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Restrucuturing trusts could have unforseen circumstances

CCH consultant editor Jillian Lawry examines some of the aspects of the proposal to tax trust distributions of beneficiary income to minors at 33%.

Sunday, February 11th 2001, 4:30PM

Draft legislation introduced to Parliament recently contains details of the third major piece of anti-avoidance legislation stemming from the introduction of higher tax rates last year.

The Taxation (Beneficiary Income of Minors, Services-Related Payments and Remedial Matters) Bill includes a proposal to tax certain distributions of beneficiary income to a child under the age of 16 at the rate of 33% from April 1.

Currently this income could be taxed at a rate of 19.5%, depending on the particular beneficiary's other income. The policy behind this proposal is to target the practice of income-splitting (whereby families place income-earning assets in trusts so that the resultant income might be distributed to their children at the lower marginal tax rate).

The proposed change was first announced in the 2000 Budget and subsequently outlined in more detail in the Inland Revenue Department's issues paper Taxation of Distributions of Beneficiary Income for Trusts to Minors.

The architecture of the draft legislation differs somewhat from the changes previously mooted; in particular, the categories and the type of income subject to the 33% rate. Basically the proposals in the bill apply to:

  • beneficiary income distributed to a minor (ie, a person under 16 years of age); and
  • income derived from property settled on a trust by a relative or a guardian of the minor or an associate of a relative or guardian.

There is an exemption for beneficiary income which is $200 or less in an income year.

If the minor turns 16 during the income year then the law as currently drafted makes provision for the uplifted tax rate not to apply from the subsequent income year.

The revenue expected from this initiative is estimated to be about $10 million to $15 million. (Source: Key Facts for Taxpayers, Budget, 15 June 2000.)

Taxation of family income

Although it is expressed as a tax on individual beneficiaries, the effect of the new rules is to tax family income. This is borne out by an example found in the commentary to the bill which illustrates the policy behind the changes.

The example compares the tax liability for a family with a trust and a family without a trust. Both the families have a combined income of $150,000 (this being made up of one person earning $80,000, and the other earning $70,000). According to the calculations, under the current legislation the family with a trust has a tax liability which is $6,599 less than the family without a trust.

This example raises a number of interesting points:

  • First, income tax has traditionally been imposed as a tax on individuals, not family income.
  • Secondly, while there are, currently, potential tax savings for a family with a family trust, the example does not take into account the cost of the formation and ongoing administration of a family trust. As the trust in the example derives income from rental properties and dividends it will have to prepare accounts and file a tax return. This would erode the net saving given the level of incomes of the members of the family.

Is the legislation necessary?
Policy issues aside, is this new regime necessary given current anti-avoidance laws? Existing tax legislation does have the ability to deal with income-splitting arrangements. This includes situations where a trust is used to fund items which would normally be paid for by someone else who would not be able to write them off as expenditure against other income.

Is the legislation a breach of human rights?
It is against the law to discriminate against an individual on the ground of age. It is interesting to note that the Human Rights Act 1993 provides that the age discrimination category potentially applies to persons 16 years of age and over. Perhaps that is why the definition of a minor for the purposes of the new rules is under 16 years of age, and not under 18 as originally anticipated.

The distinction between ages provides food for potential claims against trustees if children of 16 years and over are preferred over their younger siblings when it comes to trust distributions.

It might be that trustees will prefer to pay out to older beneficiaries with beneficial tax positions until such time as the minors become of age.

« New law changes will make trusts more importantTying in your will with your family trust »

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