Family Trusts in NZ: Tax and Legal Considerations

In New Zealand, Family Trusts are a popular tool for estate planning, asset protection, and wealth management. They allow individuals to manage and protect their assets while taking advantage of certain tax benefits. But before diving into setting up a Family Trust, it's important to understand the tax and legal aspects surrounding them. This blog explores the key considerations for New Zealand residents looking to use Family Trusts effectively.

What is a Family Trust?

A Family Trust is a legal arrangement where a person (the settlor) places assets into a trust, which are then managed by trustees on behalf of the beneficiaries. The trust is a separate legal entity, and its assets are owned by the trust rather than the individual. The purpose is often to provide for family members, protect assets, and potentially reduce tax obligations.

Legal Structure of a Family Trust

In New Zealand, a Family Trust is established under the Trustee Act 1956. The settlor appoints trustees, who hold the assets on behalf of the beneficiaries. The trust deed (the legal document that outlines how the trust is to be run) is crucial, as it dictates the rights and duties of the trustees, the powers of the settlor, and the entitlements of the beneficiaries.

It’s also important to note that New Zealand law requires the trustees to act in the best interest of the beneficiaries and adhere to fiduciary duties. Trustees must make decisions with prudence, fairness, and care.

Why Do People Set Up Family Trusts in New Zealand?

There are a number of reasons why people establish Family Trusts in New Zealand:

1. Asset Protection: One of the primary reasons for creating a Family Trust is to protect assets from potential creditors, claims, or legal disputes. Because the trust is a separate legal entity, the assets are not directly owned by individuals and may not be at risk in cases of personal financial troubles or divorce settlements.
2. Estate Planning: A Family Trust can help ensure that wealth is passed on to future generations, according to the settlor’s wishes. By holding assets in the trust, the settlor can avoid the probate process, which can be time-consuming and costly when transferring assets through a will.
3. Tax Efficiency: A Family Trust can help manage the tax liability of beneficiaries. It can spread income across different beneficiaries, potentially lowering the overall tax burden if beneficiaries are in lower tax brackets.
4. Privacy: Trusts offer a level of privacy because, unlike wills, they do not become public record upon the death of the settlor. This can be appealing for individuals who value discretion regarding their financial affairs.

Taxation of Family Trusts in New Zealand

While there are numerous benefits to setting up a Family Trust, it’s essential to be aware of the tax rules that apply to trusts in New Zealand.

Trust Income and Tax Rates

A Family Trust is taxed at a flat rate of 33% on income retained within the trust. If income is distributed to beneficiaries, the beneficiaries are taxed according to their individual tax rates. This can be beneficial if income is distributed to beneficiaries who are in lower tax brackets.

However, if the trust is considered a “discretionary trust,” where the trustees have discretion over who receives income, then the tax rules may differ slightly. For instance, trustees may choose to allocate income to beneficiaries who are taxed at a lower rate, thus reducing the trust's overall tax liability.

It’s important to remember that income distributed to beneficiaries must be properly documented, and trusts are required to file annual tax returns.

GST Considerations

Trusts can be involved in commercial activities, and if they generate income from taxable activities, such as renting out property, they may need to register for Goods and Services Tax (GST). However, if the trust is not engaged in taxable activities, then GST will not apply.

Legal Considerations for Family Trusts

1. Trustee Duties and Responsibilities: Trustees have significant legal responsibilities and must adhere to the terms outlined in the trust deed. They must act in the best interest of beneficiaries, avoid conflicts of interest, and ensure the proper management of trust assets. Trustees can be personally liable for any breach of trust, so it’s essential they fully understand their obligations.
2. Trustee Appointment: It’s important to choose trustees wisely, as they will hold responsibility for the trust's operations. Trustees can be individuals or professional trust companies. Some people choose to appoint independent trustees to avoid potential conflicts of interest.
3. Changes to Trusts: If changes need to be made to the trust, such as altering beneficiaries or adding assets, these changes should be made according to the procedures set out in the trust deed. The process is usually not overly complicated but must be done correctly to ensure compliance with the law.
4. Trustee Remuneration: Trustees are allowed to receive reasonable remuneration for their services, although this must be explicitly stated in the trust deed. The remuneration must be appropriate to the level of work and responsibility involved.

Family Trusts and Relationship Property

One critical legal aspect to consider is how a Family Trust interacts with relationship property laws in New Zealand. When a person is married or in a civil union, their relationship property is divided under the Property (Relationships) Act 1976 if the relationship ends. In the case of a Family Trust, assets held within the trust may or may not be considered relationship property.

For example, if a trust was created before a marriage, the assets within the trust may not be considered relationship property. However, if the trust was established during the marriage, or if the trust’s assets are deemed to be for the benefit of both partners, the assets may be considered relationship property in the event of a separation or divorce.

Recent Developments and Changes in Trust Law

There have been recent updates to New Zealand’s trust laws, notably the Trusts Act 2019, which came into force on January 30, 2021. The Trusts Act modernizes the legal framework surrounding trusts and places greater emphasis on transparency and accountability. The key changes include:

• Mandatory Record-Keeping: Trustees are required to keep comprehensive records of the trust’s activities, including decisions made, documents, and correspondence.
• Beneficiary Information: Trustees are now obligated to inform beneficiaries about the trust’s existence, its terms, and its administration.
• Trustee Duty to Act in Good Faith: The Act clarifies that trustees must act in the best interest of the beneficiaries and must consider the beneficiaries' needs when making decisions.



Conclusion

Family Trusts can be a powerful tool for asset protection, tax management, and estate planning in New Zealand. However, setting up and managing a Family Trust comes with significant legal and tax obligations. To ensure that a trust is structured correctly and operates in compliance with New Zealand law, it's vital to seek professional legal and financial advice.

Whether you're looking to protect assets, manage tax liabilities, or create a lasting legacy for future generations, understanding the legal and tax implications of Family Trusts is crucial for making the most of this powerful tool.