Trust tests
Issue: Scope of trustee for relative test
Submission
(15 – WHK Taylors)
The trustee for relative test in section YB 5 may apply more widely than intended.
Comment
Officials agree that the trustee for relative test in section YB 5 should not apply for the purposes of the land provisions. This would be consistent with the land provision exclusions in the other beneficiary-related tests in sections YB 6 and YB 9.
Recommendation
That the submission be accepted.
Issue: Scope of beneficiary-related trusts tests
Submissions
(15 – WHK Taylors, 32 – KPMG, 48 – PricewaterhouseCoopers for nine electricity lines companies, 68A – Corporate Taxpayers Group)
Energy consumer trusts should be excluded from the trustee and beneficiary test in section YB 6 because of their public nature.
Discounts to consumers from electricity lines companies owned by consumer trusts should be excluded from the dividend definition. Currently consumers, while beneficiaries of the company’s shareholding trust, are not treated as associated with the shareholder. Therefore the requirement in section CD 6(1)(a)(ii) is not satisfied. However, changes proposed in the bill are likely to result in the discounts being treated as dividends from 1 April 2009.
The scope of the trustee and beneficiary test in section YB 6 and the settlor and beneficiary test in section YB 9 are too broad and should not be adopted. In particular, the trustee and beneficiary test in section YB 6 should be amended to associate a trustee and a beneficiary only where the trust was established mainly to benefit that beneficiary.
Comment
The beneficiary-related trusts tests are important elements of the new associated persons provisions and are necessary if the provisions are to be effective. Exceptions have been included in these tests so that they do not apply for the purposes of land provisions. These exclusions are designed so that the beneficiary-related tests do not apply too broadly.
Officials agree that energy consumer trusts established under the Energy Companies Act 1992 should be excluded from the test associating trustees and beneficiaries and the trustee for relatives test. This is because such trusts (having a very large pool of beneficiaries) are public in nature and do not pose a risk to the tax base. These large public trusts are quite different in nature from private trusts, which are intended to be covered by the test associating trustees and beneficiaries.
We agree that discounts to consumers from electricity lines companies should not be treated as dividends. Excluding energy consumer trusts from the trustee and beneficiary and trustee for relatives tests, along with the recommendation in this report not to proceed with certain changes to the dividend rules, will address concerns that the reforms could mean these discounts could be treated as dividends.
Officials consider that the unit trust that administers bonus bonds should also be excluded from the test associating trustees and beneficiaries, and the trustee for relatives test. This unit trust is excluded from the unit trust definition in section YA 1 of the Income Tax Act 2007 and therefore is not treated as a company. This means that the trust-related associated persons tests apply to it.
Recommendation
That the submissions be accepted, subject to officials’ comments.
Issue: Exclusion for charitable organisations in beneficiary-related tests
Submissions
(72 – Russell McVeagh)
The beneficiary-related tests in sections YB 6 and YB 9 will have significant unintended consequences when the beneficiary of many trusts is the same charity. The trustee and settlor of each such trust would be associated with the trustee and settlor of all such trusts without being aware of the fact.
The proposed tripartite test in section YB 14 should be amended so it does not apply if parties are associated under section YB 6 (trustee and beneficiary test) or section YB 9 (settlor and beneficiary test).
Comment
Officials agree that the beneficiary-related tests in sections YB 6 and YB 9 could have unintended consequences when the beneficiary of many trusts is the same charity. This issue is best addressed by excluding “charitable organisations” (as defined under section YA 1 of the Income Tax Act 2007) from the definition of “beneficiary” for the purposes of sections YB 6 and YB 9. This would ensure that trustees and settlors of trusts which have the same charity as a beneficiary would not be associated.
The separate recommendation in this report that the tripartite test apply only to associate persons if they are each associated with the same third person under different associated persons tests, will also assist in addressing concerns about over-reach.
Recommendation
That the submissions be accepted, subject to officials’ comments.
Issue: Exception in trustee and beneficiary test for purpose trusts
Submission
(32 – KPMG)
An exemption should apply when an association arises because of eligibility to benefit under a purpose trust, such as a community trust.
Comment
Officials note that because purpose trusts do not at law have beneficiaries, the beneficiary-related tests in the associated persons rules are not relevant to these trusts.
In particular, “community trusts” referred to in the Community Trusts Act 1999 are expressly stated to be purpose trusts. These trusts were established to hold the shares in the successor companies to the former trustee banks.
Therefore it is not necessary to exclude purpose trusts such as community and charitable trusts from the definition of “trustee” in the trustee and beneficiary test in section YB 6. However, there are several existing references in the Income Tax Act 2007 that refer to a beneficiary of a community trust (sections HC 21(3) and HC 32(2)). These references are incorrect and should be amended to refer to a person who receives a distribution from a community trust.
Recommendation
That the submission be declined.
That existing references to a beneficiary of a community trust be amended.
Issue: Scope of two trustees with common settlor test
Submissions
(15 – WHK Taylors, 57 – Tomlinson Paull, 62 – Minter Ellison Rudd Watts, 68A – Corporate Taxpayers Group, 70 – Deloitte)
The two trustees with common settlor test in section YB 7 is too broad. For example, it could result in the entire client bases in a law firm being associated to each other because the firm’s lawyers were the nominal settlors of clients’ trusts. Therefore, this test should be either removed or modified to apply only to a settlor who has a beneficial interest in the trust property. The test should also only apply to settlors who have made settlements on or after 1 April 2009.
Professional trustees such as the trustee companies should be excluded from the operation of the proposed sections YB 7 to YB 9.
Comment
Officials do not consider that a professional advisor who acts as a nominal settlor will be treated as a common settlor for the purposes of the associated persons definitions. This is because under the nominee look through rule in section YB 21 of the Income Tax Act 2007, it is the client that would be treated as the settlor rather than the professional advisor, who is merely acting as a nominee. This interpretation is specifically supported by Inland Revenue’s Tax Information Bulletin, November 1989, paragraph 6.93. The nominee look through rule in section YB 21 is the successor provision of section HH 1(1) of the Income Tax Act 2004 (which concerned nominal settlements).
We note that professional trustees such as the trustee companies often act as the trustee of unit trust investment vehicles. Because unit trusts are treated as companies for income tax purposes, it is the companies-related tests – in particular, section YB 3 – that will be mainly relevant. The 25 percent threshold in section YB 3 would ensure that investors are typically not associated with the unit trust.
The two trustees with common settlor test is an important element of the new associated persons provisions and is necessary if the provisions are to be effective. Officials consider that it is not appropriate to limit the application of this test to trusts settled on or after 1 April 2009 as this would significantly limit the effectiveness of the new provisions.
Recommendation
That the submissions be declined.
Issue: Definition of “common settlor”
Submission
(Matter raised by officials)
For the purposes of the test associating two trustees with a common settlor in section YB 7, two persons who are married, in a civil union, or in a de facto relationship should be treated as the same person.
Comment
It may be possible to circumvent the new associated persons definition in the bill by the use of “mirror trusts” – that is, spouse A settles a family trust for the benefit of spouse B and spouse B settles another family trust for the benefit of spouse A. Officials consider that the test associating two trustees with a common settlor should apply to such mirror trusts. To ensure this, it is necessary to amend section YB 7 of the bill to treat persons who are married, in a civil union, or in a de facto relationship as the same person for the purpose of identifying a common settlor.
Recommendation
That the submission be accepted.
Issue: Scope of trustee and settlor test
Submission
(15 – WHK Taylors, 32 – KPMG, 70 – Deloitte)
The trustee and settlor test in section YB 8 is too broad. Therefore, this test should be either removed or modified to apply only to a settlor who has a beneficial interest in the trust property. The test should also only apply to settlors who have made settlements on or after 1 April 2009.
Comment
The trustee and settlor test is an important element of the new associated persons provisions and is necessary if the provisions are to be effective. Officials consider that it is not appropriate to limit the application of this test to trusts settled on or after 1 April 2009 as this would significantly limit the effectiveness of the new provisions.
We also consider that the settlor basis of many of the trust-related associated persons tests is consistent with the settlor focus of the trust taxation rules in the Income Tax Act.
Officials note that the separate recommendation in this report that the tripartite test apply only to associate two persons if they are each associated with the same third person under different associated persons tests will also assist in addressing concerns about overreach.
Recommendation
That the submission be declined.
Issue: Exception in trustee and settlor test for charitable trusts
Submissions
(32 – KPMG, 68A – Corporate Taxpayers Group)
Philanthropic settlements on charitable and non-charitable trusts are a common occurrence. All persons making settlements on these trusts are associated with the trust. The tripartite test would associate all such persons.
In the corporate environment, corporates can gift funds to various trusts; these trusts will now be associated.
Comment
Officials agree that there should be an exception for charitable trusts in the trustee and settlor test in section YB 8. An exception would prevent donors to charitable trusts being associated with each other. A charitable trust under the Income Tax Act 2007 is required to be registered as a charitable entity under the Charities Act 2005 and is therefore subject to the regulatory requirements of that Act. Officials do not consider that these entities pose a risk to the tax base and therefore it is not necessary to include them in the trustee and settlor associated persons test.
Officials do not consider that this exception should be extended to non-charitable trusts as they are not subject to the same level of regulation as charitable trusts registered under the Charities Act 2005. However, we consider that the separate recommendation in this report that the tripartite test apply only to associate two persons if they are each associated with the same third person under different associated persons tests will address concerns about overreach in this area.
Recommendation
That the submissions be accepted, subject to officials’ comments.
Issue: Definition of “settlor”
Submissions
(39 – Russell McVeagh, 62 – Minter Ellison Rudd Watts, 68A – Corporate Taxpayers Group, 70 – Deloitte)
The settlor concept for the purposes of the associated persons rules would be better targeted by focussing on persons who truly control or materially influence the trust’s affairs and benefits from it.
The definition of “settlor” should not include a person who provides financial assistance to a trust or who makes settlements on the trust of less than a prescribed amount (perhaps $5,000). Otherwise, beneficiaries who do not charge interest on credit current account balances and professional advisors who make nominal settlements on a trust would be treated as settlors.
The definition of a “settlor” should be defined to include the settlor only when they have some ongoing relationship with the trust.
Comment
The settlor-based test of association (common settlor, trustee-settlor and settlor-beneficiary tests in new sections YB 7, YB 8 and YB 9) use the definition of “settlor” set out in section HC 27, with the modification that a settlor does not include a person who provides services to a trust for less than market value. This modification was designed to prevent a professional advisor who provides services at no charge being treated as a settlor.
The current definition of “settlor” in section HC 27 is used extensively in the Income Tax Act. In particular, the definition in section HC 27 is used in the current common settlor and trustee-settlor associated persons tests. These tests are applied in a wide range of operative provisions in the Income Tax Act such as the depreciation, transfer pricing, thin capitalisation, share lending and international tax rules. The extensive use of this definition is consistent with the settlor-based focus of the trust taxation rules in the Income Tax Act.
We consider that the submissions to treat as settlors only persons who control or materially influence or who have some ongoing relationship with the trust would introduce an undesirable subjective element to the definition of “settlor”. It would also lead to application of the settlor-based tests being uncertain.
It would be inappropriate to have a blanket exclusion from the settlor definition for persons who provide financial assistance (for example, an interest-free loan) to a trust because these amounts could be very substantial. The current settlor definition does not contain a minimum threshold and officials consider that this approach should be maintained for the purposes of the associated persons reforms.
Professional advisors who make nominal settlement on a trust are not treated as settlors under current law – this treatment will continue under the associated persons reforms. This point is discussed under the previous “Scope of two trustees with common settlor test” issue. Officials also consider that beneficiaries who have received distributions and are not paid interest on their credit current account balances are not treated as settlors.
Recommendation
That the submissions be declined.
Issue: Scope of trustee and person with a power of appointment or removal
Submission
(15 – WHK Taylors, 39 – Russell McVeagh, 68A – Corporate Taxpayers Group, 33 – Investment Savings and Insurance Association of NZ Inc)
The test in section YB 11 associating a trustee and a person with a power of appointment or removal of the trustee is too broad and should be either removed or modified to apply only to an appointor if the tax base is threatened. The test should also only apply where the appointor has a beneficial interest under the trust. Alternatively, section YB 11 should apply only if the person has both the power of appointment and removal or just the power of removal.
Comment
This test in section YB 11 is intended to complement the test associating a trustee and settlor in section YB 8. In many cases, a settlor of a trust, as the author of the instrument creating and governing administration of the trust, retains the power to appoint or remove trustees. However, this power could be reposed in a separate person. Officials consider there is sufficient connection between a trustee of a trust and the person who has the power to appoint or remove the trustee to justify treating them as associated persons. For the associated persons definitions to be effective, it is considered necessary to include this test. Officials do not support attempting to limit the application of this test only to avoidance situations where the tax base is threatened because of the uncertainty this approach entails. Neither would officials support limiting the test to situations where the appointor has a beneficial interest under the trust because the nature of a discretionary trust means an appointor could be made a discretionary beneficiary after the power of appointment is exercised.
Recommendation
That the submission be declined.
Issue: Appointors who are professional advisors
Submission
(57 – Tomlinson Paull)
The trustee-appointor test in proposed section YB 11 could give rise to significant overreach when professional advisors are nominated as appointors. This test, coupled with the proposed tripartite test, would result in completely unrelated trusts being associated, merely because a trusted advisor has been granted the power to appoint or remove trustees.
Comment
Officials agree the trustee-appointer test in proposed section YB 11, in conjunction with the tripartite test, should not associate otherwise unrelated trusts because a professional advisor acting in their capacity has been granted the power to appoint or remove trustees by their clients. The nominee look through rule may not apply to attribute this power to clients.
Officials consider that this concern is addressed by the separate recommendation in this report that the tripartite test apply only to associate two persons if they are each associated with the same third person under different associated persons tests.
Recommendation
That the submission be accepted, subject to officials’ comments.
Issue: Exceptions for employee trusts
Submission
(Matter raised by officials)
An exception for employee trusts in section YB 15 should be made for the test associating a trustee of a trust and a person who has the power of appointment or removal of the trustee.
Comment
The various trust-related tests, other than the test in section YB 11 associating a trustee of a trust and a person who has the power of appointment or removal of the trustee, contain exceptions in section YB 15 for certain employee trusts. It would be consistent if section YB 15 also contained an employee trust exception in relation to section YB 11.
Recommendation
That the submission be accepted.