For most families, the objective in establishing a family trust is to safeguard your
family’s assets against business and other risks. The sections below briefly
describe some of the most commonly used protections offered by family trusts.
It’s important to keep in mind that assets are only protected if they have been
completely given away to a trust. If you have retained some assets, or the trust
still owes you money, then this will be vulnerable to a variety of claims.
Without a family trust, business owners run a considerable risk that their
family assets could be vulnerable. A range of situations could bring this about,
including:
• Creditors, if there is a business failure
• Compliance issues, resulting in action taken against you or your business
under, say, occupational health and safety laws, and/or
• Action taken against directors or senior management of a company.
Trusts are not only for employers. Looking to the future, if you establish your
own business or are in a senior position in business, you should also consider
some method of protecting your assets as this type of business activity may
expose you to legal claims.
Conducting business in New Zealand is carried out on a personal basis as a
sole trader, or through a joint venture, partnership, company or trust. When a
trust is used as a vehicle to run a business it’s commonly called a ‘trading trust’
or a ‘development trust’.
Special rules apply if your business involves trading in land or developing real
estate. These activities need to be separated from your other business and
personal assets to avoid association for tax purposes.
There are specific tax rules covering land sales and associated persons. If you
are a property dealer or developer, anyone you are associated with can also be
taxed as a property dealer or developer. This can happen unwittingly. The result
can be that a profit may become taxable when the property is sold. If you can
avoid being treated as associated, any profit can be a tax-free capital gain.
The structures that need to be put in place in these circumstances are
complex; we would expect both your lawyer and your accountant to be involved
in advising about this.
Trusts are often used to help avoid claims by a former spouse or partner; for
example a claim against your son or daughter’s inheritance.
When a couple separates – whether they were married or in a civil union, de
facto or same sex – the basic rule is that they share equally in all ‘relationship
property’. These are the assets they have built up together during their
relationship. There are some exceptions, such as inherited property, and
the court has some overriding discretion. In reality, however, it’s easy for an
inheritance to become relationship property if, for example, you use inherited
money to pay off your joint mortgage.
One solution is to ensure that any inheritance is kept in a trust separate from
relationship property. Putting your children’s inheritance in a trust will help avoid
claims from a rogue son-in-law or daughter-in-law.
Before you enter a de facto relationship, marriage or civil union, if you have
significant assets you should carefully consider how best to protect your
personal assets in case you later separate or one of you dies.
The equal sharing rule does not apply to short duration relationships (usually
less than three years). However, transferring your assets to a trust just before
the three year period ends is not likely to be effective. Relationship property
law has claw-back rules which apply if you have given away assets with the
intention of defeating a future claim.
If you are going into a second or subsequent relationship, civil union or
marriage, and you have children from an existing or from previous
partnerships, it’s even more important to ensure that your
assets are preserved in order to make the division of
property fair and just, and to ensure your children’s
interests are preserved.
A trust can help to ensure your assets are safeguarded for a
child with special needs such as a disability. This protection
might be given through the family trust, or by setting up a
separate trust for the individual child. However, you need to be
aware that trust assets can be treated by the authorities as
financial resources that should be used first before asking
for government help, such as a benefit.
The trustees can exercise their discretion to make available to the beneficiaries
any income and/or capital to help meet their legitimate cash requirements. The
trust could also make loans for capital needs such as housing, or even buy a
home for occupation by a beneficiary.
Similar protection can be arranged when you have doubts about the ability of a
child or other family member to manage their financial affairs.
You may feel the need to protect your children or other family members from
their own folly or lifestyle. It can be left up to the trustees to give these children
control of some or all the assets held in trust at a future date and, in the
meantime, provide for their reasonable needs.
Sometimes parents or grandparents want to establish a
separate trust or trusts to help fund education costs for
their children or grandchildren. Often these trusts specify
levels of education to be funded, such as high school
costs, boarding fees and/or tertiary level expenses.
Establishing a trust will help protect your estate against family protection and
testamentary promise claims.
If your Will doesn’t provide adequately for your spouse or partner, children,
grandchildren or other close family members you may have been significantly
financially supporting, claims may be made against your estate after your death,
under the Family Protection Act 1955.
The claimant/s must show that you had a moral obligation to provide for them
and that your Will did not provide for their adequate maintenance and support.
If provision is made under your trust for those for whom you have a moral
obligation to provide, claims can usually be avoided. However, your children in
particular have a right to be acknowledged as members of the family.
A testamentary promise claim can be made against an estate if the deceased
promised to reward someone by his or her Will in return for work or services.
These claims are made under the Law Reform (Testamentary Promises) Act
1949. To support a claim there must have been something done for you
by the claimant, such as looking after you without being paid (for example,
housekeepers or companions).
While evidence is needed to prove the claim, often the promise will be implied
in the circumstances. Assets held in a trust at your death are not part of your
estate and cannot be claimed under the testamentary promises legislation.
Establishing a trust principally to avoid paying tax is not likely to be effective.
If there is a tax saving by establishing a trust, it must be seen as an incidental
benefit, not the sole or dominant purpose of the trust.
Tax savings can be made if the trustees have flexibility to decide which
beneficiaries should receive income each year. Trusts are taxed at the maximum
individual rate (currently 33%) but income distributed to beneficiaries is taxed at
their own personal rate. Using a trust for tax efficiency requires careful advice.
A decision as to how much income is to be allocated to a beneficiary must be
made within 12 months of the balance date for the trust.
The 2011 Supreme Court decision, Penny & Hooper v Inland Revenue,
emphasises that an artificial arrangement intended mainly to avoid tax can be
ignored by the Inland Revenue (IRD) for income tax purposes even if the trust
itself is perfectly valid.
Penny & Hooper v Inland Revenue2
Two surgeons (Messrs Penny and Hooper) each put their business into a company.
Each company was owned by a family trust. In each case the company paid the surgeon
a salary far lower than what he was previously earning. Most of their earnings were
channelled through their trust. Because this reduced the amount of tax in each case,
the IRD invoked the anti-avoidance rule in the Income Tax Act 2007.
The Supreme Court agreed with the IRD; the trust and company arrangement was legally
valid but the surgeons must pay income tax on what they actually earned, not just the
notional salary. The surgeons also had to pay $25,000 towards the IRD’s legal costs.
Other structures such as Look Through Companies (LTCs – previously called
Loss Attributing Qualifying Companies), partnerships, and Portfolio Investment
Entities (PIEs) may offer tax advantages for individual investors. It’s important
to remember, however, that these structures do not offer the asset protection
available through a trust.
Strict rules apply if you want to apply for a government benefit or assistance
such as legal aid, student loans, the unemployment benefit, etc. These rules
have been in place for a long time. Assets transferred to a trust can be treated
as resources that you should use first before asking for government help.
Even if you have transferred assets to a trust of which you are not a beneficiary,
you may still be denied assistance from the state.
The same is true also of using a trust in order to qualify for a rest home subsidy.
In that situation, there are strict limits on how much you may put into a trust
each year.
New Zealand does not currently have any capital gains tax or any inheritance
or estate tax. Gift duty (a tax on gifts of large amounts) was abolished in
2011. This means property of substantial value can now be given to a trust
immediately. In recent years, some political parties have indicated they would
like New Zealand to adopt a capital gains tax similar to the Australian model.
Having family wealth in a trust could help defer such a tax for a generation
or more.
By law, most trusts cannot last forever. To avoid
the uncertainty of the old legal rules, most family
trusts now adopt a fixed period of 80 years. Under
current law, this is the maximum number of years
allowed for trusts other than purely charitable
trusts. The New Zealand Law Commission is
considering reform of the law but this could take
some years before it takes effect.
If your assets are owned by a trust they may
be preserved for the next generation. It must
be remembered, however, that most trusts will
mature after 80 years and the process must
then be started again. Many families may not
be taking this trust life cycle into account.
There is currently no requirement for public registration or disclosure for private
trusts. A trust’s annual accounts and activities are not available to anyone else
except the settlor, trustees and the beneficiaries.
The trust deed can also restrict the type of information beneficiaries can access.
This is limited by recent court decisions which set the minimum information
a trustee must provide beneficiaries who request it. Beneficiaries are usually
entitled to see deeds, accounts and the record of decisions of the trustees,
but are not entitled to know the reasoning of the trustees when exercising
their discretion.
Charitable trusts and foundations must be registered in order to obtain their taxexempt
status. Trust information is publicly available on the Charities Register,
unless you ask for confidentiality.
Your family trust could include named charities or charitable purposes generally
as potential beneficiaries. If charitable purposes or named charities are included
the trustees can make charitable payments without the need to register as
a charity.
Since 2008 trustees have been entitled to a tax rebate up to 100% of trust
income distributed for charitable purposes.
There is always the possibility of changes to trust law, or associated laws
affecting trusts, which may remove some of the benefits attached to a trust or
frustrate some of the original objectives of the trust.
No one knows what future law changes there might be or when they might
occur. However, it is comforting to know that the fundamental structure of a trust
has stood the test of time over hundreds of years.
If there are changes to the law, modern trust deeds usually provide the trustees
with a power to vary some of the terms of the trust, which may ensure the
provisions of the deed can be adjusted to comply with law changes. It’s
important that your trust deed includes wide powers to resettle and to vary
the trust.
For more information please contact Tina McLennan
