Payment of income or capital to a beneficiary, whether or not it the form of cash is called a distribution.

The tax treatment of distributions from a trust depends on the trust’s classification for tax purposes.  This classification is for tax purposes only and has no effect for trust law purposes.  There are three classifications of trust for tax purposes:

• complying trusts
• foreign trusts, and
• non-complying trusts

Complying trusts

Most trusts settled in New Zealand are complying trusts.  A complying trust is a trust that was settled by a New Zealand resident settlor where all the trusts tax filing obligations have been met and all of the trust’s income has been taxed in full in New Zealand.

Complying trust income is taxed as trustee income or beneficiary income,  However, distributions of accumulated income, capital gains and corpus (property settled onto the trust) are tax-free.

Foreign trusts

A foreign trust is a trust that has not had a New Zealand resident settlor at anytime between 17 December 1987 (when the current trust rules were introduced) and the date of a distribution from the trust.  A trust can be a foreign trust even if it has a New Zealand resident trustee.  This is because for New Zealand tax purposes the residence of the trust is determined by reference to the residence of the settlor not the trustee.

Distributions of New Zealand source income and taxable distributions from foreign trusts are taxable in New Zealand.  Taxable distributions are distributions of non-arm’s length capital gain and accumulated income derived on or after 1 April 1988. New Zealand source income and taxable distributions are taxed at the beneficiary’s marginal rate. 

Trustees of foreign trusts must also pay tax on any trustee income that is derived in New Zealand at the rate of 33%.

Income accumulated before 1 April 1988, corpus and arm’s length capital gain can be distributed tax-free.

For more information regarding foreign trusts see www.securetrustees.co.nz

Non-complying trusts

A non-complying trust is a trust that is neither a complying trust or a foreign trust.  Distributions of income and capital gains (other than corpus) from a non-complying trust are taxed as beneficiary income or taxable distributions.  Taxable distributions from non-complying trusts are taxed at the rate of 45%.

Trustee income derived by a non-complying trust is taxed at the 33% trustee rate.

Trust classificaition can change

A trust’s classification can change from distribution to distribution, and for this reason a trust’s classification should be confirmed each time a distribution is made.

References:

• Income Tax Act 2007, s. HC 9
• Vicki Ammundsen, Taxation of Trusts, ed 2 (2011), chapter 5
• www.securetrustees.co.nz