Accountants fear lifting the tax rate on trustee income to 39 per cent could see scores of people over-taxed.
They suggest trustees that don’t earn much income should be taxed at the current rate of 33 per cent.
Legislation is going through Parliament to lift the trustee tax rate to 39 per cent from April to ensure it aligns with the top personal income tax rate for incomes over $180,000.
The Government worries people could be using trusts to avoid the 39 per cent personal income tax rate introduced in 2021.
However, Chartered Accountants Australia New Zealand (Caanz) noted most trusts earn little income, so taxing them all at 39 per cent would “clearly” be “inappropriate”.
Inland Revenue data shows 68 per cent of trusts earned income of less than $180,000 in 2021.
The median income in this group was only $5000.
Caanz New Zealand tax lead John Cuthbertson noted that if an individual earned that level of income, they’d be taxed at a much lower rate of 10.5 per cent.
“To have them paying at not just the old 33 per cent rate, but the new 39 per cent rate, is simply taxation over-reach,” he said.
Inland Revenue looked at the situation through a different lens in its regulatory impact statement on the proposed change.
Rather than focus on the extent to which the income earned by different trustees varies, it looked at how much income trustees make altogether.
Based on the fact this number is very large ($17.1 billion across 177,000 trusts in 2021), it concluded under-taxation with the rate at 33 per cent was a bigger problem than over-taxation would be if the rate went up to 39 per cent.
“Most trustee income (78 per cent) is concentrated in a relatively small number of trusts (5 per cent),” Inland Revenue said.
“That is, under-taxation is a larger problem than over-taxation in terms of total income.
“This does not mean that all this income is under-taxed, as it does not take into account the number of settlors or beneficiaries (or their personal tax rates), but it is an indication that there is a significant amount of under-taxation.”
The data shows that while only 8 per cent of trusts earned more than $180,000 in 2021, the median income in this cohort was a whopping $430,000.
Coming back to the accountants, Caanz said it needed more information to figure out the level below which trustee income should be taxed at 33 per cent.
It suggested $100,000, but Cuthbertson said until Inland Revenue released the data it’s been collecting under a new trust disclosure regime, it was best-placed to establish an appropriate threshold.
He suggested the Government defer plans to lift the trustee rate.
“We really need to see that data, which has been painstakingly provided, to make informed decisions,” he said.
Cuthbertson said an “aggregation rule” could be used to prevent people setting up multiple trusts to try to avoid paying the 39 per cent rate.
However, given the time, resources and administration costs associated with setting up trusts, he doubted this would be a big problem.
Furthermore, splitting up large trusts would be obvious and trigger follow-up action from Inland Revenue, he said.
Inland Revenue recognised, in a fact sheet it published online, people may be concerned hiking the trustee tax rate could cause over-taxation.
However, it said this could be “mitigated” if income earned by a trust was distributed to settlors or beneficiaries, as they would only have to pay tax at their marginal personal rate.
Most people earn less than $180,000 a year, so have a marginal tax rate of 33 per cent or less.
Nonetheless, accountants warn a trustee could be accused of tax avoidance if they distributed income to a lower-income beneficiary who was told they couldn’t touch the money or had to put it back in the trust.
Indeed, Inland Revenue updated its fact sheet in June after accountants said an example it used to explain how these distributions could be made to avoid over-taxation could actually be unlawful.
Cuthbertson said the assumption over-taxation could be solved by allocating income to beneficiaries was “flawed” more generally.
“This runs counter to the reasons why most people establish trusts,” he said.
“The majority of trusts are established for reasons including asset protection, estate planning, intergenerational wealth preservation and transfer, or providing for those who cannot provide for themselves.”
Furthermore, he said it wasn’t always possible or appropriate to distribute income to beneficiaries, including within timeframes.
Cuthbertson concluded, “If we don’t right-size this tax change, we’re going to negatively affect a large number of trusts and related communities.”
The Taxation (Annual Rates for 2023-24, Multi-national Tax and Remedial Matters) Bill, which makes the change, is due to have its second reading in Parliament.
Jenée Tibshraeny is the Herald’s Wellington Business Editor, based in the Parliamentary press gallery. She specialises in Government and Reserve Bank policymaking, economics and banking.