Newsletter July 2017
1. TAXATION OF DISTRIBUTIONS FROM TRUSTS
Often we are asked to advise on distributions from Trusts. The taxation of distributions depends on the classification of a Trust and the residency of the beneficiary in receipt of a distribution. For tax purposes Trusts are classified into three categories:
· Complying Trusts – trusts where none of the income, derived by the trustee is non-resident passive income, non-resident’s foreign sourced income, or income that is exempt under CW54 and where the trustees have always satisfied their tax obligations. The requirements applies over the life of the Trust.;
· Foreign Trusts – trusts that have not had a NZ resident settlor anytime since 17 Dec 1987;
· Non-complying Trusts – trusts that are neither complying or foreign.
The distributions to beneficiaries of a Trust, other than beneficiary income distributions, will fall into one of the following categories:
· Exempt income – where the distribution is made by a complying trust
· Taxable Distribution – where the distribution consists of income or related party capital gains distributed by a foreign trust, or consist of income or capital gains distributed by a non-complying trust, or
· Non-Taxable Distribution – where the distribution consists of capital gains (other than related party gains) of a foreign trust, or corpus of a foreign or non-complying trust.
NZ has a settlor based regime for the taxation of Trusts. The term Settlor is broadly defined as “a person who transfers value to the trust”. It should be noted that a person who provides financial assistance to a Trust with an obligation to pay on demand and the right to demand is not exercised or is deferred (i.e. typical interest free loan repayable on demand), will be considered a settlor. Another example of a settlor would be a person (individual or a corporate) who guarantee’s a loan advanced by a bank to the Trust for no consideration. The concept of a Settlor is very important as it determines the taxation of Trusts. It should be noted that nominee settlors are disregarded for tax purposes. The change in the tax residency of the Settlor can have an impact on the taxation of trustee income & distributions.
The Trustee is liable for the tax obligations of the Trust in most situations, including as an agent for the Beneficiary’s tax obligations.
In case of multiple Trustees, the legislation treats joint trustees as a single notional person with each being jointly and severally liable for the tax obligations. This liability ceases when the Trustee resigns and notifies the Commissioner. In the absence of such a notification the Commissioner will continue to hold the Trustee liable.
Whilst trusts are taxed in NZ by reference to the residence of the Settlor, the residence of Trustees becomes important in a number of situations for example when deciding whether a trustee derives resident or non-resident passive income. As Trustees are treated as a single notional person, it is enough to have only one NZ resident Trustee for the rest of the Trustees (even if resident offshore) to be treated as a single notional person resident in NZ
A. BENEFICIARY INCOME
Income can be taxed either as Trustee Income at a 33% tax rate or as a Beneficiary Income at the marginal tax rate of a Beneficiary, unless a distribution is made to a NZ resident minor beneficiary in which case the applicable tax rate will be 33%. Whilst beneficiary income is taxed only once, a taxable distribution of an amount that is not Beneficiary income may be taxed twice, once to the Trustee and secondly to the Beneficiary. Generally the obligation to satisfy the income tax liability rests with the trustee as the agent for the Beneficiary. For income to be Beneficiary income it must be paid or absolutely vest in the Beneficiary within a prescribed period.
Distributions to Minor Beneficiaries
Minor Beneficiary income is excluded income for the Minor Beneficiary and the Trustee is liable to pay tax for the minor beneficiary (natural person resident in NZ under the age of 16) at the end of the income year of derivation. If all of these three criteria are not met then the minor beneficiary rule will not apply. There are some exemptions from the minor beneficiary rule, the most common being the de-minimis threshold of $ 1,000.
B . TRUSTEE INCOME
NZ sourced income derived by the Trustee of a Trust is generally assessable income. Trust rules however contain specific provisions that deal with foreign sourced amounts derived by the Trustee. The general proposition is that foreign sourced amounts will be assessable as Trustee income if the settlor is a NZ resident.
Foreign sourced amounts – non-resident trustees
Where a Trust has non-resident trustees, foreign sourced amounts will not be assessable as Trustee Income unless the Settlor is a NZ resident (other a transitional resident). In case where there is more than one Settlor the foreign sourced amount will be assessable if one of the Settlors is a NZ resident during the income year. It is enough for the settlor to be resident in NZ at any time in the year.
Foreign sourced amounts – resident trustees
Resident Trustee will not be taxable in NZ on foreign sourced amounts if no Settlor is NZ resident at any time in the year (other than a transitional resident), and the Trust is a registered Foreign Trust that has complied with its registration & disclosure obligations under s 59B of TAA.
C. DISTRIBUTIONS FROM COMPLYING, FOREIGN & NON-COMPLYING TRUSTS
A distribution from a complying trust that is not beneficiary income is an exempt income for the beneficiary.
Certain distributions from foreign and non-complying trusts may be classified as “Taxable Distributions” and taxed to the beneficiary. Income derived by a trustee of a foreign or a non-complying trust may not have been liable to NZ income tax at the level of Trustee and consequently accumulated income will be taxable when distributed to NZ
resident beneficiaries.
A Trustee makes a distribution to a beneficiary when the trustee transfers value to a person because the person is a beneficiary. An example of a distribution is when the trustee permits beneficiaries to reside in a property owned by a trust without paying market rental. For a complying trust such distribution will be exempt income for the beneficiary. However such a distribution by foreign or non-complying trust may be treated as a “taxable distribution” and taxed accordingly. What constitutes a “taxable distribution” varies between Foreign and Non-Complying Trusts.
Foreign Trusts – Taxable Distribution
A distribution made by a Trustee of a Foreign Trust to a NZ resident Beneficiary is a Taxable Distribution if it is a distribution of:
- Accumulated Trustee Income;
- Related party capital gains.
A taxable distribution received by a NZ resident beneficiary is subject to NZ income tax at the marginal tax rate of a Beneficiary. Distributions of a Third Party Capital gain and Corpus do not form part of Taxable Distributions and therefore will not be subject to tax in NZ if distributed to a NZ resident Beneficiary.
Taxable Distribution from Foreign Trust to a non-resident beneficiary is taxable to the extent that income has a NZ source with consequential double taxation. Accordingly NZ Foreign Trusts should avoid accumulating NZ sourced income and keep in mind that a foreign currency bank account with a NZ bank will give rise to NZ sourced income/ loss. There are ordering rules to determine the character of the distribution with the first slice of any distribution being seen to be sourced from income followed by accumulated income, related party capital gain, capital gain and corpus.
Non-complying Trusts
A distribution made by a Trustee of a Non-Complying Trust to a NZ resident beneficiary is a Taxable Distribution if it is a distribution of the following:
- Accumulated Trustee Income;
- Any Capital gains
A taxable distribution received by a NZ resident Beneficiary is subject to NZ income tax at 45%. Distributions of Corpus do not form part of Taxable Distribution and therefore will not be subject to tax in NZ if distributed to a NZ resident Beneficiary.
Taxable Distribution from Foreign Trust to a non-resident beneficiary is taxable to the extent that income has a NZ source with consequential double taxation. Accordingly NZ Foreign Trusts should avoid accumulating NZ sourced income and keep in mind that a foreign currency bank account with a NZ bank will give rise to NZ sourced income/loss. There are ordering rules to determine the character of the distribution with the first slice of any distribution being seen to be sourced from income followed by accumulated income, related party capital gain, capital gain and corpus.
Non-complying Trusts
A distribution made by a Trustee of a Non-Complying Trust to a NZ resident beneficiary is a Taxable Distribution if it is a distribution of the following:
- Accumulated Trustee Income;
- Any Capital gains
A taxable distribution received by a NZ resident Beneficiary is subject to NZ income tax at 45%. Distributions of Corpus do not form part of Taxable Distribution and therefore will not be subject to tax in NZ if distributed to a NZ resident Beneficiary.
Ordering rules
When it comes to distributions from foreign or non-complying trusts one must be mindful of the ordering rules. The purpose of the ordering rules is to prevent manipulation of distributions so as to achieve either non-taxation of a distribution, streaming of distributions or a deferral of taxation that could arise as a result of distributing non-taxable amounts before taxable amounts. Ordering rules prescribe the order and classification of distributions.
D. MIGRANTS MOVING TO NEW ZEALAND
Migrants moving to NZ or NZ citizens returning to live in NZ may need to consider their NZ income tax implications if they are a settlor, trustee or a beneficiary of a foreign or a non-complying trust.
When a non-resident settles a Trust before assuming residence in NZ, such trust will be a Foreign Trust regardless of the residence of the trustees or the beneficiaries. The Trust can retain its foreign Trust status for up to one year after the settlor, who is not a transitional resident, becomes resident in NZ. To prevent the Trust from becoming a non-complying Trust at the end of this period, the Settlor (who is a natural person) may elect for the Trust to become a complying Trust. If the election is not made within the time frame specified, the Trust will become a non-complying trust in relation to distribution of amounts derived by the Trustee after the expiry of the election period, even if the Trustee has paid tax on trustee income.
Distributions to Transitional Residents
Where a transitional resident receives beneficiary income from a foreign or non-complying trust, the income retains its underlying character. If income has a foreign source, then it will be exempt for the transitional resident beneficiary.
Where a trustee of a Foreign Trust derives NZ sourced income or capital gain, such distributions to a transitional resident will be subject to ordering rules and will be taxable where the distribution comprises accumulated trustee income and related party capital gain amounts that have a NZ source.
If a person ceases to be a NZ tax resident and resumes his NZ tax residency within 5 years, such person will be taxable in NZ on all distributions received from a foreign or non-complying trust during the period of absence.
E. NZ RESIDENTS LEAVING NEW ZEALAND
Where New Zealanders who are either Trustees, Settlors or Beneficiaries of NZ Trusts leave New Zealand, they can create a whole host of issues for themselves in their new country of residence and for the remaining NZ trustees.
Most foreign countries tax trusts by reference to the residence of trustee (e.g. Australia). More often than not it is enough for one Trustee to be resident in Australia, which will bring the NZ Trust into the Australian tax net. Whilst income from NZ trust could be distributed to a Beneficiary, this may not be so with capital gains, which could give rise to an unintended exposure to capital gains tax (CGT) in Australia.
Furthermore migration of Settlors, Trustees, Beneficiaries needs to be considered for the purposes of Residential Land Withholding Tax and Offshore Persons.
Summary
Taxation of trusts and distributions can be complex and is largely dependent on the facts of each case. If you are in doubt please speak to us.
2. FIF – AUSTRALIAN LISTED SHARES EXEMPTION
Effective 01 April 2017 the exemption from FIF rules for Australian listed shares will be simplified. Prior to the amendment of s EX31 the exemption broadly applied to shares in certain Australian –resident companies that were listed on an approved index under ASX Operating Rules, which created uncertainty as companies move on or off the approved index from time to time. To simplify the uncertainty s EX31 was amended to apply to shares in Australian resident companies that are listed on ASX irrespective of whether they are also listed on ASX approved index. The ASX exemption is intended to apply to the majority of listed Australian shares provided however that they meet the remaining criteria in s EX 31 namely that the company must be Australian tax resident maintaining franking account.
3. EMPLOYEE SHARE SCHEMES – START UP COMPANIES
In May 2017 the Government released an official’s issue paper proposing a deferral mechanism for taxation of employee share schemes (ESS) for startup companies. The aim of measures introduced in Taxation (Annual Rates for 2017-18, Investment and Employment Income, and Remedial Matters) Bill (The Bill) is to ensure that the taxation of ESS benefits is consistent with the taxation of cash remuneration, i.e. that the employees will be taxable on shares received in connection with ESS, once the employee becomes the economic owner. This is when all conditions relating to ownership are satisfied, referred to as Share Scheme Taxing Date.
The Government recognises that start-up companies face liquidity problems and that remuneration through ESS plays an important role in the retention of employees.
The issue with start-up companies is that it may be difficult for employees to sell shares which are not readily traded to cover the resulting income tax liability. Furthermore if there is no earnings history or realizable assets the valuation of such shares can be somewhat difficult. The Commissioner’s Statement CS 17/01 provides guidelines on determining the value of shares. Whilst various valuation methods are discussed it is not prescriptive. An independent third party valuation is preferred.
The proposed deferral regime for startup companies enables the company to elect to defer the recognition of ESS income until there is a “Liquidity Event”, when shares are more easily able to be valued, to fund the tax on income. The taxing point will be triggered if any of the following occur (i.e. IPO, sale of company’s assets followed by distribution to shareholders, cancellation of shares, ceasing to be a NZ tax resident). The employee would be taxed on the value of shares at this point less any amount paid for shares by the employee. The employer will be allowed a corresponding deduction at this point. Both Employee income and the employer deduction would be deferred. Any increase in value after an IPO has taken place would generally be tax free. If the employee sells his shares within 6 months after initial IPO, it is suggested that the sale price and not the listing price, or some weighted average of the two, be used to determine the employees tax liability. It is also proposed that recognition of income cannot be deferred by more than 7 years.
Whilst deferring the taxing point appears to be a good idea, the longer the taxing point is deferred the greater the resulting income tax liability, assuming that company’s shares increase in value with time. The issues paper also raises a question of how a “Startup Company” should be defined. The current thinking is that the annual turnover of a NZ startup company should not exceed $ 10 Mil.
In the case where a startup company applies for an R&D Loss cash out the cost of ESS will be included in R&D cash out calculation only once it becomes deductible for the company.
4. HOLIDAY HOMES & GST
Taxpayers who own holiday homes which are rented out should be aware that such rental will not constitute the supply of accommodation in a dwelling for GST purposes and accordingly will be subject to GST when the owner is a registered person or deemed to be registered person.
Therefore it is crucial that such properties are not held by persons who carry on taxable activities, such as commercial letting as the value of combined supplies could breach the $ 60,000 GST registration threshold.
This can have disastrous consequences as the entire sale proceeds of the holiday home becomes subject to GST with the input tax credit being limited to the tax fraction of the original purchase price. The GST registered person will only ever get the personal use percentage of that input tax credit on ultimate disposal of the property and of course the government collects 3/23rds of the overall gain. This is a highly undesirable situation for most.
Taxpayers with valuable holiday homes could easily breach the $ 60,000 GST registration threshold especially when the holiday homes are owned in a Family Trust as supplies for less than a market value to associated persons (e.g. family members of the Settlor) are deemed to take place at market value for GST purposes.
Given that only the supply of accommodation in a dwelling occupied by a person as their principal place of residence is an exempt supply, arguably occupancy of a holiday home by beneficiaries of the Trust creates taxable supplies.
FINAL REMARKS
Should you have any questions on the content of this newsletter, please do not hesitate to contact us. We will gladly provide clarification or assistance as the case may be.
