How does New Zealand treat trusts for income tax purposes?

New Zealand trusts operate under a settlor-based regime, i.e. the tax residence of the settlor will broadly determine the taxation of income derived by the trust. On a global scale, this is quite different from other jurisdictions, which tend to focus upon the tax residence of the trustees. 

As such, income derived by a trust will be taxable in New Zealand if: 

• The settlor of the trust is a New Zealand tax resident (subject to various modifications); or 

• The income has a New Zealand source. 

Definition of settlor 

The definition of settlor is therefore very important in understanding how trusts are taxed. 

A settlor is widely defined and includes anyone who has transferred value to a trust. Ask the question, “Who has given something to the trust”?   

Persons who direct another to make a settlement upon a trust will be deemed the settlor.  The person who is directed to make the settlement is ignored.   

Tax rate 

Income derived by a trust can be treated as either: 

• Beneficiary income; or 

• Trustee income.  

Beneficiary income is generally taxed at the applicable rate of the beneficiary.   

Trustee income is taxed at 33%.   

Foreign sourced amounts  

Foreign sourced amounts derived by trusts who have non-resident trustees are taxable if at any time in the income year a settlor of the trust is a New Zealand tax resident, who does not qualify as a transitional resident. 

However, this rule does not apply if: 

• No settlement (transfer of value) has been made on the trust after 17 December 1987; or 

• The only settlements made on the trust have been made by settlors who were not tax resident at the time of the settlement or at any time after 17 December 1987.  

Foreign-sourced amounts derived by a resident trustee 

Foreign-sourced amounts derived by a New Zealand resident trustee are not taxable if no settlor of the trust is a New Zealand tax resident at any time during the tax year (the person is not a New Zealand tax resident for the purposes of these provisions if they are a transitional tax resident).   

Distributions from a trust 

Where a trust makes a distribution to a beneficiary, its tax treatment is dependent upon the characterisation of the trust. Broadly, there are three types of trusts that are recognised: 

• A complying trust; 

• A foreign trust; 

• A non-complying trust. 

(N.B New Zealand legislation deems unit trusts to meet the definition of a company for income tax purposes). 

The following table provides a broad summary of how distributions to beneficiaries (assuming the beneficiary is a New Zealand tax resident) from a trust are taxed in New Zealand: 

Distribution	Complying trust	Foreign trust	Non-complying trust
Beneficiary income	Taxed at the beneficiary’s tax rate	Taxed at the beneficiary’s tax rate	Taxed at the beneficiary’s tax rate
Trust Corpus (settlements made to the trust)	Not taxable	Not taxable	Not taxable
Capital gains (derived from non-associated persons)	Not taxable	Not taxable	Taxed at 45%
Capital gains (derived from associated parties)	Not taxable	Taxed at the beneficiary’s tax rate	Taxed at 45%
Accumulated trustee income	Not taxable	Taxed at the beneficiary’s tax rate	Taxed at 45%

 

Ordering rules 

For foreign trusts and non-complying trusts, you can’t just determine that any distribution is of corpus.  There are ordering rules that prevent trusts from distributing amounts to beneficiaries that would not be subject to tax in preference of those that would be subject to tax.   

For example, a foreign trust cannot distribute trust corpus (not taxable) in preference to accumulated trustee income (taxed at the beneficiary’s tax rate).  

Specifically, distributions from a foreign trust and a non-complying trust are deemed to be made in the following order: 

• Current year income; 

• Accumulated trustee income; 

• Current year capital gains (including both associated and non-associated); 

• Accumulated capital gains (including both associated and non-associated); 

• The corpus of the trust.  

Complying trust 

A trust will be a complying trust if: 

• The trustee income does not include any non-residents foreign sourced income; and 

• The trustee income does not include any non-resident passive income; and 

• The tax obligations relating to the trustee’s income tax liability have been satisfied each year. 

In summary, a complying trust is a trust that pays tax in New Zealand at the highest tax rate and on time. 

Foreign trust 

A trust will be a foreign trust if the trust has never had a New Zealand resident settlor.  

Non-complying trust 

By default, a trust that is neither a complying trust nor a foreign trust will be a non-complying trust.  

Electing to be a complying trust 

Where a settlor of a foreign trust becomes a New Zealand tax resident, the trust would likely become a non-complying trust. 

However, the settlor may elect for the trust to become a complying trust.  The election must be made no later than: 

• 12 months after the settlor becomes a New Zealand tax resident; or 

• 12 months after the end of the transitional tax residency period of the settlor, if the settlor qualifies as a transitional tax resident.  

Where the election is made, the trust is treated as a foreign trust to the extent to which the distribution is of amounts derived before the election date and a complying trust in respect of amounts derived after the election.  

Form IR 463 must be completed to elect, the election form is found here. 

Contact your local BDO adviser today to learn more.