To trust or not to trust
Although this sounds like relationship advice, I’m nowhere near qualified enough to write on this topic. Instead this brief article looks at whether you should be forming a Trust or not.
With approximately 500,000 trusts currently set-up in New Zealand it feels a bit like every man and his dog has a trust and it gives a false sense of requirement to have one. Just because your neighbour has a trust it doesn’t mean that you must have one as well.
Instead look at your reasons for wanting a Trust and also the obligations and responsibilities that come with it. Trusts are generally established for reasons like asset protection (from creditors, partners etc.), intergenerational wealth transfers, means testing, taxation etc.
However, Trusts can also be pulled apart if the sole purpose of the trust is to defraud creditors, reduce your income assessment used in means testing by government agencies (child support and residential care subsidies), or if the Trust is not administered properly. In a few instances Trusts have been declared by courts as “sham” and have been found to be “operating as an alter-ego for the settlor”.
Going back to the fundamentals of Trust law, if you’re settling a trust you are giving away all your rights to the assets you move into the trust and entrusting other people, the Trustees, to look after them. Generally, you will become one of the trustees in order to keep some control on how the assets are being used. However, this raises another issue; you as a Trustee are personally liable for any GST and income tax liability not paid by the Trust.
I mentioned above that taxation may have been one of the reasons people set-up trusts. A few years ago when the highest personal tax rate was above the Trust tax rate of 33% there was an incentive to redirect income through the Trust so you could get the advantages of a lower tax bill. However, this is no longer the case, with the top individual tax rate currently set at 33% as well.
Also, distributing income to beneficiaries may be trickier than thought, with a distinction needing to be made between capital and income distributions. The tricky part is that not all Trusts give their Trustees the discretion as to what income to distribute, so you could be left with some earnings unable to be transferred to the beneficiaries.
Trusts are also time consuming and costly to set-up and administer. Greg Sheehan, CEO RightWay Ltd, has a favorite saying when it comes to Family Trusts- “don’t waste your time and money if you don’t plan on administering them properly”, because this is exactly what many people are doing. The Law Commission has recently published its recommendations for trust law reform. Amongst other things, these recommend significant reforms to Trustees’ duties, limitations on Trustee exemptions and indemnity clauses, and broadening the default powers of Trustees. While the final wording of the law is some way off, you can bet that it won’t reduce the administration requirement on Trustees.
Family Trusts also run the risk of disagreements and even breakdown in relationships between family members over the way the Trust is being managed and by whom.
In summary, if you’ve decided to establish a trust, do it properly. Have all the decisions documented, administer it correctly, accept that your assets are no longer yours and act like it. Don’t think that you can use a Trust to reduce your other liabilities (child support or residential home care repayments) as there have been many changes put in place to deal with these situations. And one last thing, don’t listen to your neighbour, unless he/she is a tax advisor!
So if you’re more confused than before, or this article has sparked a lot of questions, then send us an email or raise it with your accountant or lawyer next time you see them.
Article republished with the permission of Greg Sheehan - CEO of RightWay
03 Dec 2013 by The Team at RightWay