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Trust disclosure rules a step closer to reality

Tax Alert - April 2022

As readers may be aware, in December 2020, the Government enacted new disclosure requirements for domestic trusts which apply for the 2021-22 and later income years. This is so the Government can gain insight on the effectiveness of the top personal tax rate of 39% as well as enable it to better understand and monitor the use of structures and entities by trustees. An “integrity risk” arises because current income retained in a trust is taxed at 33% with no further income tax imposed if this income is subsequently distributed to a beneficiary who might be on the highest marginal rate of 39%. Under these new disclosure rules, Inland Revenue will have complete visibility over how trusts are being used to fund annual capital distributions from income taxed at the lower trust tax rate. The government will use the information collected to decide on whether the trustee tax rate should also be increased to 39%. The cynics among us suspect this decision has already been made and that collecting this information is to justify this tax policy change heading into the next election.

For most trusts, there is now a legislative requirement to prepare financial statements for tax purposes to a minimum standard (which overlays the Trusts Act 2019 requirement to keep core accounting records). Plus it is necessary to disclose a lot of detailed information about settlements, settlors, and distributions to Inland Revenue as part of filing the annual trust tax return. Sounds simple in theory, but there is no doubt these measures will increase compliance costs for most trusts. We note in the regulatory impact statement, Officials admit they “have limited understanding of the compliance costs that trusts will face with the increased disclosure requirements and how large the costs will be”.Some legislative amendments and an Order in Council have been only just been finalised, following a period of public consultation which commenced in October last year.

As a result of this consultation, there has been some improvement on the minimum financial statement proposals, but in our view, this does not meaningfully reduce the amount of information that all trusts need to disclose when filing the tax return. At the time of writing, we are still waiting for Inland Revenue to release its final operational guidance on how to apply the rules.

First, it is important to note that not all trusts are caught by these rules. Trustees should first check if they qualify to be excluded from these rules, as this will save considerably angst. The largest category that will be exempt are non-active trusts who have filed an IR 633 declaration. Typically trusts holding the family home, with no income and expenditure will be considered non-active.

Reasonable trustee fees, administration fees and interest income earned of not more than $200 each are disregarded, as is expenditure incidental to the occupation of a dwelling owned by the trust and incurred by the beneficiaries. All trustees should immediately review whether their trust is non-active and file the IR 633 declaration if not already done. The other trusts that are carved out from these rules include foreign trusts, charitable trusts, trusts that choose to be a Maori Authority, trusts that are widely held superannuation funds and lines trusts.

On 7 March 2021, an Order in Council (OIC) was made setting minimum standards for trust financial statements for income years ending on or after 31 March 2022. This is so the Government can collect consistent and better-quality information across all trusts for its monitoring purposes. Inland Revenue comments that not all of the estimated 180,000 complying trusts that have been reporting assessable income were necessarily preparing financial statements, noting that only 110,000 trusts are submitting an IR10 (the summary of financial statements).

As a core requirement, all trusts (including “simplified reporting trusts”) must prepare financial statements consisting of a statement of financial position and a statement of profit and loss. These financial statements:

  • must be prepared using double-entry accounting;
  • must disclose which of the prescribed valuation methods (historical cost, tax value or market value) have been used in valuing assets and liabilities, but also disclose the specific valuation method used for shares, ownership interests, land, and buildings;
  • show dividends and interest received either net or gross of resident withholding tax; and
  • show dividends either grossed up or net of imputation credits.

Further, information from the financial statements will need to be copied to the relevant IR prescribed forms (e.g. IR 10 the financial statements summary, the IR 6 form income tax return for estate or trust; and IR 6B Estate for trust beneficiary details) as part of the tax return disclosure rules and conversely, there is a requirement that these amounts must also be “shown” in the financial statements.

Trusts with assessable income of less than $100,000, deductible expenditure of less than $100,000 and total assets at the accounting period of less than $5 million are considered to be “simplified reporting trusts” and at a minimum must comply with the core requirements noted above. Trusts that do not meet one or more of these thresholds have the following additional requirements. The financial statements for these types of trusts must also:

  • follow principles of accrual accounting;
  • show comparative figures;
  • include a statement of accounting policies and assumptions and a description of any material changes therein;
  • include a reconciliation between net profit and trustees taxable income;
  • include an appropriately detailed, taxation-based schedule of fixed assets and depreciable property;
  • include certain other prescribed information if the trust derives income from forestry or has specified livestock; and
  • provide details of transactions entered into between the trustee and any associated person, excepting minor transactions that are incidental, those at market value and those transactions which are already separately disclosed in the tax return disclosure.

Having legally been required to prepare financial statements to this standard, there is no requirement that these be provided to Inland Revenue, instead, they are held by the trustee as part of the accounting records. Although information from the financial statements will need to be copied (or automatically populated by software) to the prescribed disclosure forms (for example the IR 6, the IR 6B and IR 10).

The next task for trustees is to file various disclosures of all settlements, settlors, distributions and those with the power of appointment via the IR 6 and IR6B forms, which we understand have been redesigned to collect all the new information now required. Accountants will be asking for a lot more information from their trustee clients this year.

We had hoped to provide our readers with more details on this aspect as the original exposure draft issued for consultation was fundamentally flawed and impractical in several respects. But alas, the final version of this had not appeared in time for our publishing deadline.

We do know at least that as a result of submissions, a small legislative amendment has been passed to introduce a minor and incidental test regarding the type of distributions that will need to be disclosed (similar to the rule for settlements). For example, take the case of a holiday home owned by a trust which beneficiaries can use freely without paying rent. This is technically a non-cash distribution, but because it is not a taxable distribution, until now no information about this needed to be provided to Inland Revenue. But under the new rules, trustees would need to collect and disclose information concerning these types of distributions. Imagine the paperwork where multiple generations of a family trust use a holiday home! Theoretically, the legislative change should mean that “minor and incidental use” of a holiday home need not be disclosed. We remain hopeful that the operating statement will elaborate and provide clear guidance on what is “minor and incidental” in various contexts as it could mean different things for different scenarios.

We will update this article once the operating statement is released, so please check back to our web page. Otherwise please contact your usual tax advisor for more information on these rules and trustee obligations for the 2021/2022 tax return.

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