TRUSTS AND BENEFICIARY CURRENT ACCOUNTS
November 24, 2021
A new world has emerged for Trusts and Trustees alike with the plethora of legislation recently enacted. Both the Trusts Act 2019 and the Tax Administration Act 1994 have dictated Trustees become familiar with statutory duties and compliance obligations. One particular matter likely to require Trustees attention is that pertaining to beneficiary current accounts. This article explores the topic, and the associated issues Trustees should give consideration to.
In New Zealand it’s been fairly common practice for Trustees to resolve to make income distributions to beneficiaries. Those Trustee approved distributions however are more often than not, never paid out to the recipient beneficiary. Alternatively, the amount of the distribution paid to the recipient beneficiary is less than that which was approved. Both of these scenarios result in the full distribution or the balance of the distribution, being recorded as a balance outstanding and owing to the recipient beneficiary. Ultimately, this practice creates a credit in the beneficiary’s current account. Correspondingly, a liability is recorded in the financial statement prepared for the Trust as owing by the Trustees to the recipient beneficiary.
An amendment to the Income Tax Act 2007 has been made which states the Inland Revenue Department will deem beneficiaries who have current accounts of $25,000 or more to be settlors of a Trust where interest has not been paid at the prescribed rate (or higher) on the balance owed to the beneficiary.
Three issues arise as a consequence of the legislative enactment and the practice of Trustees resolving but not paying the said distributions to their recipient beneficiaries.
The first is Trustees have never had to disclose to a party they are in fact a beneficiary of the Trust under their control. Nor for that matter, have Trustees ever had to disclose to a beneficiary they are owed the amount of funds recorded in their beneficiary current account. With the additional obligations of disclosure the Trusts Act 2019 now imposes upon Trustees however, disclosure of being a beneficiary is required. So to may be the quantum of funds owed to a beneficiary. This could result in the beneficiary demanding payment of the funds recorded as owing to them.
The second issue associated with beneficiary current accounts relates to the perspective the Inland Revenue Department may adopt. The Commissioner could question whether there has actually been a proper distribution of income to the beneficiary if the beneficiary current account has existed for many years. This could have adverse tax consequences with respect to tax efficient distributions made. It’s likely this issue will be brought to the attention of the Commissioner when information is provided to the Inland Revenue Department as is now required under the recent amendments made to the Tax Administration Act 1994. For further detail in this respect refer to the article ‘New Tax Law For New Zealand Trusts’ which you can find by clicking on the link here.
Finally, and possibly the most far reaching of the issues this matter raises, is that relating to a beneficiary being deemed a settlor of a trust. Where a person qualifies as a settlor of a trust through their beneficiary current account, unwelcomed tax implications may arise. For example, an increase in the number of settlors of the Trust may adversely affect the tax classification of the Trust (complying trust, foreign trust, non-complying trust), see the foreign trust regime applied, and attract land tax provisions (denial of main home exemptions, imposition of bright line tax on the subsequent sale of the property and application of tainting rules) that otherwise would not apply. These are just a few examples where negative tax consequences may be triggered.
WHAT YOU SHOULD DO NOW
Trustees should recognise the tax and trust landscape has changed significantly. As such, they need to take advice where appropriate to ensure they are satisfying their duties and the Trust under their control meets all legislative provisions.
In particular, all transactions and balances should be supported by adequate and complete documentation. This means Trustee Resolutions evidencing the transactions that have occurred and Acknowledgments of Debt and Loan Agreements with prescribed rates of interest (or higher) are put in place in respect of liabilities owed. Documentation is especially important given the new powers of scrutiny the Commissioner has as discussed in the previously article.
Aside from ensuring appropriate documentation exists, the question surrounding the charging and paying of interest on beneficiary current accounts should be considered by Trustees as it could be tax inefficient. This may lead to Trustees taking steps to reduce current account balances below the legislative threshold, possibly by paying funds owed to the beneficiary in question or making a distribution of assets to the beneficiary.
Trustees would be well advised to discuss documentation needs with their Greenlion Advisor. In this respect, Greenlion has been busy lately writing to those Trust clients where it holds the position of independent trustee advising the documentation required to give credence to the transactions noted in the financial statements it prepares for its Trust clients.
For clients who do not have an independent trustee or those who simply wish to discuss their Trust’s affairs, contact the Trustee Services division at Greenlion. It can conduct a review of your Trust and provide you with recommendations to ensure you satisfy your Trustee duties and your Trust remains compliant.