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Beneficiary income, Taxation

Trustees now have greater discretion regarding RWT credits

Historically, absent a specific anti-avoidance provision, trustees have been unclear as to whether resident withholding tax (RWT) credits must be allocated in proportion to interest income or if the credits could be “streamed” for better effect.

A recent amendment to the Income Tax Act 2007 has clarified the position and now provides that a trustee can substitute cash distributions to beneficiaries for RWT credits.  A trustee who does so is then entitled to a credit to the extent that cash has been substituted for RWT credits. 

On first reading the mechanism by which this is achieved in the Income Tax Act is somewhat confusing and reads more like origami instructions.  However, perseverance will provide elucidation as to the mechanism, which is demonstrated by this example.

Example

The trustees of the Aspiring Trust derive $100.00 interest income.  After payment of resident withholding tax at 33% this equates to $67.00 cash and $33.00 RWT credits.

The trustees resolve to distribute the entire interest payment to Thomas, a beneficiary of the Aspiring Trust who has a marginal tax rate of 17.5%.

The  distribution is effected by a $67.00 cash to Thomas from the interest income received by the trustees and a further cash payment (referred to in the legislation as a substitution payment) of $15.50 together with $17.50 (of the original $33.00 RWT credit).  The tax on $100.00 for Thomas (given his marginal rate) is $17.50.  This means that Thomas receives cash of $82.50 ($67.00 + $15.50) and $17.50 of RWT credits.  Accordingly, Thomas has no further tax liability.

The trustees then offset the substitution payment made to Thomas of $15.50 against the remaining $15.50 of RWT credits and are in a revenue neutral position.

References:  

  • Income Tax Act 2007,  s LB 3(1),(4),(5), RE 2(6)
  • Vicki Ammundsen, Taxation of Trusts (ed 2), CCH New Zealand Limited 2011 at 15-090
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Discussion

2 thoughts on “Trustees now have greater discretion regarding RWT credits

  1. Hi Vicki

    Thanks for the article. I have been looking at the RWT Substitution Payment rules, and I agree that they are confusing. I had a couple of comments on your example:

    1. I agree with what you say about Thomas and the tax effect for him. However, in practice the trustees would normally distribute the Gross Interest of $100 to Thomas, rather than the net amount. If in the example the distribution (by way of trustee resolution) was $100, it would seem that Thomas would have $115.50 of income and tax on this would be $20.21. The RWT credit would still be $17.50 and there would be net tax to pay of $2.71.

    Does this mean that these new rules will only operate properly if trustees distribute the net interest amount rather than the gross?

    2. I was confused by your final sentence. I understood that the trustees had an RWT credit of $15.50 (courtesy of S LB 3(5)) and this credit arises because of the RWT substitution payment i.e. the RWT credits and the substitution payment are effectively the same thing so they can’t “offset”. Wouldn’t this then mean that the trustees would be entitled to a tax refund of $15.50, which would not be a tax neutral outcome?

    Regards

    Chris Lindsay

    Posted by Chris Lindsay | February 21, 2012, 8:36 pm
    • Thanks for your response.

      It is acknowledged that a more practical stance is often taken with regard to RWT. I believe that the example given is correct even though it may not match how the new regime is understood to apply.

      As the new regime applies to the credit not the entire payment, my reading is that, essentially we are looking at the net result not the gross result.

      It is helpful to go back to the policy behind this, which allows a trustee a credit to the extent that cash is substituted for RWT credits. A cash substitute for RWT turns off RWT credits for the beneficiary (see LB 3(4) and LB 3(1)) (compared with income paid with the credit and no substitution payment (RE 2(6))) and LB 3(5) re-instates a different credit for the trustees making a substitution payment.

      Not sure that helps!

      Posted by vickiammundsen | March 2, 2012, 6:52 pm

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