Trusts and Business Structures
We hear a lot about family trusts. Many of us have them. Some of us are contemplating setting one up. It is opportune to review the trust animal and how it fits into the everyday lives and business of New Zealanders.
In New Zealand, trusts law is contained in both case law and statute. Most of the rules surrounding the creation and use of trusts stem from ancient principles of equity and English cases that have existed for scores, and in some cases, hundreds of years. These have changed little from their origins, although the New Zealand courts have given them their own domestic flavour. Our parliament has covered some aspects of trusts law in legislation. The main statute is the Trustee Act 1956 which mainly sets rules for the administration of trusts and their oversight by the courts.
Trusts are currently topical, not only because of their growing popularity:
- The NZ Law Commission has just completed a review of the law on trusts in New Zealand. It estimates that New Zealand has up to 500,000 trusts used for a variety of purposes ranging from ownership of the family home to use in business, for charities, and by many (e.g. Maori) to hold land and other assets collectively. It has concluded that the nature of trust relationships and the legal implications of operating a trust are not well understood. It is promulgating a complete overhaul of trust law, including the Trustee Act, to remove much of the current complexity. This will also raise the bar of compliance and reporting to beneficiaries by trustees.
- The IRD has recently announced that it will be auditing family trusts to ensure that they are paying the correct amount of income tax. The Supreme Court found in favour of IRD in the Penny and Hooper case in 2010. These Christchurch surgeons were using their family trusts to split their practice income with their wives. IRD believes this practice was widespread in many businesses as a result of accounting advice given prior to Penny and Hooper. Taxpayers had a period of voluntary disclosure during which tax concessions were available and it is now seeking out those who didn’t come forward during the amnesty.
- Gift Duty was abolished in New Zealand from 1 October 2011. This allowed the transfer of assets from individuals to trusts without the previous laborious gifting programmes which limited gifts free of duty to $27,000 per annum.
- The sanctity of the trust as an entity, which as stated above has evolved over centuries, is presently being challenged in the debate surrounding proposed amendments to the Property Relationships Act 1976. The courts have been struggling recently to decide whether the use of trusts to quarantine assets of partners in a relationship should be allowed to continue.
Many of us seek to separate our family home and assets from our business activities. A trust is a very effective vehicle for achieving this. Some have their business owned by a separate trading trust. Others have their investments in a separate investment trust.
To understand the basic concept of a trust, think separate individual, an entity, a “person”.
Some reasons for setting up a family trust:
- protecting and safeguarding family assets from personal claims against individuals arising from business liability and debts and unforeseen financial disasters;
- tax advantages in certain circumstances (spreading of the burden of income tax and insulation of assets from income, capital gains, or death taxes imposed by different governments at different times);
- confidentiality around financial affairs;
- setting aside a special purpose fund, such as education of children and grandchildren;
- maximising opportunity for eligibility for Residential Care Subsidy, and qualification for other government subsidies which are subjected to means testing imposed by different governments;
- preserving assets after the settlor of the trust has passed away for up to 80 years ;
- ensuring the children, not their partners, keep their inheritances.
- unlikely for most of us we hope, but, so long as the individual is not a “final” beneficiary, the assets of a trust fall outside the jurisdiction of and thereby attack from the Ministry of Business Innovation and Enterprise, should the individual come under the control of the Official Assignee in Bankruptcy or under investigation from the Companies Office.
- avoiding unwanted claims on the estate of a deceased person – such as from a former partner.
When setting up a trust, it is advisable to have one independent professional trustee. This will add experience to management, assist with compliance with trust law and accounting practice, and help shield the trust from the risk of falling foul of IRD – all things currently under review.
The person setting up the trust (settlor) can be a discretionary beneficiary. Grandchildren are the normally the “final” beneficiaries to ensure longevity of the Trust. Trusts can last for 80 years and trustees can be empowered in the Trust Deed to wind it up sooner. They can also have ultimate flexibility in how the income and assets are distributed along the way. Family Protection legislation can limit this discretion in some circumstances.
Trading and Investment Trusts
The Trading Trust and the Investment Trust are in essence and in format the same as the Family Trust. They are utilised for business operations and business/investment asset ownership respectively. Often, for ease of management and to add a further layer of independence and protection, a company will be the Trustee. It will hold the assets on trust for nominated beneficiaries but will not hold the assets itself. Again, it is important to have good business advisors to assist in the role of managing these Trusts - people who have business experience and acumen and are familiar and comfortable with business governance and risk issues.
A trading trust operates in similar manner to a company as a vehicle to operate business. An investment trust is utilised to own business and investment assets. Some use investment trusts to own the shares in their trading companies.
Some reasons for having a Trading or Investment Trust include :
- separation and isolation of business income, assets and risks from personal and family assets;
- isolation of the various aspects of overall business into discreetly separate entities for risk minimisation, asset protection, and for tax purposes;
- to provide a level of protection from attack under the Property Relationships Act in the event of a relationship breakdown;
- to avoid personal guarantees to banks and trade credit providers. Directors of limited liability companies are traditionally expected to personally guarantee, on unlimited terms, the operations of their company. Trustees of a trading or investment trusts are not usually so asked, so long as the trust assets are “on risk” to the extent of their value.
In summary, trading and investment trusts provide vehicles for ownership of ventures and business activities or parts thereof (often themselves owned by companies) without risking or affecting the family trust, the home and the family’s assets. The family members can be both income and capital beneficiaries at the discretion of the settlor.