What is a trust?

Trust is not an entity; it is just a relationship between the settlor and the trustee. There are three important parties in a trust. They are settlor, trustee and beneficiary. Settlor is the person who set up the trust. Trustee is a representative of settlor who manages the trust and is the legal ‘face’ of the trust. The Trustee is liable for the trust’s tax and legal obligations. The Beneficiary is the person who is benefits from the trust income.

One of the important elements of a trust is that the trustee looks after the property (assets) for the benefit of beneficiary. The Trust can be started with a sum of $100, and later family home, investments, and other assets can be gifted to the trust. A trust, other than a charitable trust has a maximum life span of 80 years. The rationale is to promote the liquidity of assets in the society, otherwise assets can always be locked into trust and the general public may not have access to that.

Tax classification of trust?

Income Tax Act 2007 subpart HC classifies trust into 3 types: complying, non-complying and foreign trust. Most (about 95%) family trust set up in New Zealand are complying trust, even though when the settlor moves overseas the complying trust can still maintain its status and distribute New Zealand source income to beneficiaries or trustees.

How trust is taxed?

The tax on trust is determined by reference to the settlor’s residence and the source of the income. If settlor is New Zealand tax resident the worldwide income of the trust will be taxable in New Zealand. If settlor is non-resident then only New Zealand sourced income will be taxable.

The income a trust derives is either a trustee income or a beneficiary income. Beneficiary income is income distributed to beneficiary. It is taxed at beneficiary’s marginal tax rate and usually it is paid by trustee on behalf of beneficiary. However, with minor beneficiary (beneficiary under 16 years old) income is taxed at 33% regardless of the beneficiary’s marginal tax rate.  All the other Income that is not paid to a beneficiary is trustee income, which is taxed at 33%.

Trust cannot distribute loss to the beneficiary it can only retain the loss for future income. Once loss is recovered it can start making distribution to beneficiary.

For example: Kumar family trust owns a rental property it made a profit of $10,000 in the year ending 31-03-2014. Mr. and Mrs. Kumar and their son (Raj over 16 years) are a beneficiary of the trust. Trust distributes $10,000(rental income) to Raj, this it will be taxed at 10.5%, total tax paid would be $1,050. If Mr. and Mrs. Kumar owns this property in their personal capacity they will have to pay tax at 33% (highest tax rate), total tax paid would be $3,300. So by having a trust they will save tax of $2,250 in a year.

How assets are transferred from settlor to a trust?

The assets are sold to a trust from the settlor at assets’ market values. The trust may not have money, so the settlor lends the money and then the settlor forgives the debts as a gift to the trust. After 1^st October 2011, the limit of $27,000 that you could gift without paying gift duty was removed. Therefore you can forgive all debts a trust owes to you straight away.

The final idea is to own fewer assets under the settlors’ names so they can protect their assets from being claimed and obtain tax advantage (If is merely incidental)

Benefits of a trust

1. 1.Protect assets against claims and
2. 2.Ensure later generations own it not their partners.
3. 3.Set aside money for special usage like education or special purpose.
4. 4.Retirement home subsidy.

Risk of a trust

If the proper documentation is not maintained such as trustee meeting minutes and there is a lack of independence in the trustee. The trust can be considered as a ‘sham’ due to improper conducts. It means the trust could not protect the settlor’s assets as expected.

You also need to be careful about tax avoidance in a leading tax case on taxation of trust Penny and Hooper v Commissioner of Inland Revenue [2011] NZSC 95 (SC) it was held if the purpose or effect of setting up a trust is altering the incidence of tax, which is more than merely incidental, and in the absence of legitimate reason for doing so it can be considered as tax avoidance. Section BG1 of Income Tax Act 2007 gives powers to the Commissioner of Inland Revenue to make the arrangement null and void and recalculate the tax.

In the next article, we will cover the new changes being made to financial reporting standards nearly 95% of businesses in New Zealand will be affected and about 8 legislations will be amended to reflect those changes. These changes are effective from 01^st April 2014, and this is going to be a major change to the reporting standards. The whole idea is to make financial reporting simpler for the small businesses.

About the author:

Saurav Wadhwa is an Auckland based chartered accountant and a director of IBBZ Accounting Limited. Saurav is a tax specialist with Masters in Tax with Distinction (Auckland) and have 10 years of experience in the industry. He is very passionate about helping small business owners. His easy going personality and a friendly nature makes him easily approachable. For all your tax problems, small business accounting, overdue tax returns,  tax debt, tax consultancy, and IRD audits & disputes  you can contact him at This email address is being protected from spambots. You need JavaScript enabled to view it.  or 027 5555 458.

Disclaimer:

Information above is provided for general use only, if you are intending to rely on any of the information above please consult with us or seek a professional advice. We accept no responsibility of what so ever if above information result in any kind of loss to you, tax laws differs and varies for individual circumstances.