KEY POINTS:
More than 70 per cent of family trusts are open to challenge, and 20 per cent of those are at serious risk of being bust right open. So says Mark Maxwell, author of a new book: Trusts - A Kiwi Sham?
Maxwell has a website called Integritytrust.co.nz which features a free Trust Bust test. Most trustees using it have found their trusts open to some level of legal challenge.
Despite what the TV advertisements suggest, protecting your assets with a family trust isn't just simply paying a few hundred bucks and buying a trust as you would an iPod or tent.
It's not just ex-spouses and the kids' ill-chosen partners that the 200,000 New Zealanders who have family trusts need worry about. Business creditors, the Inland Revenue Department (IRD), and Work and Income New Zealand (WINZ), could fight to have your trust declared a sham, says Maxwell.
If they win, the trusts' assets are returned to you, allowing partners, business creditors and the government agencies to fight for a cut.
The biggest risks that open trusts to legal challenge, says Maxwell are:
* Trustees not participating in decision-making and as a result breaching trust law
* Failing to hold meetings and write up documentation
* Producing no financial statements
* Intermingling trust and personal assets
* Ignoring gifting procedures
In many cases people try to manage their own trusts without being fully aware of their obligations, says the Public Trust's managing solicitor Auckland, Henry Stokes. "This is an absolutely crucial part where a lot of people let themselves down."
Maxwell's advice to people with family trusts is if they are in any doubt about their trusts to get a Warrant of Fitness done by a trust specialist and ensure they carry out any remedial work advised.
When it comes to legal challenges of trusts, by far the majority come from ex-partners who have been denied a cut of the family home or other assets at the time of a break-up. "Invariably it is the individual not the trust being sued," says Maxwell.
Another common scenario, says Maxwell, is an elderly person who is applying for a rest home subsidy. If they have put assets in a trust and gifted to the trust over the years, WINZ might try to challenge the trust as a sham and have the assets returned to the individual's ownership, so that he or she would no long qualify for the subsidy. Maxwell expects to see this become increasingly common as the trust generation ages.
Family law specialist and author of Untying the Knot Vivienne Crawshaw cites the example of a Haumoana farm owner whose farm was in trust, but he took drawings from "his" business, which was relationship property, and applied it to the farm. His ex-wife was paid half the increase in the value of the farm during the time of their relationship: "a whacking great $200,000 on top of half the house and business."
Lawyer Ross Holmes remembers one case where a family was taken to court by the IRD for using a trading trust to ensure that their income paid by the trust was sufficiently low to qualify for family assistance payments of about $10,000 per year. The couple used the trust bank account as if it was their own - buying groceries and day-to-day things with it.
Your beneficiaries can even take court action if they feel they have been cut out of the family trust, or if as beneficiaries they believe you aren't managing their inheritance properly.
Holmes, who sells off-the-shelf trusts, says there is a big problem in the industry with both private and professional trustees who don't carry out their obligations correctly, putting the trust at risk.
It isn't necessary, he says, to hire high-priced professionals such as himself to manage simple trusts. You do, however, need to educate yourself if you want to be sole trustee of your own trust.
Holmes, author of Successful Trust Management - a guide for DIY trust management, warns against getting family and friends to be trustees if you're not going to consult them and keep proper records of those meetings.
Independent trustees are worthwhile when it comes to trusts with complex affairs and people who want a trustee to manage the trust when they die, says Holmes. Stokes says having an independent trustee and annual meetings can ensure you don't continue to treat assets as your own. "That is quite a crucial part of what courts look at if someone does challenge a trust structure."
TAX
There are many taxation traps people with trusts can fall into, says Vinita Gordon, accountant at Lowthers Tax.
The first is to ignore the gifting rules. These rules allow you to gift $27,000 a year [or $54,000 if you're a couple] into your family trust. The advantage of this is that if your family home is in the family trust and you're owed a debt by the trust for that home, you can forgive that debt over a number of years.
One of the main reasons to do this is to ensure that business creditors cannot make a claim against the property. While the trust still owes you a debt, that debt to you can be taken into account in determining payments to your creditors, says Gordon. "You could be forced to call upon the debt."
Also if you "gift" to the trust, by for example paying the mortgage on a family home owned by the trust out of your own pocket, and don't follow the rules, the IRD could hit you up for gift duty.
Gordon says another reason to keep up with a gifting programme is that if you want to apply for a rest home subsidy from the government, you need to have completed your gifting five years before you move.
Gordon warns that setting up a family trust specifically for the purpose of avoiding a tax liability won't work. "The IRD can have that trust wound up. They treat it as a sham and get the property out."
PROPERTY INVESTMENT AND TRUSTS
Woe betide the property investor that gets his or her trusts in a pickle. Many first-time investors have no idea how to protect their equity.
On one hand, says Maxwell, many property investors hold their properties in loss attributing qualifying companies (LAQCs) so they can claim any real losses, or accounting losses from depreciation and other costs of running the property, against personal taxes. But property in an LAQC remains part of the family assets, putting it at risk if there is a relationship breakdown or business failure.
On the other hand if you put the investment property into a trust, you ring-fence the equity, but you can't claim the losses to mitigate your personal tax. You can, however, says Gordon, roll the losses forward to offset against future profits, providing you file tax returns.
One of the common intermingling problems that trust lawyers see is where a property owner has the rents banked into a personal account rather than the trust's own bank account, opening it to challenge.
* Individual trustees can join the NZ Trustees Association as a Family Trust Member. www.nzta.org.nz
* Trusts - A Kiwi Sham?, $29.95, will be published later this month and be available from online bookseller Good Returns Bookstore in April and local bookshops in July.