Guest Post: Lack of trust

A guest post by Mark Keating:

For tax practitioners the talking point of the Government budget was the unexpected increase in the tax rate for trusts – but post-budget discussion by the main stream media has largely overlooked this feature.

This change was justified by the Government as a “revenue integrity measure”.  Inland Revenue released a Fact Sheet explaining that the increase is necessary to prevent taxpayers from deriving (and presumably holding) income in a trust, and thereby being taxed at 33% rather than deriving (or distributing) that income to the beneficiaries personally – some of whom Inland Revenue obviously suspects would otherwise be taxable at the highest personal tax rate of 39% on income over $180,000 per year.

It is questionable whether all beneficiaries of trusts might be subject to the top 39% rate … but Inland Revenue is clearly targeting the minority of trusts it considers are being used by those high income taxpayers to continue paying tax at the 33% trust rate. The Fact Sheet explains:

In the 2021 income year there were 177,000 trusts that reported assessable income. Of those 177,000 trusts, only 9,000, (5%) accounted for 78 percent of trustee income ($13.3 billion out of $17.1 billion). These trusts would pay most of the additional tax. 

The lower 75 percent of trusts in terms of trustee income (133,000) accounted for only 2.5 percent of trustee income ($0.4 billion). This includes the lower 24 percent of trusts (43,000) that had only beneficiary income; they would not be affected by a change in the trustee tax rate.

The logic is that:

• If income is retained by the trust, it will be taxed at the increased 39% rate; or alternatively
• If income is distributed to beneficiaries then it will be taxed at their personal rates – meaning if it is received by high income taxpayers it will also be taxed at their top 39% rate.

So Inland Revenue is explicit that this increase is targeted at the wealthiest trusts – and estimates that the 39% rate will generate an additional $300million tax each year.  

As with all revenue estimates, this presumably does not take account of changes in taxpayer behaviour in response to tax changes.  And, strangely, Inland Revenue even gives tax planning advice for those less wealth trusts on how to avoid the new 39% rate.   The Fact Sheet provides an example of a family trust in which:

• The wife already has $180,000 of income; 
• The husband has $70,000 of income; 
•  The trust has $50,000 of income;  and
• The couple have an adult son (Bary) not subject to the minor beneficiary rule.

Inland Revenue explains that to avoid the new 39% trust rate the trustees may distribute the trust’s income:

• to the husband, so that income is taxed to him at the 33% personal rate; or
• to the adult child, so that income is taxed to him at the lower marginal rates.

Inland Revenue explains with respect to the son:

Income can be allocated to him as beneficiary income and taxed at his personal tax rates (e.g., up to $14,000 at 10.5%, over $14,000 and up to $48,000 at 17.5%). 

If the trustees do not want to distribute this income to Bary, it can be credited to his current account, available to be called upon at any time, or a sub-trust arrangement can be set up so that Bary’s interest in a portion of the trust assets is recognised and protected.

So Inland Revenue are explicitly advising Trustees to distribute income to lower income beneficiaries for tax purposes to avoid the new 39% rate, while actually retaining those funds within the Trust.  How is that recommendation a “revenue integrity measure”?

The Government seems to be daring the opposition to pledge to reverse this tax increase on trusts, just as it dared the opposition to reverse the top 39% personal tax rate – something National originally vowed to do … only to quietly drop that pledge.  It therefore seems both our major parties favour imposing higher taxes.

Was it merely a coincidence that the increased tax for trusts follows closely the findings of the Inland Revenue high-wealth individuals research project in April?

At that time many commentators question the motives behind the report and suggested it was deliberately designed to sway public opinion in favour of increasing taxes (or introducing new taxes) upon the wealthy.  A few brave responses stated that we should celebrate and be grateful to (rather than tax more) our most successful citizens for the economic growth they generate for the rest of us.  But those voices have been ignored.

The Inland Revenue report on our wealthiest citizens disclosed that collectively the 311 families surveyed paid almost $1billion in tax in the 2021 income year – or approximately 1% of total tax.  Their taxes paid for a lot nurses and policeman and other government services that we all enjoy. 

Some commentators have noted that the new 39% rate only comes into effect from 1 April 2024 – meaning its implementation will actually depend upon the will of the new Government elected later this year.  

The Finance Minister acknowledged that tax policy will be a key issue in the coming election.  It therefore must be remembered that the Law Commission report into trusts published in 2011 both:

• acknowledged the valid, non-tax benefits provided by trusts for preserving assets, or business and estate planning; and 
• noted the sheer number of trusts in New Zealand.  

Each trust generally has a number of beneficiaries and all of them now have a personal interest in that tax debate when they cast their vote later this year.