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I expect many NEWMARKET. readers will have trusts, which are a popular vehicle for protecting assets in New Zealand, so any changes to the trust tax rate will be of interest.
One of the Labour government’s last acts was introducing legislation to increase the trust tax rate to 39% from 1 April 2024. This was predictable, given it was surprising it was not increased to 39% to match the top personal tax rate when that was applied to income above $180,000 from 1 April 2021.
On the one hand, aligning the trust tax rate with the highest personal tax rate makes sense for those exposed to the top tax rate. It removes the obvious incentive for diverting income that might otherwise be taxed personally into trusts. On the other hand, it is a relatively blunt instrument because the highest personal marginal tax rate only applies to income above $180,000. If all trusts are taxed at 39%, regardless of the level of income of the trust and its beneficiaries, there will be over-taxation.
CAANZ (previously the Institute of Chartered Accountants), has been vociferous in its opposition to the implementation of a blanket 39% tax rate for trusts. The vast majority of trusts earn less than $180,000, and furthermore, the minority of trusts that earn more than this collectively account for 81% of the total income earned by all trusts. Why punish the lower earning family trusts?
While some may argue that trusts with lower income could avoid being impacted by the increase to 39% through allocating income to beneficiaries on lower tax rates, that argument is premised on all trusts having the ability to allocate income to beneficiaries and that it is appropriate and desirable to do so. There may well be valid reasons for trustees not wanting to distribute income to beneficiaries.
It seems sensible to carve out the large number of smaller trusts that would be unfairly negatively impacted by these rules, while still making sure that the appropriate amount of tax is paid by higher earners.
It now appears that the government have been listening. Finance Minister Nicola Willis has indicated that the legislation as drafted by Labour will be amended to include exceptions to the 39% tax rate. At the moment we do not have the shape of these exceptions, but it seems likely that there will be a two-tier tax system for trusts. There will be an income threshold, e.g. $10,000, with trusts earning below this continuing to be taxed at 33%. Doubtless there will be avoidance measures instituted to prevent taxpayers from splitting income across multiple trusts to sit below the threshold.
This is a positive development. The problem is that at time of writing (28/2/2024), a 1 April 2024 deadline to declare dividends into trusts at 33% is fast approaching. But trustees still do not know what rules are going to apply next tax year, and therefore whether they should declare dividends with a two-tier rate. There should have been more thought put into the development of this policy, and it should never have been drafted with an intention to apply from 1 April 2024. Unfortunately, this phenomenon of taxpayers effectively operating in an environment where tax rules are unknown is not unique to the trust tax rate changes. The government’s intended changes to the interest limitation and bright-line rules are other examples of public announcements of rule changes, including an indication that the new rules apply in the current year, without sufficient detail to allow planning by tax professionals.
In summary, it’s pleasing that the government is listening to considered feedback and acknowledging that there will be overreach in implementing a blanket 39% trust tax rate. However, there needs to be more clarity, and quickly, as to what these changes will be.
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