Included in this year’s budget announcements was a change to the tax rate for trusts, moving from 33% to 39% from 1 April 2024. For the many New Zealanders who have a family trust this may likely cause some concern.
This move follows the introduction of significant disclosure requirements, which trustees will recently have grappled with while filing their 2021/22 tax returns. The Budget Press Release suggests that the change in tax rate follows a detailed analysis indicating that high income earners were circumnavigating the increase in income tax rate through a greater use of trusts – there was an almost 50% increase in income subject to the trustee tax rate when comparing 2020 with 2021.
The Budget Press Release also suggests that the change in tax rate won’t materially impact most of New Zealand’s 400,000 trusts. According to the IRD the top 5% of trusts accounted for 78% of all trustee income in the 2021 tax year. There are also some exemptions from the increased tax rate for deceased estates and trusts that support disabled people.
The fact that the majority of trusts will not be paying the majority of the tax will be of little comfort to the significant number of trusts held by ‘regular New Zealanders’ with a marginal tax rate of 33% or lower.
Some considerations to navigate the new tax rate
Declare dividends
The change in tax rate will likely bring about consideration of declaring dividends from companies. Current dividend policies may be still be appropriate, but consideration could be taken to declare dividends where large dividends are likely in the next few years, or where the company has significant retained earnings.
Allocate income to beneficiaries
While not the driving factor for trust structures, it has been common practice to direct trust income to beneficiaries, taking advantage of their lower marginal tax rates. Now that the trust rate is increasing to 39%, this expands the opportunity to distribute funds to beneficiaries up to $180,000.
There are also times allocation may not be possible. Take the Government’s most recent tax change regarding interest. For a trust to make an allocation it must have something to allocate. When it comes to a rental property this may not exist after paying interest to the bank yet as that interest is non-deductible the trust will still have tax to pay at 39% on the net income. Another hit to landlords who are already suffering from decreased cashflow.
The future of trusts
Trusts are not just for tax planning and they remain a relevant structure for many situations. While the 6% tax rate differential was beneficial, other benefits, such as asset protection, risk mitigation and wealth preservation very much remain.
Having said that, given the increase compliance and disclosure requirements and the tax rate hike it might be time to consider why you have a trust structure in place. If you are thinking about winding up the trust, or are unsure how best to handle the new tax rate, at McClean and Co we are happy to help, please get in contact.
