There has been a considerable comment in the media regarding the effect of the Inland Revenue Department's Draft Public Ruling - Debt Forgiveness In Consideration of Natural Love and Affection. The effects of the draft ruling not only call into question the wisdom of continuing the well established practice of forgiving debts to the trustees of a family trust but also the fundamental anomalies that exist in respect of the section under the Income Tax Act that brings forgiveness of debt within the accrual provisions.
IRD had received about 30 submissions on its draft ruling and they raise a number of concerns ranging from disputing the IRD’s interpretation of the legislation, to the inconsistencies and uncertainties perpetuated by the draft ruling. These submissions will have little impact on the draft ruling when it is finally made binding, probably by the end of this month.
Unless there is a change in the law to address what might be described as the unintended effects of section EH 4(6), practitioners will have to accept that, the official view of the Commissioner will be that published in the draft ruling.
It is important that the ruling and how it will be applied is correctly understood. No client will wish to risk the uncertainty and expense of testing that view through the courts. I fear that in some cases there will be no option if the IRD take a hard line in trying to raise revenue from this.
It is worth noting that income tax payable by the trustees of a family trust on the remission of the debt by the settlor is a voluntary tax and trustees do not have to accept the gift. It is a legal requirement that the forgiveness of the debt, whether in whole or part, be by way of deed which will require the trustees to be a party to the document.
It has been intimated that the new public ruling will not be retrospective and no trustee will make the same mistake twice by accepting the forgiveness of a debt to the settlor, until such time as the trust deed has been amended to comply with the new binding ruling.
One solution is to amend the trust deed by excluding beneficiaries for whom there is no natural love and affection, but any undue haste to do so may not be the appropriate course. Consider:
Clearly any amendment to the trust deed should be done with caution and not as a simple "knee jerk" reaction. New trust deeds should be drafted with the new public ruling in mind.
Other possibilities should be considered, and their potential risks assessed by the settlors and trustees. Unless the gifting is critical a "wait and see" approach may be appropriate, particularly if the reintroduction of Estate Duty was a prime motivation for the establishment of the trust.
One such possibility is the repayment by the trustees of part of the debt by way of a cheque payable to the settlor in return for a cheque drawn by the settlor payable to the trustees, by way of a gift to the trust for an equivalent amount (usually for $27,000).
A word of warning though, the further gift to the trust is not caught by the accrual provisions at all, as it is not the remission of a debt but a straight gift of cash to the trustees. There is a school of thought (based on Canadian case law) that such a procedure may be challenged by the IRD where there are no actual funds available to meet the cheques when presented.
Expert advice should be sought from those who are keeping up to date on developments in relation to the gifting issue. There is no one answer and what might work for some may prove to be wholly inappropriate for others.
It is worth noting that IRD are issuing a practice statement this month on gift statements and will also issue a booklet on gifting in April this year. Essential reading for those who truly want to be up with the play.
Mark Cassidy is a business development manager with New Zealand Guardian Trust. He can be contacted by email
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