OPINION: The Law Commission recently released "Review of the Law of Trusts", which summarises its recommendations for a new Trusts Act, and follows a series of issues papers released since early 2010.
The report makes several recommendations to modernise the law of trusts, pointing out that some existing laws are not only "complex and difficult to understand, but . . . simply unreadable".
It is estimated that there are between 300,000 and 500,000 trusts in New Zealand. The exact number is unknown because, unlike companies, there is no central register of trusts. For example, a simple trust that only owns the family home and derives no taxable income does not need to register with Inland Revenue.
Trusts have become so popular that it sometimes seems like some people have fear of missing out if they don't have one, but in reality most people probably don't need one.
Business owners are often advised to use a trust. Reasons include:
Asset protection. This is relevant if a person has significant assets that would otherwise be at risk due to other investments and activities. A simple example is a business owner's desire to protect the family home from potential claims arising from a business they carry on.
Providing for family members. Settling income-producing assets on a trust provides a mechanism for directing benefits, in the form of income and/or assets, to family members. It also enables "restricted" access to those assets, thereby keeping them safe from relationship property claims.
I like to think of a business as a fruit tree. A lot of time and money is invested to develop and maintain a productive tree. The reward is the harvest of fruit. Some of that fruit stays with the tree, and makes it bigger, stronger, and more productive. Some is picked, because it is needed to feed the orchardist, or be invested into other, new trees. If too much fruit is left on the tree, there's a risk the birds will get at it.
In this context, a trust is like a preserving jar. It's a place to store the fruit, separate from the tree, where it can be held to benefit family members over a period of time, and where it is protected from the unwanted attention of birds.
There is a perception that trusts are wonderful mechanisms for minimising tax. There are some tax advantages but, since the top personal tax rate was reduced from 39 per cent to match the trustee rate of 33 per cent, those advantages are fewer. Tax effectiveness is also affected by a rule requiring income allocated to beneficiaries aged under 16 to be taxed at the trustee rate (except in limited circumstances), and Inland Revenue's default position that at least 80 per cent of income earned from personal services be taxed in the hands of the controlling individual regardless of business structure.
Trusts can be complicated. There is often a difference between what the trust earns on an accounting basis and its taxable income. That has increasingly become the case where trusts are (often wisely) used for holding investments, such as deposits, bonds and portfolio interests in shares. Trusts also come with responsibilities, including duties of trustees to manage the trust's assets prudently for the good of its beneficiaries.
There's no doubt that trusts will be around for centuries to come, as they serve useful purposes. That's why it's important that the law governing them is kept up to date. But trusts are not for everyone and are not a way of eliminating tax.
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