New Zealand has around 400,000 registered trusts, and those with ties to trusts will no doubt be left pondering the impacts of the Government's recently announced tax rate changes as part of the 2023 Budget. It was announced the trustee tax rate is increasing from 33% to 39%. You might be wondering, are trusts still relevant and what is the benefit of them? In this article, we summarise what these trustee tax changes mean for you, and your trust.
More about the change
The trustee tax rate is applied to income retained by the trust, not distributed to the beneficiaries. Previously this rate had been set at 33%, but from 1 April 2024 the rate will be bumped up to 39%.
All this means is that the trustees will need to allocate more of the trust's income towards taxes, resulting in less disposable income within the trust itself, and therefore perhaps impacting the tax-efficient nature of trusts as they stand currently.
The motivation behind adjusting the trustee tax rate, is to align the top personal tax rate with the trustee tax rate – a result of the current misalignment is that a portion of trustees who would be paying the top personal tax rate, could circumvent the need to pay more tax through the use of trusts.
Data from Inland Revenue from the 2021/22 tax year, showed that there was almost a 50% spike in income subject to the trustee rate, between the 2020 tax year, and the 2021 tax year. At the time, the government indicated that if trusts were increasingly used to reduce paying tax, they would look to take some steps to action it – and it appears this budget is them putting their money where their mouth is.
The impact of this increase will predominantly affect those who have income retained within their trusts, particularly high-income individuals and families. The rise in tax rate means reduced net income in the trust, potentially altering the dynamics of how the trust is used, or how income or assets are distributed within the trust itself.
The analysis from the government suggests that only a small proportion of trusts will pay most of the additional tax. The top five percent of trusts with some taxable income accounted for 78 percent of all trustee income in the 2021 tax year. Despite that, it’ll be of little comfort to the majority of trusts held by ‘regular Kiwis’ who have a marginal tax rate of 33% or lower.
The budget press release does state:
“[t]rusts with lower-rate beneficiaries can continue to use existing rules to mitigate over-taxation”
However, what this does mean is that a trust will need to distribute its annual income to beneficiaries in order to access a lower tax rate, and this itself may be met with reluctance, as this approach requires regular distributions which may be inconsistent with trust deeds.
Are there still benefits of having a trust?
Despite the trustee tax changes, it's important to remember the numerous advantages trusts bring to the table. These financial instruments serve as excellent means of wealth protection and estate planning. Trusts can protect assets from business risks, keep property within the family, and provide for minors or family members with special needs. They also offer a level of control over how and when beneficiaries receive their inheritance.
Trusts do still provide significant flexibility with respect to tax planning. As we mentioned above, whilst it might require you to pay distributions to beneficiaries more frequently and require a change to the trust deed, Kiwis can still use the trust to be taxed at their personal marginal tax rate, which for a large portion of trustees will be lower than the new trustee tax rate of 39%.
Whilst it may appear inconvenient, the change is perhaps a good time to revisit your financial plans, and how the trust is being used strategically as part of that. The fundamental advantages of trusts remain, particularly in asset protection and estate planning. We’ve tried to outline some of the key things that are worth considering with these changes, however, we recommend talking to your trust or tax professional to get advice on how these changes will affect your personal situation.
When will the change happen?
Even though the change has been tabled in the 2023 budget with an effective date of 1 April 2024, it is still subject to consultation through the Select Committee process, and that has been welcomed by most to ensure that all the nuances, unexpected consequences and issues of the trust tax change can be addressed appropriately.