In a matter of days, many of New Zealand’s trusts will face a change that’s set to increase their annual tax rate by a whopping 18%. This shift, impacting nearly 50,000 trusts, is tabled to hit with the new financial year starting April 1, 2024.

 

The catalyst? A leap in the trustee tax rate from a flat 33% to a flat 39% targeting NZ trusts with trustee income over $10,000 — those that significantly contribute to the sector’s tax pool.

The eye-watering figures don’t stop there, according to the Finance and Expenditure Committee, the top 5%, or roughly 9,000 of 177,000 trusts, accounted for nearly 80% of this tax income, paying $13.3b of a new estimate total trust tax of $17.1b.

This adjustment is designed to align the trustee tax rate with the top individual marginal rate, a move initiated by the former Labour government without the progressive income tax thresholds afforded to individuals. The introduction of the 39% tax rate in 2021 led to a ballooning of taxable ‘trustee income’ from $11.4 billion in 2020 to $17.1 billion in 2021, as per Inland Revenue (IR) data1. This shifting from allocated beneficiary income back to trust income maintained a maximum tax rate of 33%. The benefit of that retained income is now gone.

As a result, many investors, accountants, lawyers, and wealth advisers have been reviewing their and their client asset base to advise the best course of action. The result, a flock towards Portfolio Investment Entities (PIE) in particular, managed funds, who benefit from a capped maximum tax rate of 28%. Assets that can be comparably shifted into the PIE regime can save investors up to 40% on their tax bill, equating to 0.55% of the asset value per annum in a majority of years.

 

The Impact on New Zealand Trusts

The initial tax proposal presented a flat trust tax change to 39%, up from the 33% on trustee income. Many trusts, tax advisers, and industry bodies highlighting that most trusts don’t have high income (often due to beneficiary income distributions), with calls to create exemptions to limit the over taxation and financial burden this would create on many.

This week, the Finance Minister Nicola Willis welcomed the proposed changes, which emerged from the Parliament’s Finance and Expenditure Committee’s review of the Taxation (Annual Rates for 2023–24, Multinational Tax, and Remedial Matters) Bill. The revisions aim to balance the tax rates for high-income individuals and trusts, ensuring fairness across the board.

The final report, presented now for Parliament, said “We broadly agree with the proposal in these submissions that trusts with income below a de minimis threshold be taxed at the lower rate… (sic) These amendments would mean that, for the 2024–25 and later income years...(sic): 

  • trusts with trustee income up to and including $10,000 (after deductible expenses) would continue to be taxed at 33%
  • trusts with trustee income of more than $10,000 (after deductible expenses) would be taxed at 39%.”

The 39% tax change is expected to impact approximately 49,000 of New Zealand’s 400,000 trusts, with the rest remaining unaffected.

Additionally, the committee has recommended measures to simplify tax compliance for estates and trusts, especially those set up for disabled individuals, and exclude certain trusts from the heightened tax rate.

The upcoming shift in tax regulations could have a profound impact on the tax obligations of New Zealand trusts, particularly those that generate a significant portion of the income. With $470 billion in assets distributed among 150,000 entities, trustees are now critically evaluating their asset allocation, distribution strategies, and the fundamental purpose of their trusts.

Of note, investments in shares have seen a substantial increase, more than doubling over the past decade to 2022. The Inland Revenue’s Trust Disclosure report from November 2023, covering the 2022 tax year, highlighted an impressive $91 billion invested in shares.

 

A Strategic Pivot to owning PIEs

But here’s the silver lining - trusts can potentially mitigate some of this impending financial impact. How? By strategically shifting some investment assets into funds with a PIE structure. These benefit from a top tax rate of 28%, a game- changer that’s already enticing both investors and advisers. This pivot not only shields trusts from the full force of the tax hike but reduces their tax obligation and also underscores the agility and foresight needed in today’s investment landscape.

Although the $91 billion also includes ownership of private businesses, which are ineligible for the PIE regime, there exists a considerable pool of publicly traded assets including those listed on the NZX, but more commonly abroad via major markets. These assets are often held directly or through foreign funds and Exchange-Traded Funds (ETFs). With the expansion of PIE- structured funds, many of these publicly traded assets can now be aligned with a similar strategy in a PIE. This approach places assets into a well-diversified fund that benefits from a capped tax rate of 28%, offering a tax reduction of up to 40% in average and above average years compared to the 39% tax rate on directly held shares.

This presents an efficient and effective way to minimise the overall tax burden, while still achieving the same underlying investment objective.

Important to note is that investors, wealth advisers, and accountants, need also to pay attention to the Foreign Investment Funds (FIF) tax obligations.

FIF tax targets New Zealand tax residents with investments in offshore entities not registered on the NZX or ASX, levying tax on the year-over-year appreciation of these assets, not merely the dividends or income they generate. Among the various methods for calculating this tax, PIE structured funds are mandated to use the Fair Dividend Rate (FDR) method, which assumes a 5% “deemed dividend” based on the portfolio’s value. For a 28% PIR investor, this creates a 1.4% annual tax obligation, less the correct capturing of foreign tax credits for dividend withholding taxes.

Ahead of the 1st April 2024, numerous investors are strategically transitioning their international investments (such as direct stocks in companies like Apple, holdings in Australian Unit Trusts, or shares in foreign-listed ETFs) to PIE-structured funds. The motivation? Trustees and investors are cognisant of the benefit of holding assets via the PIE regime, however, if they retain their foreign assets and then decide to sell part way through the year and then move into the PIE structured funds there is the potential to end up with a higher tax bill – paying tax under the foreign investment fund rules using the FDR or CV method up until the point in time they are sold, then again for the remainder of the year under the periodic FDR method once moved into the PIE. As a result, a timely assessment and consideration of foreign assets is also needed as part of any investors strategic move into PIEs. It is not a 31 March deadline, but something decision makers and advisers may not want to leave too long.

Outside of international assets, the trust tax changes also act as a timely reminder for investors to consider how they are managing their local cash assets. With a growing range of cash and enhanced cash fund options, there are now attractive ways to generate higher yield while also benefiting from the PIE capped tax rate of 28%, a material saving vs having cash taxed at 39%.

Examples of tax impact on cash can be found here: https://kernelwealth.co.nz/blog/why-cash-funds-can-be-great-alternatives-to-term-deposits-or-saving-accounts 

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1 https://www.ird.govt.nz/-/media/project/ir/home/documents/about-us/tax-statistics---current/trust-disclosures/trust-disclosures/trust-disclosure-information---2022-tax-year.pdf