Tax distortions are increasing.
A short while ago the top tax rate for both an individual and a family trust was 33 percent. When this was increased to 39 percent for the individual, there was an obvious incentive to retain as much income in a trust as possible.
This led to the former government proposing an increase to 39 percent tax on trusts, effective from 1 April 2024. At this stage the new government has made no comment regarding the previous government’s proposed 39% flat tax rate for trusts. The Bill covering this lapsed when Parliament recessed for the election.
If we assume the new government follows through with this and your taxable income is less than $180,000 (the threshold for the increase to 39 percent tax) it would pay to distribute as much of the trust income to you or any other beneficiary whose income is below $180,000. You would be paying tax at 33 percent whereas the trust would be paying tax at 39 percent. Remember, if you allocate income to a beneficiary to save some tax, you must also pay that beneficiary the money, at some stage.
There is just one problem. One of the prime reasons for setting up a family trust is to protect family assets so they can’t be sold up by creditors, if you’re ever sued. So, if the trustees of your trust distribute income every year to you and you don’t spend it, those savings would not be protected from someone suing you. Whereas the assets remaining in your family trust do not belong to you and would not be available to pay your debts.
As you can imagine, the income distributed from your family trust to save tax could accumulate to quite a large sum. If you give it back to the trust, ie its gone in a circle, Inland Revenue could say you only distributed it to avoid tax. It’s very difficult to predict when IRD will use the avoidance provisions they have at their disposal– please take our word for it being a risk.
Companies pay tax at the rate of 28 percent. Therefore, if you accumulated your savings within a company, you would pay a lot less tax than you would by doing so through a trust. You wouldn’t have the protection a trust offers, but that that might not necessarily matter to you.
The only time you would pay more than 28 percent is when you wanted to use some of the money. You would need to declare a dividend, which would then become part of your income.
When you retire and your income falls, you might find the distributions from a company ultimately get taxed at a lower rate than 28 percent and you actually get some tax back, depending on your other income.
It’s unlikely the government would consider putting up the company tax rate because New Zealand companies would not be competitive with those overseas.