Having appeared to fall out of fashion with the demise of some tax benefits in the past decade, there has been debate about the place and value of trusts in managing and protecting one’s assets and wealth.
Far from disappearing, however, trusts continue to be utilised for a wide variety of reasons.
According to the Law Commission’s review of trusts law delivered in 2013, trusts form an important part of New Zealand’s economic and social life.
“Trusts provide an effective way to separate the ownership of property from those who are to benefit from that ownership, and enable assets to be held collectively rather than individually.”
The Commission estimated in its report that the number of trusts operating in New Zealand is between 300,000 and 500,000.
They are used by families to hold their wealth collectively, by charities, for those in business who seek a flexible governance structure, by financiers for complex transactions and by Maori groups managing Maori land or Treaty of Waitangi settlements.
And while some tax benefits were removed with the equalisation of tax a decade ago, there are still some benefits that can be accessed when structuring a trust.
So who should be using a trust?
Much of the motivation for using trusts, currently, is around protecting assets. Therefore anyone starting a business should consider using a trust. Similarly, a trust would be useful for anyone who has an asset they wish to protect (for example, property, shares, or a family business).
One of the benefits which comes as an extension of asset protection is that the trust doesn’t die when you die. Trustees will continue to manage the trust and its assets, on the basis of the trust deed, even after your death. This is why people often refer to trusts as “a living will”. Therefore the trust is advantageous if you want your assets to continue to operate in a certain way after your death. For example if there is a rental property in the trust, the trust is not required to liquidate this after the settlor’s death which would be advantageous if the property market was flat or in decline.
Trusts also have benefits in terms of means testing in some circumstances. If you are in a trust, you are positioning yourself to respond to means testing as it may apply to you in various circumstances in the future.
An additional benefit is that setting up a trust forces you to sit down and think with another person about what it is you want to do with your assets. Anyone contemplating a trust should carefully consider its purpose and how it will operate. If the trust is managing a property, for example, items such as tenancy or occupancy arrangements need to be crystal clear.
While some of the focus around tax has been reduced, trusts still remain an effective vehicle for a family or business to manage overall taxation.
The top personal tax rate at 33% is in line with the trustee rate, however the tax rate on individual income up to $14,000 is just 10.5% and the rate on the next $34,000 just 17.5%. As a result, a trust remains an effective vehicle for accessing the low tax rates available to family members aged 16 years or older. So annual tax savings of $8,424 are possible for each beneficiary income allocation of $48,000.
Similarly, the company tax rate at 28% is below the trustee rate, with the prospect that it may move lower in coming years as corporate tax rates in Australasia move lower in response to tax competition. Low company tax rates provide tax planning opportunities for trusts, firstly by way of their use as beneficiaries of trust income, and secondly as vehicles that are established by the trust to hold income producing assets that might otherwise be held by the trust directly. Both approaches will reduce the effective tax rate to 28% from the trustee rate of 33%.
However, anyone contemplating structuring their finances through trusts should do so for reasons other than simply the pursuit of tax benefits and get professional advice.
Many trusts include charitable objectives. Charities are generally not subject to taxation on their income. Consideration should be given to the tax advantages available through the making of charitable distributions annually. If the income is retained at the trust level tax will be paid at 33%, which is firstly a charge against the trust assets, but also has the effect of reducing the trust capital available to benefit the selected charities. Depending on the financial position of the trust and the wishes of the settlors, distributions of income annually may be appropriate.
For those trusts that are established exclusively for charitable purposes, setting up and registering as a special purpose charitable trust could be appropriate. Charitable trusts can provide both income tax exemption and allow control of assets to be maintained for the life of the settlor, albeit that ultimately all distributions must be to further the charitable objects.
However, trusts do not suit every situation and despite the plethora of offers and resources on the internet, neither are they a DIY project. So it is necessary to work with professional advisers to tailor a trust and the assets you are planning to put into the trust to your specific set of circumstances and objectives.
There is a reasonable cost to set up and run a trust properly. And they must be run properly to be compliant and offer appropriate protection as any trust that is not operated properly runs the risk of being dismantled by the courts.
Trusts must also operate according to the trust deed and the regulatory requirements on an annual basis and that includes arranging trustee meetings; managing gifting (see break-out box); preparing annual accounts and being registered and up to date for tax; as well as on-going advice, as needed, on the working of the trust.
Typically, trusts are struck down (or busted) in situations where a claimant can demonstrate that the trust is not acting as a trust. There are celebrated cases that have been tested in court and while there are plans to update trust legislation (see break-out box), it is important to ensure that your trust is managed appropriately.
In general terms, it is better to have the trust in place as a means of protection and the trustees to be looking over the interests of the trust, than not.
What you need to know about trusts
Some people don’t wish to put their assets into a trust because they don't wish to lose control. There is also potential inconvenience that comes with having an agreement (and signatures) from trustees when the trust wishes to transact business or marke a decision.
Increasingly, there is also the burden of liability that comes with trusts.
All trustees are required to act in the best interests of the trust and share unlimited liability. In the past it was commonplace to have your accountant or lawyer or both as trustees of your family trust. But increasingly, professional advisers are electing not to become trustees as they can become liable for debts, penalties or claims made against the trust.
So finding trustees can be a real challenge. Corporate trustees are one option; another is to seek people you know who understand the requirements of being a trustee.
Similarly, those operating family trusts need to think about the future and providing succession planning, which might include having the beneficiaries (usually your children) become trustees at some point.
A recent Court of Appeal case in a long-running matrimonial property dispute found that as a result of the application of certain trust mechanisms, notably the powers of appointment, those trusts and the assets in them could be considered relationship property. The potential impact of this decision, if the claim is upheld by the High Court, is a further step in hindering one spouse holding back assets in the event of a relationship breakdown.
The Trustee Act specifies the duties of a trustee and it is important that trustees understand these. (See Trustee obligations below).
Are trusts dead? Far from it. They are alive and working well.
But they require careful administration and management to ensure they deliver the protection that they are intended to provide.
WHAT IS REQUIRED OF A TRUST?
At a high level every trust must:
▶ Have a proper Deed of Trust
▶ Register and file with the IRD
▶ Have a separate bank account
▶ Prepare annual accounts
▶ Hold regular meetings
▶ Act in the best interests of the trust (and comply with the law) This includes keeping within the authority of the trust deed and observing the provisions of the Trustee Act 1956. If a trustee
acts outside their authority or fails to do something which he or she is obliged to do, they will be in breach of the trust
▶ Not delegate. They must personally carry out the terms of the trust deed - although they are permitted to delegate specialist or routine matters to appropriate agents
▶ Invest properly and prudently. To meet the trust’s objectives, manage risk and record and regularly review an appropriate investment strategy
▶ Be impartial. Trustees must act impartially towards beneficiaries and avoid any potential conflict of interest between their role as trustee and their other personal interest in the trust
▶ Keep, manage and file records. Keep proper books of account and taxation records, file annual returns of the trust for tax purposes, and record transfers of assets and distributions of
income and capital to the beneficiaries as well as maintaining minutes of meetings and resolutions
▶ Update beneficiaries. Keep beneficiaries informed of their rights under the trust.
New trust legislation
The Government has signalled it will review the legislation governing trusts, based on the recommendations from the Law Commission’s review in 2013. Law Commissioner Sir Grant Hammond said there was confusion in the community about trusts, and the principal legislation dealing with them, and that the Trustee Act 1956, was “sadly in need of modernisation”. Work continues towards the introduction of a new Trusts Act which will modernise the law of trusts making it clearer and more user- friendly for individuals and business.
What is gifting?
When a trust is established, the settlor gifts assets into the trust (e.g. settling property or handing over shares or money into the trust to be looked after for the benefit of the beneficiaries.) So let’s say you sell your million dollar house into the trust. The trust will owe you that money. You can decide to leave all or part of that money or value owing to you essentially a loan; or gift by forgiveness part or all of it for the future benefit of the trust’s beneficiaries.