IRD review shines spotlight on trust behaviour

This article was current at the time of publication.

The Inland Revenue Department (IRD) says the new disclosure regime for trusts is delivering “a much richer understanding” of how trusts are used in New Zealand.

The increased disclosure requirements came into force with the 2022 tax year, and IRD’s review looked at data provided up to June 2023.

Increased disclosure was intended to support IRD’s ability to assess compliance with the 39 per cent personal tax rate introduced in April 2021. It was also intended to help the department understand and monitor the use of structures and entities by trustees.

Tax specialist Angus Ogilvie FCPA, managing director of Generate Accounting, says the behaviour identified in the review reflected reaction to the 39 per cent personal tax rate rather than action toward the move in the trustee tax rate announced in Budget 2023 and due to come into force on 1 April 2024.

Whack-a-mole activity

Ogilvie notes that the “whack-a-mole” activity will likely continue as taxpayers rearrange their affairs to consider the new trustee rate. He believes it will be fascinating to see if the focus shifts to companies and PIEs (portfolio investment entity) in order to arbitrage tax rate differences.

PIEs have a default top tax rate of 28 per cent.  For example, investors might establish one to hold term deposits on which interest would otherwise have been taxable at a personal tax rate of 33 per cent or 39 per cent.

Taxpayers could also transfer income-generating assets from trusts to companies to reduce tax, provided they didn’t need to access the income personally.

Who filed and disclosed?

IRD says that, of New Zealand’s 426,000 registered trusts, 265,000 might have needed to file a return and self-disclose. IRD received 226,000 returns.

Of these, 26,000 provided no financial information but indicated they were required to comply; 16,000 filed only an IR10, which doesn’t fully meet the requirements; and 35,000 filed a return with no income – so technically weren’t required to comply.

The amount of income being retained as trustee income, rather than being allocated as beneficiary income, rose from 35 per cent in 2020 to 60 per cent in 2022.

The amount of income allocated to individuals earning over NZ$180,000, the threshold for the personal 39 per cent tax rate, halved, from NZ$900 million to NZ$450 million.

The number of individuals earning between NZ$170,000 and NZ$180,000 – just below the threshold – who had beneficiary income allocated to them tripled, and the amount allocated to them quadrupled.

Ogilvie says all these results are unsurprising given the rise in the top personal tax rate to 39 per cent from April 2021.

Income allocation to the young

The IRD notes “a significant spike” in income allocations to 16 to 20-year-olds.

The average allocation was NZ$18,000, second only to the 61 to 65 age cohort.

Ogilvie says some trustees were likely positioning to take advantage of the disparity between the new 39 per cent trustee tax rate and the “minor beneficiary rule,” under which trust income for those aged 16 or under is taxed at 33 per cent. This is called income streaming.

Ogilvie says it’s likely the default rate will be raised to 39 per cent, and another option for IRD would be to lift the minor beneficiary age to 18 or higher.

However, for those aged 17 to 20 with low or no income, income streaming was still possible. “You’re still winning up to NZ$70,000 where the 33 per cent rate kicks in,” he says.

The review notes “many” taxpayers failing to disclose beneficiary income and/or trust distributions for social policy purposes.

For example, 1400 individuals receiving Working for Families payments failed to declare trust distributions but were allocated NZ$110 million over and above their beneficiary income.
Charities lose out.

Similarly, a “significant amount” of income allocations to charities are not being distributed – which, IRD says, is inconsistent with other “donation/gift” rules that require funds to pass to the donee to qualify for a deduction.

Ogilvie says trustees allocating, but not distributing income to minors and others are taking a risk that those who have other income could be landed with a large tax bill, particularly given the new funding for IRD audit activity recently announced by the new government. 

“A beneficiary’s IRD number is reported when distributions are made. IRD will probably write to those people and claw back, and there may be some penalties and interest.”
Trustees must be able to ascertain what other sources of income a beneficiary has, Ogilvie says.

IRD intends to undertake a “post-implementation review” of the disclosure regime during 2024, including public consultation.

This would aim to determine whether changes can be made to improve or simplify future disclosures.