BBQ and dinner conversations frequently centre on business and property and along the way, trusts. Indeed, our land is dominated by trusts, with several hundred thousand existing today in Aotearoa. Their prevalence is due to their abilities to act as vehicles to conduct business affairs, offer asset protection against creditor and relationship claims, safely transfer inheritance to loved ones, and bestow incidental tax advantages. Despite their popularity, trust legends and lies abound, a couple of which are recounted below.
Myth 1: Trusts are used by dishonest people, for dubious purposes.
New Zealand epitomises the spirit of entrepreneurship, with a high number of small and medium size businesses dotting our economic landscape.
Behind every business lies dreams of success. Not all business succeed, however. Some fail, often through no fault of their owners.
Take for example the business established by John and Kate. They created Window Installations which supplied windows for houses. Initially the business was successful, employing up to 10 people at its height. In 2022 however the business sold windows to XYZ Home Builders Limited. Before XYZ Home Builders Limited fully paid for the windows, it was placed into receivership. At the time, Window Installations was owed over $200,000. The failure of XYZ Home Builders Limited caused a domino effect. Windows Installation couldn’t pay its creditors and so also failed. To make matters worse, John and Kate lost their home and at the age of 54 were adjudged bankrupt. The closure of Windows Installations didn’t affect only John and Kate. Their employees lost their jobs too, consequently making it difficult to put bread and butter on their own tables each week. This scenario is one that is regularly faced by many businesses in New Zealand each and every year.
John and Kate were by no means dishonest. Nor did they engage in any dubious dodgy business practice. They were hard-working kiwis who were affected by another business’ failure. The ending of this story could have been different if a bons fide structure had been used to conduct the windows installation business and a trust employed to hold John and Kate’s house. Employees may well have retained their jobs too and been spared the financial stress that accompanies the unexpected loss of employment.
Myth 2: Trusts aren’t worth the paper they’re written on and are easily busted.
According to Statistics New Zealand, 18,744 marriages and civil unions were registered in 2023. Analysis of stats tells us a lot of those entering into this state of happy couple hood were doing so for the second time. Furthermore, they were embarking on their committed relationships later in life, after they’ve established their careers, built some wealth and had children.
Unfortunately, not all those who play together, stay together. 7593 is the reported number of couples that divorced last year. This number doesn’t take into account the number of de facto relationships that break up.
Whilst heartbreak is predominately the effect of relationship demise, frequently decimation of wealth is its friend. In a bid to protect against losing the assets one brings to a relationship, people create trusts and transfer their assets to their trust.
A case in point is Jamie and Kate. At the time of meeting, Jamie worked as a journalist. He had a son and lived in a 3-bedroom house. He didn’t own the house. Rather a trust held it. Jamie’s friends had told him trusts weren’t worth the cost of the paper they were written on and could easily be busted. His solicitor however advised him to settle a trust for himself and his son to protect the house against claims from future relationship partners. Jamie accepted his solicitor’s advice and transferred the home to the trust. He figured even if he didn’t need the trust to protect his assets against subsequent relationship claims, he could always use it to pass his house to his son upon his death.
When Jamie met Kate, she was working as a part-time office administrator. She had no assets. After six months, Jamie and Kate decided to live together in the home. Jamie’s son stayed with them several days a week. Kate continued to work, albeit part-time. Her real passion was portrait painting. Unfortunately, their de facto relationship was not happy and ended 2 years after they began co-habiting. Kate subsequently brought a claim for half the value of the house.
Jamies was worried until he saw his solicitors. They said the house wasn’t Jamie’s personal property nor was it relationship property. This made it hard for Kate to bring a claim against it. Additionally, the trust had been well run, with compliance work done annually as was legally required. Ultimately his solicitors thought the trust would protect the house against Kate’s claims, which is exactly what it did do.
Myth 3: Trusts no longer give you any tax advantages.
Prior to 1 April 2024, the trust tax rate was 33%. That rate changed however on our statute books, increasing on 1 April 2024 to 39% in alignment with the top marginal income tax rate. Accompanying the increased trustee tax rate was the view trusts no longer give taxation benefits. This is erroneous.
Trustees can allocate income to beneficiaries who return that income in their personal income tax returns and pay tax at their personal marginal tax rates. By doing so, quite a bit of tax can be saved, given income tax rates range from 10.5% up to 39% when the $180,000 threshold is reached.
Take for example a company called Splash and Dab Commercial Painters Ltd. The company has two shareholders being Dillon who owns 1 share and the Dillon Family Trust who owns 99 shares. Dillion’s personal income tax rate is 39% as is the trustee tax rate. The Trust has two beneficiaries being Dillon and his son, Peter.
The company decides to pay a dividend of $50,000 to the Dillon Family Trust. Upon receipt, the trustees decide to make an income distribution of $50,000 to Peter opposed to retaining the money as trustee income.
Peter is 20 years old and studies commerce at university. He does not work and earns no income. The payment Peter receives will be taxed at his average income tax rate being 16%. Tax at the rate of 33% has already have been paid on the $50,000 gross dividend received by the trust. Thus, because Peter’s personal income tax rate is less than 33%, a tax credit of 17% will arise. If the trustees had made an income distribution straight to Dillon opposed to Peter, further tax on the income received would have been payable because Dillon personal income tax rate is 39%. Accordingly, by the trust being a shareholder of the company, and the dividend being paid to the trust and then onto the beneficiary Peter, a tax saving has been achieved.
It should be noted that establishing a structure, including a trust, solely to procure a tax advantage, is unlawful. That said, trusts these days are mostly established for asset protection purposes, and tax benefits are merely incidental – which is lawful.
SUMMARY
The humble trust is not a recent phenomenon. Historically it’s been said their origins lies in the Middle Ages, arising during the Crusades times. Contrary to this popular view, concepts underpinning the trust show they have tentacles stretching as far back as Aristotle times. Their longevity is testament to their capabilities, being able to adapt to a populace’s changing attitudes and norms, satisfying evolving socio-economic needs. This aside, the trust is often misunderstood which I hope this article helps to remedy – just a little.