To trust or not to trust

RSM NEW ZEALAND

TO TRUST OR NOT TO TRUST A practical overview to family trusts and their financial and tax implications

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WHAT OR WHO IS INVOLVED IN A TRUST AND HOW? The settlor The settlor is the person who forms the trust and puts in (settles) the initial assets.

Any person who has legal capacity, who is or may become the owner of assets and has the power to dispose of that property, can be a settlor and create a trust.

For tax purposes a settlor can also include any person who at any time provides benefit to a trust for less than market consideration.

Determining who is a settlor of a trust and whether he or she is a resident is important in establishing whether the trust’s overseas income is taxable in New Zealand. These factors also affect the category of a trust and therefore which distributions to beneficiaries are nontaxable.

The trustee(s) The person in a trust document holding the trust property.

Any person with legal capacity or a trustee company authorised by the Trustee Companies Act 1967 can be named as a trustee (ie. the Public Trust or Guardian Trust) A trustee can be appointed by a trust document, under the Trustee Act 1956 or by court appointment.

It is recommended to have at least two trustees, one of whom should be independent from the settlor and beneficiaries.

Beneficiaries A person for whose benefit property is held under the terms of a trust document Any one or more people, a club or an organisation may be a beneficiary to a trust.

A settlor can be included as a beneficiary.

Trust deed A trust deed or trust document, is the formal document setting out names of trustees and beneficiaries, details of how and when the trust property can be distributed and the rights, responsibilities and powers of the trustees.

The maximum term of a trust permitted by law is eighty years. However trustees can wind up a trust well before then if they wish to do so.

A trust is the legal relationship created when a person places assets under the control of a person for the benefit of some other person or people or for a specified purpose.

The assets transferred to the trustees become their property, but they hold the assets on trust for the beneficiaries. The trustees are therefore the owners of the property and have a legal obligation to deal with the property in the manner set out in the trust deed.

WHAT ARE THE TYPES OF TRUSTS? Fixed (or non-discretionary) trusts With this type of trust, the number of beneficiaries and their relative shares are fixed at the outset. For example, a trust might be established for a handicapped child to ensure that the child will be properly cared for if the parents or guardians are deceased.

Discretionary trusts Here, the trust deed gives the trustees a discretion about matters such as which of the beneficiaries is to receive a benefit, what each beneficiary’s share will be and, in some cases, who may be a beneficiary. Discretionary trusts are more common than fixed trusts; nowadays, most family trusts are discretionary.

For the purposes of the Income Tax Act 2007, trusts can also be placed into one of three distinct categories 1. Complying trusts Generally a trust which has at all relevant times been liable to New Zealand tax on all trustee income, and has fully accounted for its New Zealand tax liabilities 2. Foreign trusts Essentially a trust where, in relation to any distributions, there has been no New Zealand resident settlor from 17 December 1987 (or the date that the Trust was first settled, if that is later) up to the time the distribution is made.

3. Non-complying trusts This is any trust other than a complying or foreign trust. Generally these would be trusts which had a resident New Zealand settlor at some time after 17 December 1987 but have not paid New Zealand tax on all trustee income derived since the trust was settled.

The main significance of the categories is that they determine the way in which certain distributions from trusts are taxed in the hands of beneficiaries.

A complying trust may become a non-complying trust if no settlor is a New Zealand resident eg. where the sole settlor of the trust emigrates from New Zealand or is a transitional migrant.

NEW ARRIVALS IN NEW ZEALAND New residents who arrive in New Zealand may have settled a trust before they arrived in here. Such a trust would normally be a foreign trust, but may become a non-complying trust upon the relocation to New Zealand. The election may need to be made to become a complying trust.

WHAT ARE THE BENEFITS OF A TRUST? • Organise your financial affairs • Provide for your dependents • Hold and manage property for those who cannot do so themselves • Protect family property from careless family members or from relationship property claims, and enable property to be passed on to future generations • Protect yourself from business risk • Protect a child from a greedy spouse, or from worry that there might be one in the future • Protect yourself against future unforeseen events

WHAT ASSETS CAN BE TRANSFERRED TO A TRUST? An essential element to setting up a trust is there must be property or something that can be owned. Examples include land and building, shares/equities, interest bearing securities, leases and licences, trademarks and agencies, plant and equipment, a business – particularly a new business or cash/ money.

If there are no funds in the trust to pay for an asset then the sale can be done by selling an asset to a trust and taking back a loan – interest free and repayable on demand. This is done by the trustees signing a document acknowledging that they owe the settlor the purchase price of the asset.

Alternatively, assets can be gifted directly to the trust

REPEAL OF GIFT DUTY In October 2011 gift duty was repealed. This means that assets of any value can be transferred into a trust after that date without incurring gift duty.

This means:

partner then a court may set aside the asset(s) transferred under the Property (Relationship) Act 1976.

Transferring assets into the trust may also affect your ability to get the residential care subsidy.

The above provisions will more likely apply if you gift your assets into the trust rather than selling them and then gradually forgiving the debt owed to you.

We strongly suggest that you check with your lawyer before gifting assets into your trust.

THE OPERATION OF A TRUST Trusts can trade just like any other business and can do so in partnership with other trusts and other entities and persons.

At law a trust is represented by its trustees. The trustees are liable for trust debts and are usually indemnified out of the trust assets for this purpose. Trustee’s names appear on share registers and land title deeds. When structured effectively, trust assets are well protected from personal creditors and relationship property claims.

• The settlor can forgive any outstanding debt owed by the trustees to the settlor in respect of assets sold previously into the trust.

A trustee company can also be formed to act as a trustee and obtain limited liability.

• The settlor can transfer assets into the trust by gift rather than sale.

FINANCIAL IMPLICATIONS

CAUTION NEEDED FOR GIFTING Although gift duty has been repealed there are various legal requirements and several legal provisions that allow property to be clawed back in certain circumstances. These include if the transfer of assets was done with the intention of defeating the rights of creditors or the rights of a spouse /

The trust’s capital and income can be paid to or used only for the benefit of the beneficiaries referred to in the trust deed. If the settlor is not a beneficiary, then the trust cannot distribute any of its money to the settlor. Of course, if the trust owes money to the settlor then it can repay the debt.

Income derived by trustees will either be trustee or beneficiary income based on the following:

Beneficiary income • Comprises the income of a trust which vests absolutely in the beneficiary during the income year, or is paid or applied to the beneficiary during or within six months or by the earlier of the date on which the trustee files the tax return or the date by which the trustee must file a tax return.

• A New Zealand beneficiary in receipt of “beneficiary income” is liable to tax on worldwide income at the normal tax rate for that beneficiary. Non-resident beneficiaries are only liable to tax on New Zealand sourced income.

Trustee income Where a trust derives income which is not paid or applied as beneficiary income, this will become trustee income attracting tax in the trustee’s hands. In this regard; • All trustee income derived from New Zealand will be liable to New Zealand tax; • Trustee income derived from overseas will in general be liable to New Zealand tax where any settlor of the trust is resident in New Zealand at some time during the income year.

Special rules amy apply to trustee income when all trustees are non-resident in New Zealand.

TAX IMPLICATIONS Income can be distributed to beneficiaries at the discretion of the trustees and will be taxed in the hands of the beneficiary at their marginal tax rate. Currently these tax rates are; Income

Tax payable per dollar

$1 to $14,000

10.5 cents in the dollar

$14,001 to $48,000

17.5 cents in the dollar

$48,001 to $70,000

30 cents in the dollar

$70,001 and above

33 cents in the dollar

Income not allocated to beneficiaries remains in the trust and is added to trust capital. This income is taxed as trustee income. For qualifying trusts, all trustee income is taxed at 33%.

A child beneficiary (under 16 years at the trust balance date) is deemed to be minor and any income allocation over $1,000 to any such minor in any given year is subject to be taxed as trustee income.

Tax rules are complex Rules surrounding tax are complex and professional advice is strongly recommended prior to making any changes.

DISCLAIMER The information contained in this document is set out in general terms of basic trust features in New Zealand. You are advised to seek professional advice before acting on any information contained herein. No liability will be accepted for any losses incurred by persons relying upon the contents of this commentary.

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THE POWER OF BEING UNDERSTOOD AUDIT | TAX | CONSULTING