Written by Vicki Holder
Trusts are often established for very specific reasons, and trustees are required by law to manage a trust’s assets in line with those reasons. A trust’s purpose can be amended, or the trust can be wound up, but this will incur legal fees. Actions such as these require consensus among the trustees and may have tax implications, so it is important, when setting a trust up for property ownership, to consider your investment objectives and how you want to manage the asset. There is not much point in appointing an independent or professional trustee if you don’t intend to involve them in decisions concerning the trust’s assets.
So, what is a trust?
A trust is an equitable legal arrangement between two main parties – or three including the beneficiaries – which is documented in a trust deed. The three parties – settlor, trustee, and beneficiary – are involved in the following manner:
Assets in a trust are not owned by the person setting up the trust, rather they belong to the trust. If trust assets are treated as personal assets, then a trust should not have been set up in the first place and the trust may be considered a sham trust. Professional trustees can be employed; their role includes administering the trust and working with other trustees to look after the beneficiaries. This can protect a trust from the risk of being categorised a sham trust, which would greatly mitigate the asset protection feature.
A company can be used as a trustee to reduce personal liability. If you use a company structure and you’re the director and shareholder, this will provide more protection for your personal assets from claims by creditors of the trust, because it is the company that is the trustee.
Why should someone have a trust?
The most common reason to use a trust is to protect assets from a potential claim by a future creditor.
Other key reasons are: transfer of family wealth or inheritance through generations; providing a fund for someone who cannot look after assets on their own; managing family wealth; for a charitable purpose; or for tax reasons.
Many property owners are salaried and not sole traders or in partnerships, and accordingly may struggle to find a reason for a trust as they don't have business creditors to protect assets from. However, someone who owns a business or has a senior role in a business should consider establishing a trust for their assets.
Take the case of a director of a company with 20 employees, $1m of bank funding and a 10-year lease on premises.
Some potential claims on the director’s personal assets may include:
Generally, a trust can be set up to mitigate a potential claim from a future spouse or partner, and to ensure pre-relationship property remains separate for a particular purpose or for the benefit of children. The involvement of an independent trustee can be a sensible mechanism to reduce emotional stress in the administration of a trust and to mitigate against undue influence in trustees’ decisions.
Gower Buchanan, Director for Ray White Damerell Group Ltd says, “We commonly see the presence of independent trustees to ensure trust assets are administered correctly for the benefit of family members as identified by the trust deed. An independent trustee is another set of eyes that we welcome to ensure our clients get the best possible outcome.
“It is imperative to get an authorisation from all trustees when starting to market a property to ensure that a sale is consistent with the trust’s intentions or purpose. While we don’t refer to the trust deed in most cases, we do put faith in trustees collectively discharging their legal obligations around trust administration,” says Buchanan.
Protection from Bright-line Test changes
If you anticipate becoming self-employed in the future, you should consider putting future property purchases into a trust from the start to reduce any impact from the recently introduced Bright-line Test arrangements, particularly as the Labour Government has signaled it intends to raise the bar from the existing two years to five years as part of its 100-day plan.
It may not be clear to everyone that, when a property is transferred from the settlor’s name to the trust, this amounts to a legal change of ownership and could attract capital gains tax, says Buchanan. Even though the settlor may become both a trustee and beneficiary and feel that there has been no material change in their day-to-day relationship with the property, it is imperative that tax implications are considered, as no one likes a nasty surprise from the Inland Revenue Department.
“If you’re considering a change in the ownership of an asset, whether that be via moving the asset into a trust or into a company or vice versa, and within a five-year period, we strongly recommend you seek legal and tax advice to ensure your wealth is protected and you can plan for any tax ramifications,” says Buchanan.
Why were trusts popular in the past?
“Trusts have historically been seen as a mechanism to separate and protect assets,” says Buchanan.
The amount of estate duty charged (40 percent) was once a reason for families to set up trusts. By moving property into a trust, capital gains on these investments were not subject to tax at the higher rate.
Superannuitants were targeted with a surcharge on their income once certain thresholds were reached and, historically, trusts were used to house passive investment assets and compartmentalise revenue below these thresholds.
As discussed earlier, trusts have long been a mechanism to separate relationship property from personal property.
What are the benefits of trusts today?
As we live longer, trusts can be effective in managing wealth and allowing income to be received by later generations while the current generation is still alive. Trusts can be particularly relevant in unfortunate family circumstances where dementia or Alzheimer’s disease afflict an elderly family member, ensuring that their wishes for asset management and distributions can be carried out even after they lose the capacity to make those decisions themselves.
A trust is taxed at 33 percent on its income, unless the income is distributed to beneficiaries, in which case it is then taxed at each beneficiary’s marginal rate of tax. Beneficiaries with lower incomes, such as children aged 16, or older at university, will pay tax on that income at lower rates.
An Auckland couple, who recently bought into a commercial investment block in Ponsonby, created a trust and named their university-age children as beneficiaries. This allowed the investment returns to be taxed at the children’s lower rates, and those distributions are now used to pay the children’s university and travel expenses. When the investment is eventually sold, any tax-free capital gains will go to the children.
Capital gains made by trusts are generally tax-free, although there are exceptions, such as when a property is bought with the intention of disposal, or the two-year Bright-line Test applies (soon to be five years). Trusts with charitable purposes benefit from favourable tax treatment, which reflects the social good they do for their beneficiaries and the community at large.
“While we don’t often deal with charitable trusts, a government registry provides a helpful resource and assists us in determining whether we have contracted correctly with the charitable trust to market their property,” says Buchanan.
And, of course, there are general asset protection reasons.
Are there threats to trusts?
The Law Commission has suggested changes to the law surrounding trusts, some welcome, some not. The privacy around trusts could change with the proposed requirement to inform someone they are a beneficiary.
Complexity is another threat that makes it harder for those people who are not familiar with trusts to feel comfortable with being a trustee. Along with appointing people prepared to accept the responsibilities, it will become harder to find people with the relevant skills who are prepared to be trustees.
With increased complexity comes increased costs and the need to prepare financial statements, file income tax returns and appropriately manage the trust. Legal fees can be upwards of $1000 or more to set up a trust, and there are ongoing accounting costs to run them, which vary depending on the complexity of the trust.
You could appoint a friend or other independent person as trustee, but if they don’t know what they’re doing, there’s potential for error or the risk that the trust is viewed as a sham. Property owners need to be clear – do the benefits outweigh the costs?
An increasing issue for trusts is where beneficiaries are based overseas. For instance, distributions to beneficiaries in Australia could generate significant tax consequences in that jurisdiction, and foreign trust disclosure rules have recently been formalised and extended.
There is also the possible application of the Residential Land Withholding Tax, which may need to be deducted on a property sale, should the trust be considered an offshore person.
Winding up a trust
If you don’t need your trust anymore and want to wind it up, you must sell off all the assets, if there are any, as well as pay any taxes that are due. You must also pay off obligations like mortgages and creditors, and ultimately distribute any remaining assets to beneficiaries. Clearly, these requirements incur costs.
Are trusts still relevant today?
Buchanan considers trusts to be an integral form of property ownership that won’t be leaving us any time soon. For the right purposes, trusts are even more relevant today, particularly regarding asset protection for business owners. It is always good to ask: does the original reason my trust was set up still apply? If so, then retain it. Otherwise, perhaps wind it up or reduce the number of trusts you have, to reduce complexity and cost. If time has elapsed since establishing your trust, it’s worth revisiting the issue with your accountant to check the details.
Trustees generally have discretionary powers and authority, and they also have responsibilities. Trustees manage trusts on behalf of trust beneficiaries and can, in some cases, be held accountable for their actions or failures to act.
A trustee, as the owner of the assets, is personally liable for liabilities incurred in the performance of the trust, for example, for the payment of income tax on income earned. Before becoming a trustee, it would be wise to take legal advice to ensure you understand the limit and extent of your liability.
Article put together with help from:
Gower Buchanan – Ray White Damerell Group’s Director and Leicester Gouwland, Crowe Horwath.
About Crowe Horwath: Crowe Horwath New Zealand is the largest provider of practical accounting, audit, tax and business advice to individuals and small and medium businesses, working from a comprehensive network of over 20 offices. Crowe Horwath is part of a global accounting network that delivers high-quality audit, tax and advisory services in over 100 countries. The company is the relationship that you can count on – large enough to offer a range of expertise and skills – and small enough to provide the personal touch.
This article provides general information only, current at the time of dissemination. Any advice in it has been prepared without taking into account your personal circumstances. You should seek professional advice before acting on any material.