NZ IRD targets family trusts in tax bracket overhaul

This article was current at the time of publication.

New Zealand’s Inland Revenue Department (IRD) is stepping up its communications to accounting practitioners, in a bid to combat the use of family trusts to avoid tax.

The country’s Taxation (Income Tax Rate and Other Amendments) Bill became effective last December, allowing for the top marginal tax rate to be increased from 33 per cent to 39 per cent on 1 April this year for individuals with income over NZ$180,000.

The tax rate levied on family trusts was left unchanged at 33 per cent; however, the new tax legislation introduced greater disclosure requirements for trusts that apply for the 2021-22 financial reporting year.

The IRD is particularly concerned that individuals on the top marginal tax rate who operate trusts may try to use them to divert personal income to pay less tax.

“If that’s how it looks to us then we’ll take the necessary action,” says IRD Customer Segment Leader Tony Morris.

“We’re currently talking directly to tax agents and putting out a range of direct communications that are effectively a warning message and a guide to what kinds of activity will concern us.”

Changes to trust reporting

The IRD has bolstered the disclosure requirements for trusts in terms of having to provide financial statements and information on asset settlements and income distributions.

The new tax legislation stipulates that trustees of family trusts must file a return for a tax year of all income derived in the corresponding income year.

Trust tax returns must include:

• A statement of profit or loss and a statement of financial position
• The amount and nature of each settlement that is not the provision to the trustee at less than market value of minor services incidental to the activities of the trust and made on the trust in the income year 
• The name, date of birth, jurisdiction of tax residence, tax file number and taxpayer identification number of each settlor who makes a settlement on the trust in the income year or whose details have not previously been supplied.

Trusts must also provide details of distributions, whether they’re taxable or not.

Each distribution made by the trustee of the trust in the income year must include the amount of the distribution, name, date of birth, jurisdiction of tax residence, tax file number and taxpayer identification number of the beneficiary receiving the distribution.

“The government is trying to ensure people don’t manipulate the system and divert income to trusts which have a 33 per cent tax rate,” says Andrew Dickeson FCPA, chairman and head of tax at Auckland-based accountants and business advisers Baker Tilly Staples Rodway.

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“Inland Revenue is capturing a lot more data up-front, which will help them investigate whether some people have diverted income through their trust which should have been attributed to them as individuals at 39 per cent.

“A problem with a lot of family trusts is people think of all the assets in the trust as their own, so the accounting for the trust is terrible and there has been a lack of resolutions and disclosures. That whole mindset needs to change.”

Dickeson says the recent tax changes could see some people trying to create tax-free capital gains instead of income gains that need to be taxed at the marginal income tax rate.

“These are all areas that the IRD is going to spend more time considering, one would think,” he says. 

Legislation may spur trust closures

It’s likely the increased disclosure laws for trusts will lead to some trustees reassessing whether they need to continue operating a family trust.

The new requirements necessitate additional administration and therefore operating a trust will be more costly.

“The amount of work and costs that will be associated with maintaining your family trust will increase because there’s a need to provide a lot more ongoing financial information to Inland Revenue,” Dickeson says.

“There wasn’t that requirement up until now. So, there may be a lot of people who have trusts with not a lot in them who may decide to collapse them and just hold their family home and bank accounts in their own name.

“It’s really just this additional compliance burden that has been created. There’s [also] additional scrutiny from Inland Revenue on trusts, so trustees should expect there to be more questions about their trust and what it does and how it derived its income.”

Taking early action

With the new rules around trust disclosures having already come into effect, it makes sense for practitioners to reach out to clients early to ensure they are fully prepared.

“It’s not until you get to year-end and have to sit down with your accountant that you’re going to have to be providing all this extra information,” Dickeson adds.

“This means you’ll be looking to gather it during the year as you make distributions or look to make a settlement into the trust.

“People should be looking to catch up with their accountant and not leave it to the last minute.”

IRD’s Morris says clients should think carefully about what moves they make around the new rate and look at all the available information.

“The message really is, if you’re in doubt or have questions, the best thing to do is seek advice. And, of course, you can seek rulings from Inland Revenue.”