Yesterday we were told this would be a no-frills budget. Just a bit of business as usual. Today, the Government announced that the trust tax rate would be increasing from 33% to 39% from 1 April 2024 under the Labour Government
In support of this the Government refers to the fairness of the tax system and how other countries set the tax rates for trusts.
This is a significant move by the Government which in 2021 increased the top personal tax rate to 39% but made a conscious decision to leave the trustee rate at 33%. As with any tax change it is relatively easy to make some big picture decisions but there is significant flow on effects and already the Government has had to signal that they will have targeted measures to prevent over taxation of trusts such as deceased estates and trusts for disabled persons, however it will be interesting how the superannuation industry reacts to this as trusts are often used or the large anomaly created between the trust rate and a Portfolio Investment Entity (PIE) where the maximum tax rate is 28%.
According to the IRD most of this additional tax will be paid by around five percent of trusts. This might be true from a nominal percentage with IRD figures suggesting these five percent of trusts earn 78% of trustee income however as trusts pay a flat rate of tax the change will impact all trusts where they retain income in the trust.
The answer to this according to IRD is to allocate income to beneficiaries to utilise their lower marginal tax rates. That’s right, while IRD have stated that this is not tax avoidance in their view this is the first instance of encouraging this behaviour.
While this is something trustees should rightly consider it does ignore the other purposes of trusts. Trusts are not just for tax planning. They are also for asset protection and succession. Any allocation to beneficiaries has the result of putting assets in personal names. This defeats any asset protection the trust provides from creditors, relationship property and other claims. It can also defeat succession planning as the intention may be to make distributions from a trust but by the time this arises all the assets may be back in individuals’ names through allocation.
There are also times allocation may not be possible. The Government’s most recent tax change regarding interest springs to mind. For a trust to make an allocation it must have something to allocate. When it comes to a rental this may not exist after paying interest to the bank yet as that interest is non-deductible the trust will still have tax to pay at 39% on the net income. Another hit to landlords already suffering from decreased cashflow.
These issues, and there will of course be others, is another example of the rushed tax legislation that has become common to the current Government. The intention is for these changes to be in the budget tax bill introduced today. There has been none of the usual consultation so we can expect some significant holes in relation to the actual implementation of the changes regarding the exemptions.
This change will also bring about consideration of declaring dividends from companies. It is not a blanket rule but something that should be considered. For some, current dividend policies will still be appropriate as this income can be passed to trust beneficiaries earning less than $180,000 to avoid the 39% rate. Where dividends might be appropriate is where large dividends are likely in the next few years. This is most likely where succession is going to result in a change of shareholding, or the business is likely to be wound up. Other people who might like to consider dividends is where the company has significant retained earnings where any slow release of value is not able to be completed in a realistic time frame.
Taxation will undoubtedly become a battleground as we move towards the 2023 election, and this move by Labour is perhaps the first play in the space.
David Parker justifies the move on the trust tax rate as partly based on the IRD's research into high wealth individuals the true battleground here is a capital gains tax or a wealth tax rather than a tweak to the tax rate for trusts.
While some have described the budget as boring or no thrills, certainly to the business community this move in the trust tax rates is anything but that. We will of course be keeping you updated as this progresses and will be talking to you about what it means for your personal position.