In general terms, the income of a Trust for tax purposes is classified and separated into two parts:-
- Trustee Income - remaining income as Trustee income and taxed as such; or
- Beneficiary Income - income of a Trust which is distributed to a beneficiary and is taxed as income of the beneficiary.
When income is received in a Trust, the Trustees can elect how it is allocated:-
- to retain it in the Trust; or
- to distribute to some, or all, of the beneficiaries.
All beneficiary income is taxed at the beneficiary's marginal tax rate (ie the tax rate applicable to the beneficiary). All Trustee income is taxed at 33% (there are some exceptions to this).
Trusts can also make other distributions of money or assets to beneficiaries including:-
- distributions of capital (from Trustee income);
- distributions of capital profits or gains;
- supplying Trust property or services to a beneficiary; or
- acquiring property or services from a beneficiary which may, or may not, be subject to tax.
If Trustees wish to allocate Trust income as beneficiary income, Trustees generally have until 31 March of the financial year following receipt of the Trust income to do so. The Trust Deed must allow this - if it does not, in some cases, the deed may need to be varied.
Trustees will need to decide how Trust income is allocated. Trustees should take into account the tax rates applying to beneficiaries and assess how tax efficiency and tax savings can be made.
Tax classifications for Trusts
In addition (from a tax view) Trusts will fall into one of three different tax classifications:-
- Complying Trust;
- Non-complying Trust; or
- Foreign Trust
Determination of whether a Trust is Complying, Foreign or Non-Complying under New Zealand tax law is primarily based on the residency of the Trust's settlor or settlors.
A Complying Trust is a Trust:-
- settled by a New Zealand resident or residents;
- in which all the trustees' income has been taxable in NZ; and
- it has met all of its tax and filing obligations.
The principle advantage of a complying Trust is that the types of distributions listed above (other than distributions of beneficiary income) will not attract income tax eg distributions of capital from trustee income to beneficiaries, distribution of capital profits or gains.
A Non-Complying Trust is any Trust that is not a Complying Trust or a Foreign Trust at the time it makes its distribution. A Non-Complying Trust is often a Trust that has been settled by a non-New Zealand resident, where the settlor has later become a New Zealand resident and has not elected to make the Trust compliant. A Non-Complying Trust making distributions will be taxed at 45%. To avoid any undesirable tax consequences of being classified as a Non-Complying Trust, when a settlor moves to New Zealand the trustees can elect to make the Foreign Trust a Complying Trust. There are certain rules as to when the selection must be made.
A Foreign Trust is a Trust which has an association with New Zealand but at all times has had no New Zealand resident settlor from the date the Trust was settled until the date of the distribution. The Foreign Trust can have an association with New Zealand through a trustee, by having New Zealand sourced income or the Trust having a New Zealand resident beneficiary or beneficiaries. Certain distributions by a Foreign Trust will be classified as taxable distributions and will be taxed to a New Zealand resident beneficiary either at their marginal tax rate or as exempt income.
We strongly advise that when Trustees are deciding to make a distribution of trustee income to beneficiaries, that the Trustees consult with an accountant for the appropriate tax treatment of the income. We also suggest obtaining advice as to the classification of your Trust to ensure that it is correctly classified for the benefit of the Trust tax rate.