While there are some pockets of exceptional wealth sitting in trusts highlighted by recent Inland Revenue investigations and Government press releases, there are many more situations where other people and families will be exposed to the 39% rate for the first time, and where that wouldn’t have been the case if not for a trust structure in the mix. For example, we frequently see situations where trusts have been established to protect vulnerable children. Acknowledging there may be some limited exemptions, generally speaking, these trusts will now be subject to the 39% rate. A fairer approach could have been adding a marginal or stepped rate similar to the personal marginal tax rates.
How to navigate the new tax rate
Winding up the trust
Given the increased compliance and disclosure requirements recently imposed on trusts, and now the tax rate hike added to the pile, many will be accelerating plans to wind-up their trust. Consider why you have a trust structure in place and whether those factors remain relevant today, compared to when the trust was established. If they do, it’s likely there remains benefit in keeping the trust.
And don’t forget Brightline tax considerations if your trust owns residential rental property or other residential property held, other than the main home. A wind-up could trigger a Brightline tax event.
Declare dividends for shares in privately held companies
If your trust holds shares in privately held companies, consider declaring dividends to clear retained earnings prior to 1 April 2024 noting that:
- for all distributions, the company solvency test needs to be documented and satisfied
- for dividends, there remains the cash cost of the dividend resident withholding tax of 5% (usually) which is a real cash cost, due the 20th of the following month to the Inland Revenue
- dividends don’t have to be paid in cash and can be credited to shareholder advance accounts if desired. This would create an opportunity for funds to be drawn over time
- bank financial covenants should be considered where applicable.
Take advantage of the Portfolio Investment Entity (PIE) rules
The maximum tax rate for PIEs is, and always has been, 28%. If your trust has funds in term deposits or investments in publicly traded companies, consider shifting these into a PIE fund.
This has always been an option available to trusts, but with the tax rate differential soon to be 11%, it becomes a far more significant opportunity than it once was.
Scope for more allocation of income to beneficiaries
While not the driving factor for trust structures, it has been well documented and common practice to direct trust income to beneficiaries, taking advantage of their lower marginal tax rates.
With the trust rate at 33%, this was generally limited to taking beneficiaries total income (from all sources, including income from trusts) to $70,000, after which point, the effective tax rate benefit disappears.
Now that the trust rate is increasing to 39%, this expands the opportunity to distribute funds to beneficiaries up to $180,000, noting the current individual marginal rate of tax between $70,000 and $180,000 is 33% ... for now.
Trusts remain a relevant structure for many situations. While the potential 6% tax rate differential was beneficial, other benefits such as asset protection, risk mitigation, and wealth preservation very much remain.
Disclaimer: This article does not constitute tax or investment advice. Incorrectly undertaking restructuring activities can be considered by Inland Revenue to be tax avoidance and needs to be considered in a wider context. These comments are general in nature and your specific situation should always be discussed with your advisor.