Trust beneficiaries and settlors are wondering how the NZ Trust Act legislation changes will affect their assets. In house Trust expert, Kunal Topiwala, discusses how to protect your future.
Trusts were once a fairly simple way to protect your assets. However, they have changed dramatically over the past few years. This is thanks to new rules and legislation governing how trusts must operate.
We’ve told you about changes to the Trustee Act, and about the Inland Revenue’s expectations on what information trusts will supply. Now there’s one more new change to be aware of: beneficiaries can easily become settlors.
How does a beneficiary become a settlor?
If you set up a trust, you are likely to be the settlor. Those who benefit from the trust are the beneficiaries. In the past those roles were usually set pretty firmly. Now, a beneficiary can become a settlor without any intention to do so.
Role changes are primarily triggered by typical income distributions made by trusts. These distributions are done to provide the best possible tax outcomes for the settlor. This income often go into beneficiary accounts without actually being paid to the beneficiaries. This is recorded as a debt owed to the trust. In the past this has been pretty standard practice with some beneficiary accounts having large surpluses.
Now, however, Inland Revenue (IR) is saying that if beneficiaries are holding a balance of more than $25,000, they will automatically become settlors of the trust. The debt owed to the trust is effectively being settled on the trust, so the beneficiary is now a settlor.
Why is it a problem if a trust beneficiary becomes a settlor?
It’s not necessarily a problem for your beneficiaries to become settlors of your trust. However, it has the potential to become complicated quickly. Let’s say one of your children is now a settlor of your trust. Your trust holds many of your assets, such as your family home. If you child were to undertake a property development, for instance, your trust may become associated with that development automatically. This can ultimately end up putting your assets at risk.
This new rule can also change the way transactions are taxed. Particularly property transactions subject to the bright line test.
Moreover, you should also consider that adding extra settlors could change the tax classification of your trust. If one of your beneficiaries lives overseas, it could suddenly make the foreign trust regime apply, and they’re having to pay tax in two countries.
What should you do if you are affected by NZ Trust Changes?
There are a few ways to prevent beneficiaries becoming settlors.
One option is that trustees could pay out the beneficiaries what they are owed. Usually, though, we find that there is not usually cash available to do a big payout. Not to mention this often doesn’t fit with the timing of the trust’s long-term strategy.
An alternative option is to distribute all or some of the trust’s assets. Once again, this is not likely to be a popular choice when the settlors are still using the assets. If your home is in the trust, you certainly don’t want to give it to your beneficiaries.
We concluded that the best option is to gift back any distributions that take the balance of the beneficiary account over the $25,000 threshold. The funds can be gifted back to you, the settlor, or you can take over the debt owed by the Trust to the beneficiary and then owe the beneficiary the debt personally.
You may also choose to do nothing, and that may not be a problem in your circumstance. However, it’s vital that you understand the implications of your decision.
We can help protect your assets (regardless if you are a beneficiary or a settlor)
If you have a trust, it’s essential that you talk to us about how your trust might be affected by this change to the NZ Trust Act legislation, and consider the options for risk mitigation. Similarly, if you are looking for more information about other aspects of the Trust changes see our articles on Trusts including Family Trusts and High Tax Rates. Get in touch with us now so we can ensure you get the right advice and you’re not caught out by this new rule.
Together we can achieve more.