Foreign trusts: Tightening up the rules

Foreign trusts have been in the news recently. The government has now introduced legislation to tighten up the rules. But what are foreign trusts and is this important to you?

For many years there has been no need to file a tax return for your trust if none of the settlors was a resident in New Zealand since the time when the trust was first set up, the trust’s income was all earned overseas and was paid to overseas beneficiaries.

The New Zealand tax system is based on the assumption that we tax income earned or received in New Zealand. If the settlors always lived overseas and the income is earned overseas and paid to beneficiaries who live overseas, then there is no reason to tax the income in this country. The foreign tax regime was designed to avoid the Inland Revenue having to waste time checking returns for trusts where there is no tax to pay.

The problem is that some other countries charge income tax on a different basis. Those tax systems consider income earned by a New Zealand trust to be a New Zealand tax concern. So we are not taxing these trusts and often the country where the people are living is not taxing the income either. It was never intended that New Zealand should become a tax haven, but evidently some people have made use of this loophole.

Traditionally, only English-speaking countries had laws which allowed the establishment of trusts. So, for example, people in Europe and South America who wanted to set up a trust had to use the laws of another country in order to create their trust. Also in many countries you have to leave most of your estate to certain specified family members irrespective of what your will may say. Putting assets into a trust in another country was a way of getting around this. New Zealand seemed like a safe place where trusts would be enforced by our courts which are not as slow or expensive as some countries.

The Panama Papers

Foreign trusts were in the news recently because someone hacked into the records of a law firm in Panama. It seems there were some dodgy dealings going on. Apparently criminals and crooked politicians in other countries were hiding money in companies and other structures. Unfortunately this Panamanian law firm was also setting up trusts under New Zealand law for the benefit of some of their clients. So it seems that foreign trusts are no longer just a way to protect property.

Risks for New Zealand

These revelations clearly pose a risk to New Zealand’s reputation as a good place to do business. We do not want to be seen as a place where people can hide illegally acquired funds or avoid their obligations. The government came under some pressure to deal with the problem and tax expert John Shewan was asked to provide a report.

Mr Shewan’s recommendations have been accepted and the government has now introduced legislation which is expected to be passed by the end of the year.

New requirements ahead

The main new requirement is that foreign trusts must be registered. The registration forms must state the settlor, the people who have control, who has power to appoint and remove trustees or make other changes, and the trustees must be named. For each person their name, email address, residential address and tax number for their country of residence will need to be provided. Some beneficiary details will also need to be provided. Annual returns will be required to update this information and will have to include financial statements for the trust and details of distributions.

The new legislation will not require Inland Revenue to send this information automatically to all other countries but it will be available on enquiry from overseas authorities.

The new rules are unlikely to affect most New Zealanders. If you are living in New Zealand and receive distributions from a trust, you must pay the tax on income you receive unless the trustees have already paid it. New Zealand trustees must either declare the income as trustees’ income (and pay 33% tax) or as beneficiary income (taxed at the beneficiary’s rate). This has not changed and will not be affected by the new rules. 

Posted: Thu 06 Oct 2016

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