39% Trust Tax Rate Announced in the New Zealand May 23 Budget

Let’s discuss the upcoming 39% trust tax rate, set to be implemented from April 1, 2024, and its practical implications. While this may not have crossed the minds of many individuals, it is a significant development that aligns with the New Zealand government's focus on addressing wealth disparity and tax fairness.

The decision to establish the 39% rate as the top marginal rate for trusts is a logical step in line with the government's objectives. By closing this gap, one of the two issues is effectively resolved. The other matter at hand is the absence of a capital gains tax, which remains an intriguing subject. We eagerly await the release of the Labour Party's election manifesto to learn their stance on implementing a wealth tax or a capital gains tax. A prudent move would involve introducing a capital gains tax, although such a decision carries substantial political weight.

Now, let's delve into the practical implications of the 39% trust tax rate. The rate will come into effect from April 1, 2025, allowing individuals ample time to manage their Imputation Credit Accounts (ICAs). It is important to clear out your ICAs before March 31, 2024, and ensure you have sufficient imputation credits available. As a logical extension, it becomes necessary to pay your P3 for 2024 and your terminal for 2023 before March 31, 2024—essentially, paying them early. Remember, if you purchase tax from an IRD approved tax pooling intermediary, the credit will be applied to the tax payment dates, specifically the P3 and terminal dates after March 31, 2024. Therefore, consider buying back tax credits to earlier dates before that deadline.

It is worth noting that not everyone will clear out their tax liabilities to take advantage of the additional 5% for trusts and save the 11% difference. Certain scenarios, such as having excess ICAs or no intention to distribute profits in the foreseeable future, may call for a net present value calculation to determine the best course of action. This is akin to the decision-making process for clearing out ICAs when transferring shares, where there are instances where some ICAs are lost or partially utilized. In certain cases, paying out dividends to create a current account, without utilizing all the ICAs, may be appropriate.

Regarding minor beneficiaries, it is anticipated that they will be taxed at 33% instead of 39% for distributions from trusts. This leads to the question many have been asking: should you wind up your trust? Our advice is not to rush into any decisions. We anticipate that the aligned tax rates are here to stay, as the historical misalignment between top marginal rates and trust rates from 1999 to 2008 was rectified and will likely remain aligned going forward. Trusts still hold value, offering valuable creditor protection that should never be underestimated. Additionally, distributing income to beneficiaries as beneficiary income allows for leveraging lower marginal rates, even up to the 33% threshold. Trusts also offer advantages in areas such as charitable distributions and succession planning.

As we consider future structures, it remains preferable to have incomes derived in companies owned by trusts, or alternatively, by individuals. Companies will continue to be taxed at the current rate of 28%. There is no indication of the government raising the company tax rate. Consequently, it is advisable to retain income within the company to the greatest extent possible, minimizing the tax liability to only 28%. This approach aligns with the Australian model, where a significant mismatch between the 30% company tax rate and the 47% trust rate/top marginal rate has been in place for some time. However, unlike our Australian counterparts, we need to be cautious when making distributions from trusts to companies, considering the potential implications of gifting amounts and the associated clawback of forgiven debt, which can become taxable income for the trust if distributed to a corporate beneficiary.

These are important considerations, and it will be intriguing to see how everything unfolds. Time will tell, but it is essential not to delay discussions with your clients. Ensure that provisional tax payments are made early, and we recommend commencing the pay out of ICAs at the beginning of the New Year, rather than waiting until March. By taking timely action, you can ensure that your clients don't miss out. Additionally, it is crucial to ensure that your clients have the necessary cash flow to cover the actual 5% Resident Withholding Tax (RWT).

Prepared by Nigel Smith