatment for tax purposes

To illustrate, here is a simplified example:

ABC Trust has an investment portfolio and two main beneficiaries, Mr and Mrs Smith. Gross taxable income generated during the year was as follows:

• ABC Trust                                   $ 15,000.00
• Mr Smith                                    $ 30,000.00
• Mrs Smith                                  $ 55,000.00

At the end of the tax year, the trustees can choose how to allocate that income. Each option results in different levels of tax payable on that income, as illustrated below:

1. Retain the income with the Trust = $15,000.00 x 33% = $5,000.00 tax

(This would rise to $5,850.00 under the new 39% trustee tax rate)

• Distribute the income to Mr Smith = $15,000.00 x 17.5% = $2,625.00 tax
• Distribute the income to Mrs Smith = $15,000.00 x 30% = $4,500.00 tax

In the above example, the most tax effective option would be to allocate and distribute income to Mr Smith as he has the lowest taxable income and marginal tax rate (17.5%).

Are there any exceptions?
While many Trusts will be impacted by the above rules, there are some situations where income may not be taxed at 39% despite being retained in the Trust. For example:

1. Deceased estates and disabled beneficiary Trusts will be exempt from this new top tax rate
2. Trusts which have tax losses or deductible expenses that can be offset against income
3. Income earned within a PIE (or Portfolio Investment Entity) which has elected a 28% PIE tax rate, making such investments more attractive for Trusts
4. Company earnings for shares owned by Trusts, where income is retained in the company and not paid out as a dividend
5. Charitable Trusts, which do not pay tax on income generated

Is there still value in having a Trust?
The answer to this question is …  it depends. Determining the value of having a Trust should always come back to it’s purpose and what benefit it provides to beneficiaries, both the original settlors and future generations; now and in the future. In our view, there are still valid asset protection reasons for Trusts, including:

• Succession and estate planning
• Providing financial support for specific people
• Creditor protection for self-employed or business owners
• Family asset protection
• Separating assets from matrimonial and relationship property
• Protection from any future estate or death duties

What should you do?
With the higher tax rate and increased scrutiny of Trust activity, trustees need to balance the administration costs and tax obligations with the overall purpose of the Trust and the benefits it provides for beneficiaries. Trusts are not for everyone, however, there are clear benefits available in the right circumstances. The increased trust tax rate is just another factor for trustees to consider when determining the appropriateness of the Trust.

The G3 team has extensive experience in working with Trusts and considering the tax implications of investing as a part of broader financial planning advice. Please get in touch if you would like to discuss your situation.

 

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Disclaimer: The above information is of a general nature only.  The information in this article does in no way constitute legal or taxation advice and all readers should contact a professional for advice relating to their specific circumstances.

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