IRD guidance on the trustee tax looks a bit like tax avoidance - experts

Tax experts warn trustees could risk being done for tax avoidance if they follow Inland Revenue guidance on minimising their tax bills.

The call for caution comes as the tax department published a fact sheet explaining the ins and outs of the Government’s plan to increase the trustee tax rate from 33 to 39 per cent so it aligns with the top income tax rate for income over $180,000.

Inland Revenue said people could “mitigate over-taxation” by allocating trust income to beneficiaries on personal income tax rates below 39 per cent.

It provided the following example of a couple with a trust.

“Anthony has personal income of $70,000 and Amy has personal income of $180,000. Their trust has income of $40,000. If the income is retained as trustee income, it will be taxed at the proposed 39% trustee tax rate...

“However, allocating the income to Anthony as beneficiary income, it can be taxed at his personal tax rate. This amount can be credited to Anthony’s current account, available to be called upon at any time, or he can settle it on the trust if he wishes to do so.”

Nonetheless, Deloitte partner Robyn Walker and Baucher Consulting’s Terry Baucher feared these transactions could fail Inland Revenue’s tax avoidance sniff test.

“Despite Inland Revenue examples, we caution against trustees taking any actions which are circular in nature, or which are not genuine distributions in order to benefit from a lower tax rate, as there is a risk this could be viewed as tax avoidance if the transactions are lacking substance,” Walker said.

Baucher recognised this was a grey area, and there wasn’t always a clear line separating tax avoidance and tax minimisation.

He suggested Inland Revenue might raise its eyebrows if a pattern of income distribution from a trust suddenly changed.

He noted trusts are a vehicle that people use to protect their assets. If large sums are suddenly distributed from a trust, Inland Revenue might question what’s going on.

Tax expert Terry Baucher, founder of Baucher Consulting. NZH 30Oct19 - NZH 30Oct19 -

Baucher explained that transferring income to beneficiaries on low income to avoid paying the trustee tax rate was an existing issue. However, the incentive would be greater for more people once the trustee tax rate goes up to 39 per cent from April 1, 2024.

He recommended his clients focused on what their overriding objective of having a trust was, suggesting they “don’t let the tax tail wag the dog”.

A spokesperson for Inland Revenue was aware questions had been raised over whether the examples in the fact sheet reflected the department’s commissioner’s interpretation of the law.

The spokesperson said the fact sheet was written to facilitate discussion around the Government’s proposal to hike the trustee tax rate and wasn’t meant to be an interpretation of the current law.

He noted that once the Bill, which changes the rate, is enacted, Inland Revenue will publish guidance on the new law.

In the meantime, the fact sheet is intended to help the public make submissions on the Bill, which has been referred to the Finance and Expenditure Committee.

The Government wants to lift the trustee tax rate to prevent people from using trusts to avoid paying the top personal income tax rate, introduced in 2020.

At the time, Inland Revenue and Treasury raised their concerns around the rate being above the trustee tax rate, but the Government decided to wait and see whether this prompted a change in behaviour before aligning the two rates.

Inland Revenue, in the Regulatory Impact Statement it prepared for the proposed trustee tax hike, recognised that mitigating over-taxation by transferring income to a beneficiary could result in additional compliance costs.

However, taking a step back, it concluded that under-taxation caused by the top income tax rate and trustee tax rate being misaligned was a bigger problem than over-taxation.

“Most trustee income [78 per cent, or $13.3 billion out of $17.1b, for the 2021 financial year] is concentrated in a relatively small number of trusts [5 per cent, or 14,000 out of 177,000 trusts],” it said.

“That is, under-taxation is a larger problem than over-taxation in terms of total income.”