By Roger Thompson, HWI Specialist at Bentleys Chartered Accountants Ltd

05 June 2020

If carefully managed, New Zealand resident beneficiaries can receive tax free distributions of corpus and capital gains from offshore trusts without the trustee or beneficiary being exposed to tax on income retained in the Trust. Only distributions of income, current or accumulated, and related party gains will be subject to New Zealand tax. However, where the Trust owes money to the beneficiary, new rules applying from 1 April 2020 could result in the trustee or New Zealand beneficiary being taxed on the total trust income including that accumulated by the trustee.

The tax status of trusts in New Zealand and tax treatment of distributions to beneficiaries is primarily determined by:

• the residence of the settlor at the time a settlement is made on the Trust

• the residence of the settlor at the time foreign income is received

• the residence of the beneficiary at the time of a distribution

• the deemed source of the distribution

If the settlor is New Zealand resident at the time of the settlement the Trust will be subject to New Zealand tax on its global income and will be either a complying trust (if tax obligations are met) or a non-complying trust (if tax obligations are not met). A settlor of a non-complying trust with a non-resident trustee is personally liable for the Trust’s tax liability in most cases.

If the settlor is non-resident at the time of the settlement the Trust will be a foreign trust. This means that the trustee only pays New Zealand tax on New Zealand sourced income and only certain distributions to New Zealand resident beneficiaries will be subject to New Zealand tax. Foreign income not distributed to New Zealand resident beneficiaries is not taxed in New Zealand and it is also possible for certain capital distributions to New Zealand resident beneficiaries to be free of New Zealand tax.

In circumstances where wealthy overseas families immigrate to New Zealand it can be effective to establish a foreign trust before immigrating to New Zealand. This can allow foreign income to accumulate free of New Zealand tax with only certain distributions to New Zealand resident beneficiaries taxed in New Zealand. By applying the transitional resident exemption, a New Zealand resident beneficiary may be exempt from New Zealand tax on all distributions for 4 years after immigrating to New Zealand.

Even if the settlor subsequently becomes New Zealand resident the Trust can retain foreign trust status for up to 5 years and then become either a complying or non-complying trust. A non-complying trust can still accumulate foreign income free of New Zealand tax with New Zealand resident beneficiaries only taxed on certain distributions

However, it is very important to ensure that there is no settlement on the Trust by a New Zealand resident. If there is a settlement by a New Zealand resident this can expose both the Trustee and the settlor to New Zealand tax on the foreign income of the Trust.

The definition of a settlor is very wide and includes anyone who transfers value to the Trust, provides services to the Trust for less than market value or provides financial assistance to the Trust with an obligation to pay on demand, and the right to demand is not exercised or is deferred.

Thus, interest free and/or on demand loans to a Trust can be regarded as a settlement. A normal loan or advance to a Trust will generally be regarded as a settlement unless a market rate of interest is paid. For this reason it is preferred that settlors gift rather than lend monies to a trust before becoming New Zealand resident.

However, it is possible for inadvertent loans from beneficiaries to arise. In some cases, income or capital may be allocated to beneficiaries and recorded in a trustee resolution without the full amount being physically paid to the beneficiary at the time. This is quite common in New Zealand with the beneficiary regarded as having a current account with the Trust. Distributions might be credited to the beneficiary’s current account and cash payments to the beneficiary debited to the current account. At any point in time the beneficiary may have a debit or credit balance in the current account.

For some years, the Commissioner of Inland Revenue has had a position that the existence of such credit current account balances are not settlements on the Trust. The Commissioner has recently reviewed this position and determined that the existing position is not correct. From 1 April 2020 the Commissioner will apply a new position that amounts owing to beneficiaries will be settlements. Legislation has been introduced effective from 1 April 2020 to state that the monies owed to beneficiaries by a trust will not be regarded as settlements if either a prescribed rate of interest is paid to the beneficiary (such interest being subject to New Zealand tax) or the balance of the amount owing is not more than NZD25,000.

This means that as from 1 April 2020, loans, advances and current account balances owing to New Zealand resident beneficiaries exceeding NZD25,000 will be treated as settlements if the prescribed rate of interest is not paid to the beneficiary.

In such a case this will mean that the Trust will be regarded as having a settlor who is New Zealand resident at the time of the settlement. The effect of this is that the Trust will be subject to New Zealand income tax on its global income and if the trustee does not satisfy the New Zealand tax liability, the New Zealand resident beneficiary will become personally liable to pay it.

Trustees of offshore trusts with New Zealand resident beneficiaries owed more than NZD25,000 should act as quickly as possible to ensure that the Trust does not inadvertently become exposed to New Zealand income tax on global income.

Disclaimer:The above is general commentary only and should not be relied upon as tax advice in any specific circumstances.

Roger Thompson
Email: roger.thompson@bentleysnz.com
Phone: +64 9 600 3902

Stay in touch. Please do not hesitate to contact your client advisor.