Favouring beneficiaries on a lower tax rate

Inland Revenue has issued a QWBA (QB 15/11)  regarding whether a trustee exercising a discretion to distribute trustee income (that would be taxed at the trustee rate of 33% if retained by the trustee) to a beneficiary on a lower tax rate, a beneficiary with tax losses or a beneficiary to whom the income will be tax exempt can represent tax avoidance.

While finding that the scenarios in the QWBA are not avoidance arrangements for the purposes of the Income Tax Act, the QWBA also provides some useful guidance as to arrangements involving trusts that could be considered tax avoidance.  In this regard the points made in the QWBA is that arrangements that might invite speculation as to whether “in commercial and economic reality” the trustees have distributed income to a beneficiary.

Points to consider include:

• timing of addition and removal of beneficiaries
• how and when income is distributed
• any facts that indicate that the trustees have retained the use and benefit of the income, and
• any facts indicating whether there is a realistic prospect of beneficiaries every benefitting from the income.

As noted in QW15/11:

“95.On their own there may be nothing inherently wrong with any one of these factors. For instance, the fact that in any income year the trustees have resolved to pay beneficiary distributions by credit to account and retain the funds for use within the trust would not, on its own, indicate Parliament’s purposes for the distribution of beneficiary income were not being given effect. However, in some cases, a combination of the above facts may raise doubts as to whether, in commercial and economic reality, the trustees have made a distribution of income to a beneficiary.

96.Although argued under provisions other than the trust rules, Krukziener v CIR (No 3) (2010) 24 NZTC 24,563 (HC) is an example of where, in the context of s BG 1, a court clearly considered that the commercial and economic reality of an arrangement was that the use and benefit of income distributed by trustees was enjoyed by a person other than the beneficiaries nominated to receive the distributions.”

Given the number of family trusts where beneficiary current accounts are retained for long periods of time (and where beneficiaries may not even know they have current accounts); the third and fourth points above may give some trustees pause – and perhaps correctly so.

Worth a wee ponder.

References:

• Draft  QWBA released — PUB00236: Income tax — Scenarios on tax avoidance — 2015, 11 June 2015
• QW15/11
• Tax Information Bulletin, November 2015
• Masters v  Stewart & Ors [2014] NZHC 2419
• Income Tax Act 2007, s BG1
• Scenarios on Tax Avoidance