How is a Trust’s Income Taxed?

Income earned by a trust can be either retained by the trust or it can be distributed to the trust’s beneficiaries. The following article provides some guidelines on the taxation consequences of these two alternatives.

Tax on trustee income

Trustee income is the income that a trust receives that the trustees decide to retain in the trust. In this instance, tax is payable by the trust, or more accurately, by the trustees. This tax is calculated at the flat rate of 33 cents in the dollar.

The trustees are liable for tax on all income derived from New Zealand, irrespective of where the trustees reside. The trustees must also pay income tax on income derived from outside New Zealand where any settlor is resident in New Zealand at any time during the income year.

If a trust’s residual income tax at the end of an income year is $2,500 or more, the trust will generally have to pay provisional tax on the following year’s income.

Tax on beneficiary income

For income distributed to a beneficiary there are different taxation consequences. This depends on whether the beneficiary recipient is a New Zealand resident or a non-resident.

A New Zealand resident beneficiary is liable for New Zealand income tax on all beneficiary income from any source in the world. This will be taxable at the beneficiary’s normal tax rate, which will vary depending on the total income earned by them.

Again, provisional tax will be payable if the residual income tax earned is $2,500 or more.

In 2001, the then Minister of Finance Dr Cullen introduced the ‘Kiddy Tax’ to be effective from 1 April 2001. This deemed distributions of beneficiary income to children who are under 16 years of age (minors) to taxation at a final tax rate of 33% regardless of the tax rate that would otherwise apply. There are some limited exceptions to this, including the payment to a minor of income not exceeding $1,000 per income year.

Overseas beneficiaries

Non-resident beneficiaries only have to pay New Zealand income tax on trust income derived from New Zealand. The trust must deduct non-resident withholding tax from any interest, dividends or royalties before the beneficiary receives them; this is the final tax payable on the income.

Timing

Income can be distributed by a trust to beneficiaries at any time. However, and as our warning on page 1 of this newsletter states, most trusts, that is to say trusts with a 31 March balance date, must decide (or ‘determine’) to allocate income to a beneficiary no later than 30 September for the preceding financial year ending 31 March. This decision is usually formalised by the trustees executing a trustee resolution.

A new bill, The Taxation (International Taxation, Life Insurance and Remedial Matters) Bill, proposes an amendment which will provide more time to allocate beneficiary income from 1 April 2010. It proposes that beneficiary income be allocated by the later of:

• Six months after a trust’s balance date, or
• The shorter of the time in which the trust tax return is due or the time the trust tax return is filed.

The result of the above changes is that many trusts, at least those using a tax agent, will have up to 12 months from the trust balance date to allocate beneficiary income. This means that trusts will have up to a full year from balance date to determine beneficiary income. This is an excellent result. It is expected that the Bill will be passed shortly.