When the Government dropped its gifting rules last year it appeared to many that a saviour had fallen from the heavens.
No longer could people gift only $27,000 a year to trusts or others without incurring tax. They could now give away their assets in one fell swoop.
Common reasons for doing this are to put the family home and other assets beyond the reach of business creditors, acquisitive partners, or unsavoury daughters and sons-in-law.
Sometimes people simply want to give money to family members or others. The new rules make it an awful lot simpler.
On the surface this means people can divest themselves of assets, putting those assets beyond the reach of business creditors and others including Work & Income New Zealand. Sadly, when it comes to gifting it isn't quite so simple. Or should I say: happily for business creditors, the Official Assignee, spurned lovers and other taxpayers, it isn't so simple.
There are many other laws that affect gifting that people should consider before gifting their assets to a trust. Those laws include the Property (Relationships) Act, the Property Act, the Insolvency Act, Social Security Act and the Housing Corporation Act. The police and other law enforcement agencies also have an interest in gifting. You can bet that the Serious Fraud Office will go over all gifting by failed finance company directors with a fine tooth comb.
Gifting doesn't offer perfect protection. In the case of business owners and soon-to-be bankrupts, removing assets from their own personal ownership doesn't always work. Creditors can try to claw back such gifts if it can be proven that the business owner was insolvent at the time of making the gift. The reasons for making that gift will also come under scrutiny. If it was based on avoiding creditors, then the gift may be set aside by a court.
Under the Insolvency Act, says Lyndsey Partridge, a consultant at Chapman Tripp lawyers, the Official Assignee can claw back gifts made by a bankrupt up to five years before the date of adjudication of bankruptcy.
Likewise, says Partridge, gifts made as someone is about to enter into a business or transaction can be set aside if that person leaves him or herself with an "unreasonably low" asset backing.
Creditors and others have always been able to pursue trust assets through the courts, says Partridge. In the past, however, they usually went for the debtor's personal assets. Now that assets can be given to a trust in one go, other existing laws are likely to be used more often. "Because there won't be personal property for creditors to claim against they will increasingly have to claim against trust property."
One common reason people gift money to family trusts is to avoid paying eye-wateringly expensive residential care fees.
If they have less than $115,000 of assets other than the family home and car in their name, they can receive a residential care subsidy. Some people will be disappointed to find out that the new gifting rules don't make any difference to this subsidy.
The Ministry of Social Development has separate rules about gifting, which relate to the subsidy and other means-tested benefits.
A gifting limit of $6000 a year applies for each of the five years before applying for a residential care subsidy, says Age Concern's honorary solicitor, Jock Nicolson. "Gifts in excess of $6000 in each of the five years preceding entry into care are clawed back in assessing eligibility for free residential care."
According to the Ministry of Social Development, the permitted asset level will be progressively increased by $10,000 each year until July 1, 2025, when it will reach a limit of $350,000 for a single person or a person who also has a partner in care, and the choice of either $350,000 or $255,000 plus their home and one car for a person with a partner not in care.
That's not all. Partridge adds: "Although the $27,000 threshold for gift duty no longer applies, that threshold remains for residential care subsidy purposes and there is no specified time limit." That will no doubt be a disappointment to many readers.
Gifting property to a trust may also lead to depreciation on assets being clawed back. A common example is a property investor who has claimed depreciation on an investment property. The disposal of that property to a trust could lead to a clawback of that depreciation by the Inland Revenue Department (IRD). The IRD can also get its talons into gifts motivated by tax avoidance.
Partridge said there are instances where people have good reason not to forgive the remaining debt to their trusts. One is where you are a settlor but not a beneficiary of a trust that is benefiting from your gift.
Another, points out Phil Morgan Rees, personal client services general manager at Guardian Trust, is where you earn an income from the trust's debt to you.
By leaving loans to trusts ungifted it also leaves open the ability for a trust to repay that debt in cash once the lender has finished working and needs cashflow, says Pam Newlove, national director of privately held business at Grant Thornton New Zealand. Loan repayments from the trust will generally be tax-free.
"Lenders need to weigh up this benefit against the risk of such a loan being attacked by creditors, of course, if the lender is bankrupt," says Newlove.
Another reason to leave a debt owing by a trust to an individual is that by forgiving that debt it might become relationship property, she adds.
As well as considering the Property (Relationships) Act and Social Security Act, anyone gifting money needs to be able to prove to the IRD that it is in fact a gift. The "financial arrangement rules" also mean that gifts to entities that are not natural persons are not tax-free. People can fall foul of this rule by giving money and assets to a business, says Partridge.
Morgan Rees has a helpful way of approaching the question of gifting. Just because people can gift, doesn't mean they should, he says. "The motivation for making a gift needs to be there in the first place.
"Gift duty is only one aspect to be considered. [The rule change] just means you don't have to file a return to the IRD and you won't be taxed. What hasn't been changed is more important."
The documentation involved in gifting hasn't changed, says Morgan Rees. Gifts have to be documented and appropriate forms filed to the IRD.
Dotting your i's and crossing your t's is very important. For example, a business owner needs to be able to demonstrate that they were in a position to pay their debts when the gift was made, which means they need good documentation and solvency statements.
"It is about taking the right advice before you act," he adds. "The initial position should set out why you want to make a gift. The last thing anyone wants is for a gift to fail or be ineffective."
Newlove adds that both a client's accountant and lawyer should be involved in the decision-making process. A gift made for legal reasons may have tax implications, and vice versa.