The Pandora Papers show that New Zealand foreign trusts were popular vehicles for the globally mobile, used by foreign billionaires, politicians and others to shelter assets.
But what exactly are they and how do they work?
What is a New Zealand foreign trust?
Broadly, trusts are legal entities that allow people to protect assets. A foreign trust is one that is based in New Zealand and managed by professionals in New Zealand, but for the benefit of people overseas who don't have income and assets in this country.
How do they work?
There are three key parties:
• The "settlor" is the person who sets it up. For a foreign trust to be valid under New Zealand law, they must live overseas.
• The "trustees" are the professional advisers who manage the trust. For tax benefits to take effect, they must be based in New Zealand.
• And the "beneficiaries" are the people who ultimately benefit from the assets held in the trust. They will also be overseas.
The settlor puts assets into the trust, giving up legal control of them. This provides a layer of legal protection, for example against claims by creditors in bankruptcy or divorce proceedings, and can reduce tax liabilities.
Trustees will then manage the assets on behalf of the beneficiaries and pay out distributions as required.
How are they taxed?
As long as the settlor and beneficiaries live overseas and the trust doesn't derive income from sources in New Zealand, or make payments to people living here, the trust is exempt from New Zealand taxes.
Why is this attractive to wealthy overseas residents?
Under New Zealand's foreign trust regime, established in 1988, taxation is determined by the location of the settlor. Most other countries determine this based on the residence of the trustees.
This means that if the settlor is overseas, Inland Revenue doesn't have a claim on the income or assets introduced into the trust from outside New Zealand. This was advantageous if the settlor's home country taxed trusts based on the residence of trustees, since tax authorities there also wouldn't have a claim over assets they placed here.
But it wasn't just the tax advantages that compelled offshore providers to market New Zealand foreign trusts to their international clients. New Zealand's stable legal system and reputation for transparency and fairness meant that putting money here wouldn't carry the stigma or attention of using better-known tax havens.
And there were minimal disclosure requirements. Until 2006, the trusts were almost entirely secret. Authorities weren't even notified that they existed. After that, some disclosures were required, but trustees still didn't have to tell the tax department how much money the trusts held, what their assets were, or the identities of the people who set them up and benefited from them.
Why did this become controversial?
In 2006, Australia complained that some of its citizens were using New Zealand foreign trusts to avoid paying taxes there. As a result, the New Zealand government required trustees to tell them the name of the trust and the trustees and whether Australian residents were settlors or beneficiaries.
Clients from the rest of the world, however, could remain hidden. Demand soared and by 2016, more than 13,000 New Zealand foreign trusts had been established. But then came the Panama Papers. The massive leak of millions of secret financial records revealed that New Zealand structures had been exploited, prompting calls for reform.
What did the government do then?
Soon after the Panama Papers broke in 2016, Sir John Key's National-led government ordered an independent inquiry which found that oversight of New Zealand's foreign trusts had been inadequate. New disclosure requirements were brought in, under which trust operators must provide regular reports to Inland Revenue identifying settlors and beneficiaries and providing some financial information.
Because of these changes, many overseas users closed their New Zealand-registered trusts and moved their money elsewhere. There are now fewer than 3,000 registered with Inland Revenue.
However, rules allowing "jurisdictional arbitrage" to create tax-free trusts are still in place, despite promises by ministers to address the loophole.