23 March 2023

New Zealand has had a long love affair with family trusts. It is estimated that there were 300,000 to 500,000 trusts in existence in New Zealand and there was a time where it seemed almost every other person had one. However, it is possible that this love affair could be coming to an end.

With court cases whittling away some of the previously understood legal protections, an increase in compliance costs for things like the Trust Act 2019, AML requirements, an increase in the number of beneficiaries living overseas and tax compliance/disclosure obligations, the attractiveness of a family trust seems to have faded in recent times. And many are starting to ask what it is all for.

Is a family trust still worth it?

Whether a family trust remains suitable is completely subjective to your situation.

Even with some increased costs in compliance, trusts are likely to remain worthwhile for many people as they can provide benefits including:

• A level of asset protection if you face liability risks.

• A valuable means for handling and protecting the succession of family assets and potentially protecting some value or assets for children in terms of their relationship property concerns.

• Flexibility in terms of distribution of capital and income to beneficiaries from both a practical and taxation perspective.

However, if this is not the case and you’re considering whether you should wind up your trust, there are some things you’ll need to think about before you do so.

What to consider with trust wind up

First, there are specific legal requirements and processes to undertake a trust wind up. For instance, a trust deed may limit what options there are in relation to a transfer and who will or should benefit.

It needs to be determined what assets and liabilities exist and how these will be managed if they remain in the family trust or are transferred to individuals.

From a taxation perspective it needs to be understood what part of trust equity is being distributed and to whom. For instance, trust equity can be made up of income, retained income, capital gains and trust corpus. Each of these have different tax implications.

You then need to consider what happens if beneficiaries are residents in different countries, as each country taxes these differently.

If the trust wind up does happen, how will assets be transferred? Depending on the assets this transfer could result in taxation at the time of transfer or in the future.

Other considerations that can be easily managed if understood in advance but are all too often neglected resulting in significant tax implications, include:

Shareholder continuity

If a trust holds shares in a company, then the transfer of those shares from the trust could result in a “breach of continuity” in that company. Depending on the percentage of shares held by the trust, this could cause the company to forfeit any tax losses it has carried forward, or any imputation credits it holds. Both can be significant. For instance, losing imputation credits often results in affected retained earnings being taxed twice.

Trading stock

The transfer of stock or other similar property (such as some land) can trigger a taxable position on transfer. Further, that obligation could flow to the beneficiary if associated.

Depreciation recovery

When an asset that has been depreciated is transferred, a sale will occur at market value. This could result in taxable income if the value is higher than an asset’s written down value.

Brightline rule

The transfer could re-set the brightline period for residential land for the beneficiary resulting in future taxation on ultimate sale.

Sale of investments

The transfer of investments, such as shares, bonds, loans and cryptocurrency can all have unintended tax outcomes at the time of transfer.

GST

If an asset is subject to GST, then the transaction needs to be managed otherwise there could be a 15% cash cost to deal on transfer.

Next steps

Deciding whether to keep or wind up your family trust isn’t a decision to be made lightly. You should review the options carefully before progressing with a trust wind up and have a solid understanding of the implications of doing so.

Everyone’s circumstances are different so it’s important to make a plan that works for you. If you’d like some more information or advice from our Tax Consulting team, get in touch with us today.