IRD trustee tax guidance may look like avoidance: expert

WELLINGTON: Tax experts warn trustees could run foul of Inland Revenue tax avoidance if they follow IRD guidance on minimising their tax bills.

The call for caution comes as the tax department published a fact sheet explaining the ins and outs of the Government’s plan to increase the trustee tax rate from 33% to 39% so it aligns with the top income tax rate for income over $180,000.

Inland Revenue said people could ‘‘mitigate overtaxation’’ by allocating trust income to beneficiaries on personal income tax rates below 39%.

It provided the following example of a couple with a trust.

‘‘Anthony has personal income of $70,000 and Amy has personal income of $180,000. Their trust has income of $40,000. If the income is retained as trustee income, it will be taxed at the proposed 39% trustee tax rate . . .

‘‘However, allocating the income to Anthony as beneficiary income, it can be taxed at his personal tax rate. This amount can be credited to Anthony’s current account, available to be called upon at any time, or he can settle it on the trust if he wishes to do so.’’

Nonetheless, Deloitte partner Robyn Walker and Baucher Consulting managing director Terry Baucher feared these transactions could fail Inland Revenue’s tax avoidance sniff test.

‘‘Despite Inland Revenue examples, we caution against trustees taking any actions which are circular in nature, or which are not genuine distributions in order to benefit from a lower tax rate, as there is a risk this could be viewed as tax avoidance if the transactions are lacking substance,’’ Ms Walker said.

Mr Baucher recognised this was a grey area, and there was not always a clear line separating tax avoidance and tax minimisation.

He suggested Inland Revenue might ask questions if a pattern of income distribution from a trust suddenly changed.

He noted trusts were vehicles that people used to protect their assets. If large sums were suddenly distributed from a trust, Inland Revenue might question what’s going on.

Mr Baucher explained that transferring income to beneficiaries on low income to avoid paying the trustee tax rate was an existing issue. However, the incentive would be greater for more people once the trustee tax rate went to 39% from April 1, 2024.

He recommended his clients focus on what their overriding objective of having a trust was, suggesting they ‘‘don’t let the tax tail wag the dog’’.

A spokesman for Inland Revenue was aware questions had been raised over whether the examples in the fact sheet reflected the department’s commissioner’s interpretation of the law.

The spokesman said the fact sheet was written to facilitate discussion about the Government’s proposal to raise the trustee tax rate and was not meant to be an interpretation of the current law.

He noted that once the Bill which changes the rate was enacted, Inland Revenue would publish guidance on the new law.

In the meantime, the fact sheet was intended to help the public make submissions on the Bill, which has been referred to the finance and expenditure committee.

The Government wants to lift the trustee tax rate to prevent people using trusts to avoid paying the top personal income tax rate, introduced in 2020.

Inland Revenue concluded undertaxation caused by the top income tax rate and trustee tax rate being misaligned was a bigger issue than overtaxation.

‘‘Most trustee income [78%, or $13.3 billion out of $17.1 billion, for the 2021 financial year] is concentrated in a relatively small number of trusts [5%, or 14,000 out of 177,000 trusts],’’ it said.

‘‘That is, undertaxation is a larger problem than overtaxation in terms of total income.’’ —