Many NZ family trusts resolve to make a distribution to beneficiaries but do not pay the full distribution to them. The unpaid portion is recorded as a debt owed to the beneficiary in the financial statements.
Debts owed to beneficiaries are often “interest free and repayable on demand”. This means the trust does not pay interest on the debt and the beneficiary can demand payment of the debt at any time.
The Trusts Act 2019 and recent changes to the Income Tax Act 2007 have an impact on debts owed to beneficiaries.
From 1 April 2020, a beneficiary is deemed to be a settlor of the trust for tax purposes unless:
- the trust pays or credits the beneficiary with interest at a rate equal to or higher than the IR prescribed interest rate; or
- the debt owed to the beneficiary at the end of the income year is less than $25,000.
The prescribed rate of interest is the rate applying to low interest loans for Fringe Benefit Tax.
Why it matters
A deemed settlor might affect the associated persons rules for the trust. This could cause extra tax on land transactions by the trust, settlor or beneficiaries.
There could be adverse tax consequences for overseas trusts if a NZ resident beneficiary is deemed a settlor and the overseas trust has non-resident trustees.
Trusts Act 2019
It has been common practice for some trusts when distributing income to beneficiaries, to hold the balance as a credit against the beneficiary’s current account, instead of paying out the cash.
A debt owed to a beneficiary is an asset in the hands of the beneficiary. However many beneficiaries don’t know the trust owes them money because trustees weren’t required to disclose this information.
The Trusts Act 2019 changes that. The Act came into force on 31 January 2021 and requires trustees to disclose information about the trust to beneficiaries.
Debts owed to beneficiaries are usually repayable on demand and beneficiaries can demand repayment. Trustees need to consider how they will manage this.
For example, the trustees may need to explain they are building up funds to pay to the beneficiary as a deposit for a first home. Or, if the trustees are using the funds for the trust’s business or investments, they need to consider whether to pay interest to the beneficiary or refinance the business.
If you haven’t already, it is time to review your Trust’s beneficiary current accounts and consider if these should be repaid and the consequences if they are not.
Get in touch with us if you have any questions about how the new rules affect your trust.