New Zealand’s foreign trust rules – legitimate tax avoidance?
There has recently been a significant level of media attention regarding New Zealand’s foreign trust taxation rules. Some commentators have called the regime a tax avoidance tool. Minister of Revenue, Peter Dunne recently called the regime “legitimate tax avoidance”.
We thought this an opportune time to clarify how these rules apply and the potential commercial reasons that could cause a non-resident to utilise these rules.
A person who establishes a trust is referred to as a “settlor”. Where that person transfers value to the trust (e.g. cash or property) this is deemed to be a “settlement”. Because most settlements are bestowed upon trusts voluntarily and without compensation, they are considered to be gifts. New Zealand recently abolished the gift duty regime, and as such a settlement on a trust will not be subject to tax or duty.
A trust will require at least one “trustee” who is responsible for supervising and managing the trust. Often a company is used to act as the trustee; this is called a corporate trustee. Many New Zealand lawyers and accountants use a corporate trustee to act for client trusts.
The New Zealand tax obligations of a trust will depend on how the trust is classified under New Zealand law. The New Zealand trust regime is a "settlor" based regime. This means that the New Zealand tax treatment of the trust depends on where the settlor of the trust is resident when the trust derives income or when a distribution is made.
The New Zealand tax regime defines three types of trusts a complying trust, a foreign trust or a non-complying trust. A foreign trust is defined as a trust of which no settlor has been a resident of New Zealand in the period from the later of:
- 17 December 1987; or
- the date the trust was first settled
until the date of the distribution.
The foreign trust rules
As discussed above, the New Zealand taxation of trusts is broadly based on the tax residency status of the settlor not on the tax residency of the trustees. This approach is contrary to many countries that tax based on the residence of the trustees.
To the extent that a foreign trust derives foreign sourced income that income will be exempt from New Zealand income tax. For example, Mrs Smith lives in the US and has never been tax resident in New Zealand. Mrs Smith decides to settle a New Zealand trust. She uses a New Zealand lawyer to prepare the trust documentation and act as the trustee of the trust. Mrs Smith is able to gift her overseas assets such as US shares and US bonds to the trust without raising any adverse New Zealand tax consequences. The trust then owns these assets. The trust may derive US income on the shares and bonds, however this foreign income will not be taxable in New Zealand.
It is the operation of these rules that led to the labelling of the New Zealand foreign trust rules as “tax avoidance” and considering New Zealand a “tax haven”. A point that few commentators have raised is the fact that the foreigner may in fact still be liable for tax in his or her country when the assets are passed to the trust or when income is distributed from the trust to him or her personally.
Furthermore, on 31 October 2012 the Minister of Revenue Peter Dunne announced that New Zealand has signed the Convention on Mutual Administration Assistance in Tax Matters. This will allow the Inland Revenue to assist international requests for tracking tax evasion and collection of debt from taxpayers. These obligations are in addition to those existing under the 38 double tax agreements New Zealand has with other countries.
The policy intent
Mr Dunne has made it clear that the policy intent of these trust rules is not to provide a tax haven or shelter for wealthy foreigners. The rules avoid inadvertently imposing extra-territorial taxes that New Zealand does not have an economic claim to. In fact, the regime was designed to stop New Zealand tax residents escaping New Zealand tax by hiding assets in an overseas trust, hence taxing trusts according to the residence of the settlor, rather than the trustee, was seen as the solution.
Reasons for using the foreign trust regime
The avoidance of tax may be incidental to a valid reason for a foreigner wishing to settle a trust in New Zealand. Several examples may include:
- Investment documentation will show the owner of that investment is a New Zealand trustee. A New Zealand trustee is likely to be seen by many overseas jurisdictions as a trustworthy, well-respected and legitimate vehicle for holding investments.
- New Zealand has a reliable legal system;
- Holding assets in a New Zealand foreign trust provides asset protection without creating any adverse New Zealand tax implications;
- The benefit of discretion – information concerning the trust is not publicly disclosed.
- The investor may have issues with unrest, instability or corruption in his or her domestic country;
- The investor is setting up a geographical hub for investments;
- The cost of using the regime is relatively low when compared with other investment holding structures;
- The foreign trust regime can be used to prevent the complications of double taxation.
Does this regime impact on New Zealand’s international relations?
There is a risk that the foreign trust rules may negatively impact on New Zealand’s international relations. The Australian Tax Office has specifically released a warning to Australian taxpayers against using New Zealand’s foreign trust rules.
Full Disclosure required
Notwithstanding the fact no tax may be assessable in New Zealand, foreign trusts with resident trustees are required to file special disclosures to enable the Inland Revenue to keep track of their existence. They are also required to keep sufficient records in New Zealand to enable assessable income, if any, to be determined. This requirement was brought in following the warning by the Australian Tax Office referred to above and specifically requires Australian resident settlors to be identified. This information is available under the exchange of information provisions of double tax agreements New Zealand has with other jurisdictions.
The non-residents setting up New Zealand foreign trusts are utilising tax law quite legitimately. Foreign taxpayers may be doing this for a variety of reasons including taxation. In terms of global taxation of the individual, depending on the country of residence, the foreigner may still be subject to tax on the income.
Tax Alert November 2012 Contents:
- Tax Alert - November 2012
- The binding rulings process – the price of certainty
- Penny & Hooper - extended timeframe for voluntary disclosure concession
- Update on salary trade-off reforms
- Inland Revenue’s approach to time of supply has far reaching implications for GST registered persons
- The most significant case in Australia about the definition of “Supply”
- NZ to negotiate intergovernmental agreement on FATCA
- Upcoming Dbrief on Australian transfer pricing reform
- Bill passes its third reading