4.02.2020

Take Care with Beneficiary Loan Accounts in Credit

It is common for family trusts to resolve that a distribution be made to beneficiaries but the actual amount paid to the beneficiaries is less than the authorised “distribution”.  In the financial accounts the difference between the authorised distribution and the actual amount paid is treated as a loan or liability of the trust owed to the beneficiaries.  This liability is often recorded in the “beneficiary current accounts” for the trust.

What is the change? 
 
From 1 April 2020, a new legislative amendment to the Income Tax Act 2007 (“Act”) will come into effect which changes the current position on charging interest on beneficiary current accounts.  The change is likely to be relevant to many trusts. 
 
Under the new position, Inland Revenue will deem trust beneficiaries who have beneficiary current accounts to be settlors of the trust for tax purposes unless:  

  • the prescribed (or higher) rate of interest is charged on beneficiary current account balances; or 
  • the balance of the beneficiary’s current account in the relevant tax year is less than $25,000.   

The prescribed rate of interest is the rate which applies to certain employment-related loans and varies according to the regulations applying under the Act.

Inland Revenue’s current operational position is that a failure to charge a market rate of interest on a beneficiary current account balance will not result in the beneficiary being deemed a settlor of the trust for tax purposes.  Therefore, it has been common for beneficiary current accounts to charge no interest or low rates of interest.  Inland Revenue has confirmed that its existing position will continue to apply until 31 March 2020. 

Under Inland Revenue’s existing position, a beneficiary who receives a payment of funds from a trust (as a distribution) and later loans those funds back to the trust can already be deemed to be a settlor if the beneficiary:   

  • contracts to be paid nil or a less than market rate of interest;   
  • contracts to receive interest but does not demand such interest or defers demanding the interest; or 
  • does not demand repayment of the capital of the loan.  

 Why does it matter? 
 
The question of whether a person is a settlor of a trust can be important for a number of reasons in the taxation of trusts.  For example:

  •  An increase in the number of settlors for any particular trust increases the ambit of the associated persons rules for that trust, which may have unintended tax consequences in some cases. 
  •  Inland Revenue’s new position also creates tax risks for overseas trusts (with non-resident trustees) who have beneficiaries living in New Zealand, as follows: 
    • The tax residence of the settlors of a trust determines whether the trust is classified as a complying trust, a foreign trust or a non-complying trust.  Broadly, a greater variety of distributions from foreign and non-complying trusts are taxable, and at a higher rate, than distributions from a complying trust.    If a New Zealand resident beneficiary of an overseas trust is deemed to be a settlor, then the trust may in some cases become a non-complying trust.
    • A settlor can be liable as agent for all tax payable by the trustees on trustee income if there is no trustee resident in New Zealand (although in some cases this liability can be limited according to the proportion of settlements made by the settlor).  This may apply to New Zealand resident beneficiaries of overseas trusts who are deemed to be settlors.  That beneficiary may (as settlor) be jointly and severally liable for the tax payable by the trustees.   
  • We have also had clients who have been subject to tax in overseas jurisdictions because they were beneficiaries of the New Zealand trusts and also deemed to be settlors of those trusts.  While, the rules for determining whether a person is a settlor of a trust may be different in these overseas jurisdictions than in New Zealand, caution should be exercised. 

To prepare for the change in Inland Revenue’s policy, we recommend you discuss the implications of any beneficiary current accounts you may have with your accountant or seek specialist advice. 

Do you need expert legal advice?
Contact the expert team at Hesketh Henry.
Kerry_100x100 1
Media contact - Kerry Browne
Please contact Kerry with any media enquiries and with any questions related to marketing or sponsorships on +64 9 375 8747 or via email.

Related Articles / Insights & Opinion

Phishing for payment: How Team New Zealand was scammed
Hackers often try to scam entities making international payments by impersonating one, or both, parties to the payment.
Requirements for international yachts and crew entering New Zealand
While New Zealand’s sea borders are currently closed to most foreign Flagged vessels, a number of pleasure craft and super yachts in the Pacific are hoping to enter New Zealand in time for the Ameri...
04.12.2020 Posted in Maritime Law
Class Actions – Supreme Court rules it’s “opt-out”, Law Commission Issues Paper imminent
Following the Supreme Court decision in Southern Response v Ross [2020] NZSC 126 the Law Commission is now set to release its Issues Paper on Class Actions and Litigation Funding on 4 December 2020. ...
The Commerce Commission is set to undertake a market study into the Retail Grocery Sector
On 17 November 2020 the Minister of Commerce and Consumer Affairs announced a market study into the retail grocery sector through the Commerce Commission under Part 3A of the Commerce Act 1986 (Act)....
Court of Appeal cuts fine for Steel & Tube’s breaches of the Fair Trading Act 
The Court of Appeal in Commerce Commission v Steel & Tube Holdings Limited [2020] NZCA 549 has set aside last year’s High Court decision under the Fair Trading Act 1986 (FTA) where it imposed a ...
My way or the highway: repudiation, cancellation and dispute resolution clauses
In Jade Residential Ltd v Paul, the Court of Appeal reviewed two issues which may arise in contractual disputes: The right to cancel a contract for “partial” repudiation; and Whether an aggrieved...
Making up the shortfall: Subcontractor awarded an interim injunction requiring head contractor to hold its retentions in a separate trust account
In a recent High Court decision,[1] Hanlon Plumbing Limited (Hanlon) successfully obtained an interim injunction on a without notice basis requiring Downey Construction Limited (Downey) to pay retenti...
16.11.2020 Posted in Construction Law
Send us an enquiry
For expert legal advice, please complete the form below or call us on (09) 375 8700.
  • This field is for validation purposes and should be left unchanged.
-->