IRD guidance on trust tax tweaked over concern it was promoting tax avoidance

Revenue Minister David Parker is lifting the trust tax rate to 39 per cent to prevent people using trusts to avoid paying the top personal income tax rate. Photo / Mark Mitchell

Inland Revenue has changed its guidance on how people can avoid being “over-taxed” when the trustee tax rate goes up in April, following criticism it might’ve been promoting tax avoidance.

The tax department published a fact sheet last month explaining the ins and outs of the Government’s plan to increase the trustee tax rate from 33 to 39 per cent so it aligns with the top income tax rate for income over $180,000.

Inland Revenue noted that to “mitigate over-taxation”, income earned by a trust could be paid to a low/medium-income beneficiary of the trust. This way, the beneficiary’s personal marginal income tax rate could be applied to the income, rather than the trust rate of 39 per cent.

Inland Revenue suggested the transaction could be made purely for tax minimisation purposes – the income could be paid to the beneficiary with the intention of the beneficiary not actually spending it and/or putting it back in the trust.

Deloitte partner Robyn Walker told the Herald transactions like this, which are “circular in nature” or aren’t “genuine distributions”, could be deemed tax avoidance.

A few days after the Herald published the story last week, Inland Revenue released an updated fact sheet.

It conceded there was uncertainty under existing law about the tax treatment of income paid to a beneficiary that was then put back in a trust, and said the matter would be subject to further consultation.

One of Inland Revenue’s updated examples said, “Anthony has personal income of $70,000 and Amy has personal income of $180,000. Their trust has income of $40,000.

“If the income is retained as trustee income, it will be taxed at the proposed 39 per cent trustee tax rate…

“However, by allocating the income to Anthony as beneficiary income it can be taxed at his personal tax rate.

“To meet the definition of beneficiary income, the trustees cannot change their mind about the allocation, so he has an absolute right to withdraw the funds. If Anthony does not want to withdraw the money, it can be credited to his current account, available to be called upon at any time.”

Walker welcomed the clarification but said it still left people wondering how the current law was being interpreted.

Transferring income to beneficiaries on low income to avoid paying the trustee tax rate is an existing issue. However, the incentive will be greater for more people once the trustee tax rate goes up to 39 per cent.

This said, Walker believed that for many, it wouldn’t be worth spending say $1000 on accounting fees to save $500 on tax by moving their money around.

She pointed to Inland Revenue figures that show a decent portion (65 per cent) of income derived from trusts was treated as trustee income, rather than beneficiary income (35 per cent), in 2020 – when the trust rate aligned with the top income tax rate at the time of 33 per cent.

Walker questioned whether the bill that hikes the trust rate to 39 per cent should be amended to provide clarity on how trustees can prevent being over-taxed, without being accused of tax avoidance.

When the Herald first raised the issue with Inland Revenue, a spokesperson said the fact sheet was written to facilitate discussion around the Government’s proposal to hike the trustee tax rate and wasn’t meant to be an interpretation of the current law.

A spokesperson for Chartered Accountants Australia New Zealand said the confusion created by Inland Revenue’s guidance hiccup exemplifies why “tax changes should be the subject of a public discussion document prior to inclusion in draft legislation”.

“That gives time to ensure any change is framed accurately and appropriately.”