The rates they are a-changing…

By Viola Trnski & Robyn Walker

Are you a trustee, settlor, or beneficiary of a trust? If so, you are probably aware that the trustee tax rate is proposed to increase to align it with the top personal tax rate of 39%. 

When the top personal tax rate was increased to 39%, Inland Revenue raised concerns that trusts may be used as a vehicle to avoid paying tax if the rates were misaligned. Essentially, this would involve people diverting their income to a trust to be taxed at the 33% trustee tax rate instead of the 39% personal tax rate.

Is this really happening?

The tax rate change is not yet law, it is still in Bill form and is with the Finance and Expenditure Committee (FEC) as part of the Taxation (Annual Rates for 2023/24, Multinational, Tax and Remedial Matters) Bill (the Bill). The FEC is expected to report back the Bill this month, with the legislation enacted by the end of the month (as the Bill contains the “annual rates” of tax, which must be enacted by 31 March). 

The Bill was introduced by the previous Labour Government as part of Budget 2023, and accordingly, the expected revenue from the change has already been incorporated within the Government finances. As such it is not entirely clear what the position of the new Government is on this law change as the National Party election policies made no allowance for not progressing this change. 

When the Bill went through its first reading in May 2023, the National and ACT parties both voted against the Bill. Speaking as a Member of Parliament rather than as the Minister of Revenue, Hon Simon Watts said in respect of the Bill: “So trustee tax rate—the issue with this: the unintended consequences of this change have not been thought through. What consultation has been taken in regards to increasing the trustee tax rate? Any idea? No? Not much—not much. But that's not out of sync. The elements around the lack of consultation will mean that these proposals around the increasing of the trustee tax rate are going to cause unintended consequences, and that is going to have a significant implication.”

Submissions to the FEC have consistently raised examples of unintended consequences and examples of unfairness from the proposed rule change. So, what can we expect?

In response to questioning, Finance Minister, Hon Nicola Willis, stated that the Government is working on “carve-outs” and a “de minimis rule” to address concerns. While the Minister has not confirmed what this might look like, they could be adopting the Chartered Accountants Australia and New Zealand (CAANZ)’s suggested “two -tier” rate (discussed below).  

Given the timeframes on the Bill, we expect to see details of any carveouts sometime in March.

Questions around “fairness”

While the tax system is always grappling with what is “fair”, in this case, one disparity is potentially leading to another. As drafted, the legislation taxes all trustee income at 39% for almost all trusts, whether that income is $1, $100,000, or $1 million. On the other hand, personal income is taxed progressively, with only dollars earned above $180,000 taxed at the 39% rate. Only 11% of trusts earn income over $180,000, meaning 89% of trusts will potentially be overtaxed if the rules are applied as proposed.

Submitters highlighted this at the FEC hearing on the current tax bill. CAANZ proposed a two-tier rate to mitigate the impact of taxation overreach:

1. For trusts with income (before allocations) of $100,000 or less, the 33% rate applies; and
2. For trusts with income exceeding $100,000, the 39% rate applies.

What do I need to consider now?

If you have a trust – or are having thoughts about whether a trust is right for you – then it is important to consider different purposes that a trust can serve from a broader point of view, rather than focusing only on the tax implications. Despite the tax rate increase, trusts are still the most appropriate choice in many circumstances. Trusts serve a range of functions, from setting aside assets for future generations, creditor protection, protecting assets from relationship property issues, and charitable giving. 

Inland Revenue has recently updated its general guidance on taxing trusts, as well as an publishing an article outlining behaviours that will raise an alarm in response to the increase in the trustee tax rate. 

The article notes that Inland Revenue will be “gathering and analysing information” (certainly assisted by the new reporting disclosure requirements) to assess whether trust-related activities indicate tax avoidance. This includes where income is not actually distributed to the beneficiary (in other words, whether the beneficiary themselves, in reality, benefits from the distribution) or otherwise contrived or artificial arrangements that result in a tax advantage being obtained. 

In light of the upcoming change, it’s important to ensure distributions are genuine, structuring is for a good commercial reason, and that decisions are documented.

Our April 2024 edition of Tax Alert will provide a summary of any changes made to the Bill, including any changes to the proposed 39% trustee tax rate.

If you are thinking about making changes to your trust, or have any questions in light of this article please get in touch with your usual Deloitte advisor.