Trusts continue to form an important role in the wealth management strategy of many Kiwis. Beside the need to ensure that your trust can adapt to stay true to its purpose, a recent statement from the Commissioner of Inland Revenue further highlights the importance of having a flexible trust deed.
Inland Revenue has released an interpretation statement
outlining whether income deemed to arise under tax law, but not
trust law, can give rise to beneficiary income.
Deemed income exists only under tax law and does not usually
correspond to an actual cash flow. Consequently, deemed income
cannot itself be vested absolutely in the interest of or paid to
beneficiaries, and so the Commissioner of Inland Revenue (the
Commissioner) will only regard deemed income as being beneficiary
income when:
- Trustees can vest or pay amounts which equate to deemed income
to income beneficiaries; and
- There is an explicit link between an amount of deemed income
for tax purposes and the amount vested absolutely in the interest
of or paid to a beneficiary.
When deemed income amounts for tax purposes exceed the trust law
income of the trust, the trustees' ability to make a payment
equating to deemed income will depend on the terms of the
particular trust deed, the trustees' actions and having sufficient
amounts available in the trust fund to distribute to
beneficiaries.
The need for an explicit link between an amount of deemed income
and the amount vested or paid will require a trustees' resolution,
or a provision in the trust deed itself, which clearly specifies
that an amount being vested absolutely in interest or paid to a
beneficiary is a payment of a deemed income amount. In the absence
of an explicit link, the Commissioner may regard the amount paid or
vested as a payment of trust capital or corpus.
The Commissioner's interpretation statement also includes a
number of examples which illustrate the concepts noted above.
For more information please see below (quite technical).
Alternatively please contact our Tax Team:
Phil Barlow
Tax Director
T + 64 9 414 5444
E phil.barlow@hayesknight.co.nz
Shelley-ann Brinkley
Senior Tax Manager
T +64 9 414 5444
E shelley-ann.brinkley@hayesknight.co.nz
A more indepth look...
Trusts continue to form an important role in the wealth
management strategy of many Kiwis. Beside the need to ensure that
your trust can adapt to stay true to its purpose, a recent
statement from the Commissioner of Inland Revenue further
highlights the importance of having a flexible trust deed.
Inland Revenue has released an interpretation statement
outlining whether income deemed to arise under tax law, but not
trust law, can give rise to beneficiary income.
The thing with deemed
income
In the view of the Commissioner, there is some conflict
between:
- How the annual income derived by a trust is measured for tax
purposes, which may vary from the trust law measure of income
because of deemed income amounts; and
- The method of allocating tax law income between trustee(s) and
beneficiaries for an income year, which method is based wholly on
trust law concepts.
Practically however, deemed income for tax purposes should only
be problematic when it causes the tax law measure of income in a
particular income year to exceed the corresponding trust law
measure of income.
Examples of deemed income amounts include attributed controlled
foreign company income, foreign investment fund income, and
look-through company income based on an owner's effective look
through interest.
Deemed income for tax purposes is by default trustee income,
unless it is beneficiary income under section HC 6 of the Income
Tax Act 2007 (the ITA).
To qualify as beneficiary income under section HC 6, an amount
of income derived by a trustee in an income year must:
- Vest absolutely in interest in a beneficiary of the trust in
the income year; or
- Be paid to a beneficiary of the trust in the income year or
within the time limits specified by section HC 6(1B).
The concepts of "vesting absolutely in interest" and "paid" are
unconstrained and can be as simple as a trustees' resolution that
the amounts be held in the name of the beneficiaries. However, a
trustee can "vest absolutely" or "pay" only existing property (i.e.
the income must not be future property or an expectancy).
The time limit specified by section HC 6(1B) is the later of the
date that falls within 6-months of the end of the income year and
the due date for filing the trustees' tax return (or the date on
which the trustee's return is filed if earlier than the due
date).
Because the two limbs of section HC 6 are based on trust law
concepts, the Commissioner considers such provisions require
something to have happened within the trust before a vesting
absolutely in interest or payment of deemed income to beneficiaries
will be effective. However, because deemed income amounts exist
solely for tax law purposes and may not correspond to an actual
cash flow or an accretion to the trust, deemed income cannot itself
be vested absolutely in interest in, or paid to, a beneficiary as a
matter of trust law.
Despite this impediment, the Commissioner will recognise deemed
income as beneficiary income in an income year if an equivalent
actual amount from the trust fund is vested absolutely in interest
or paid to beneficiaries within the specified statutory time
limit.
Vesting absolutely in interest or payment of
amounts equating to deemed income
Whether it is possible to vest absolutely in interest or pay to
beneficiaries amounts equating to deemed income will depend on a
combination of the terms of the particular trust deed, the
trustees' actions and having sufficient amounts available in the
trust fund to distribute to beneficiaries in accordance with the
trust deed.
For instance, the trust deed indicates what each beneficiary is
entitled to receive, and if the trust deed distinguishes between
income and capital beneficiaries, trustees may be unable to
distribute amounts which are capital for trust law to income
beneficiaries (to comply with their fiduciary duties).
On the other hand, particular flexible trust deeds may permit
such actions by defining income for trust law purposes as being tax
law income (in which case tax law income and trust law income will
be the same) or by providing the trustees with a discretion to
distribute trust capital, or corpus, to income beneficiaries.
When trustees are uncertain as to whether, in a particular
income year, their trust deed permits them to vest absolutely in
interest or pay amounts from the trust fund equating to deemed
income, the Commissioner recommends them to seek legal advice.
Examples of when deemed income will (or will
not) be recognised as beneficiary income
The Commissioner provides three examples in his interpretation
statement to demonstrate when deemed income will or will not be
recognised as beneficiary income in an income year. These examples
are outlined below.
Each example assumes that tax law income exceeds trust law
income by a deemed income amount:
- The trust deed does not define income
Because the trust deed is silent on how income must be measured,
the trustee must distinguish between trust capital and income using
trust law concepts. As the trust law income is calculated using
ordinary concepts and is less than the tax law measure, the trustee
will not be able to vest absolutely in interest or pay an amount to
income beneficiaries that equates to the deemed income. The deemed
income will be included and taxed in trustee income. This outcome
would be the case in any income year.
- The trust deed defines trust law income as income calculated
for income tax purposes
If the trust deed defines trust income as being "income
calculated under the ITA", the trust law and tax law measure of
income would be the same. To the extent there are sufficient
amounts available in the trust fund, the trustees can vest
absolutely in interest or pay amounts to income beneficiaries that
equate to deemed income after making the appropriate
resolutions.
- The trust deed defines income using trust law concepts of
capital and income, but the trustees have the power to distribute
trust capital to income beneficiaries
Although the tax law and trust law income of a trust are
different, the trust deed provides the trustees with a discretion
to vest or pay amounts that are more than trust law income to
income beneficiaries.
To the extent that the trustees actually vest absolutely in
interest or pay amounts equating to deemed income, the deemed
income will give rise to beneficiary income, but only if there is
an "explicit link" between the amount of deemed income for tax
purposes and the amount vested or paid. If there is no such link,
the amount paid or vested may be regarded by the Commissioner as a
payment of trust capital or corpus.
An "explicit link" will exist if the trustees' resolution (or
the trust deed itself) clearly specifies that the actual amount
being vested absolutely in interest or paid to a beneficiary is a
payment of a deemed income amount. For example, the trustees may
resolve that they are paying an amount to a beneficiary because the
amount of tax income exceeds the amount of trust income.
Not just deemed income
Although the focus of the interpretation statement is on deemed
income amounts, the Commissioner acknowledges that a mismatch
between tax law income and trust law income can also arise for tax
law income amounts that correspond to an actual cash flow.
For example, timing mismatches can arise under the financial
arrangement rules which cause amounts to be included in taxable
income in a different income year than the year in which income is
recognised under trust law. Tax law may also treat some receipts
differently than under trust law, such as amounts derived on the
disposal of land, which can be characterised as income for tax
purposes but as being on capital account by a trust.
The Commissioner considers that the same reasoning as for deemed
income amounts can also apply to such mismatches.