For New Zealand income tax purposes the income of a Trust is separated into two parts – beneficiary income and trustee income. Trusts can also make other types of distributions of money or assets to beneficiaries in any of the following ways:
- Distributions of capital, from trustee income accumulated in previous years
- Distributions of capital profits or gains made from disposing of some of the Trust’s assets or property
- Supplying Trust property or services to a beneficiary for less than full value
- Acquiring property or services from a beneficiary for more than full value
- Distributions from the Trust’s corpus (an amount equal to the market value at the date of settlement of any property settled on the Trust)
Different tax rules apply depending on whether the Trust is classified by the New Zealand Inland Revenue as a complying (formerly qualifying), foreign or non-complying (formerly non-qualifying) Trust.
If the trustees wish to allocate Trust income as beneficiary income, trustees have until 31 March of the financial year following receipt of the Trust income to do so, where the Trust is listed with the Inland Revenue Department through a tax agent and where the Trust Deed permits the trustees to do so.
Most Trust Deeds provide that income not allocated prior to 30 September in any year is added to Trust capital. This was in line with the law until 1 April 2009. If this is in your Trust Deed, to take advantage of the rules and allocate income after 30 September the Trust Deed will need to be varied to allow for this.
If you do not wish to vary your Trust Deed you will need to ensure your accountant is notified and trustees minutes allocating income as beneficiary income are completed no later than 30 September each year.
In general, regardless of the type of Trust, all beneficiary income is taxed at the beneficiary’s marginal tax rate and all trustee income is taxed at 33% (there are some exceptions, including distributions to beneficiaries who are minors).
A Trust will fall within one of three different tax classifications:
- Complying Trust;
- Non-Complying Trust; or
- Foreign Trust.
The determination of whether a Trust is complying, foreign or non-complying under New Zealand tax law is primarily based on the residency of the Trust’s settlor or settlors.
In general, a Complying Trust is a Trust settled by a New Zealand resident or residents where all of the trustees’ New Zealand income tax obligations have been satisfied. A Complying Trust may also have been a Foreign Trust which has elected to become Complying on the settlor becoming a New Zealand resident.
A distribution of the types listed in (1) – (5) above from a Complying Trust will not attract income tax. This is the principal advantage of a Complying Trust.
A Non-Complying Trust is any Trust that is not a Complying Trust or a Foreign Trust at the time it makes a distribution.
If a Complying Trust’s trustee income tax has not been paid, that Trust will become Non-Complying. A Complying Trust may also become Non-Complying if the New Zealand resident settlor moves overseas and then makes further settlements to the Trust from overseas.
A Non-Complying Trust is often a Trust that has been settled by a non-New Zealand resident, where that settlor has later become a New Zealand resident and not elected to make the Trust complying.
A Trust will also be Non-Complying if non-New Zealand resident trustees derive trustee income from interest or dividends in New Zealand.
A Non-Complying Trust making a distribution of the types listed at (1) – (4) above will be taxed at 45%. Ordering rules apply to deem that capital gains and Trust corpus are distributed only after all other distributions. In many cases tax is also being paid overseas on accumulated income and capital gains, giving rise to double taxation.
A Foreign Trust is a Trust which has an association with New Zealand but at all times has had no New Zealand resident settlor from the date the Trust is first settled until the distribution in question. A Foreign Trust can have an association with New Zealand in a number of ways: through a trustee or trustees being New Zealand resident, by the Trust having New Zealand sourced income, or the Trust having a New Zealand resident beneficiary or beneficiaries.
A distribution by a Foreign Trust of one of the types listed at (1), (3) or (4) above will be classified as a taxable distribution and will be taxed to a New Zealand resident beneficiary at their marginal tax rate. A non-New Zealand resident beneficiary receiving a taxable distribution from a Foreign Trust will only be liable for income tax on income sourced in New Zealand.
If a beneficiary ceases to be a New Zealand resident then becomes a New Zealand resident again within 5 years, they must pay New Zealand income tax on any beneficiary income or taxable distribution received from a Foreign or Non-Complying Trust while they were a non resident.
To avoid the undesirable tax consequences of being classified as a Non-Complying Trust, when a settlor moves to New Zealand the trustees can elect to make a Foreign Trust a Complying Trust. All income of the Trust will then become taxable in New Zealand from the date the trustees make the election.
The election must be made to Inland Revenue within 12 months of the settlor becoming a New Zealand tax resident, unless the settlor elects to become a transitional resident.
Under Section YD1 of the Income Tax Act 2007, there are two key tests to determine whether a person is a New Zealand tax resident:
- Where a person is present in New Zealand for a period exceeding 183 days in any period of 12 months, that person shall be deemed to be tax resident in New Zealand from the first day within that 12 month period.
- A person will also be deemed resident in New Zealand if he or she has a “permanent place of abode” in New Zealand, even if they have a permanent place of abode elsewhere.
Inland Revenue considers a number of factors to determine whether a person has a permanent place of abode in New Zealand, including the continuity and duration of their presence in New Zealand, family and social ties, and employment and business interests in New Zealand.
If an election is made, we suggest the trustees review any overseas investments of the Trust to assess the tax implications for those investments.
If no election is made and no further settlements are made after the settlor becomes a New Zealand tax resident, the Trust is treated as a Foreign Trust for 12 months. After 12 months, the Trust will become a Non-Complying Trust.
A settlor may qualify for transitional resident status. A transitional resident can receive a tax exemption covering most types of foreign income for a further four years after migration. The 12 month period in which trustees of a Foreign Trust have to elect to become a Complying Trust will then start from the end of the four year transitional period.
A settlor of a Foreign Trust moving to New Zealand will qualify for transitional resident status if he or she becomes a New Zealand tax resident and has not been so at any time during the previous 10 years.
For further information, please contact Tony Fortune or Katherine McCarthy or Lauren Mcivor