Date posted: 15/02/2024

A two-tier trust tax rate solution for equitable taxation

CA ANZ is advocating for a two-tier tax rate structure to shield the majority of trusts from the looming shadow of over-taxation under the proposed 39% trustee tax rate.

In brief

  • Risk of over-taxation for 89 per cent of trusts
  • An underlying assumption
  • A two-tier tax rate

By John Cuthbertson and Scott Mason

If the proposed hike in the trustee tax rate proceeds without amendment, 89% of trusts are at risk of over taxation despite earning significantly less than $180,000 – the income threshold for individuals to be taxed on a marginal basis at the equivalent tax rate. Against this backdrop, CA ANZ is advocating for a more equitable approach: a two-tier tax rate structure with a de minimis rule. This pragmatic solution is designed to shield the majority of trusts from the looming shadow of over-taxation under the proposed 39% trustee tax rate.

Appearing before Parliament’s Finance and Expenditure Committee (FEC) recently, CA ANZ used data obtained from Inland Revenue under an Official Information Request, to highlight the disproportionate effect that the trustee tax rate increase would have on thousands of small trusts.

Inland Revenue data shows that of the trusts required to make disclosures, 83% had taxable income below $100,000, and 89% below $180,000 in the 2022 tax year. Further, 23% of trusts had taxable income below $1,000 in that period.

The proposed 39% rate is aimed at the 11% of trusts that earned 81% of the income, and in most cases that’s entirely fair. But it’s a sledgehammer that will have significant collateral damage. Based on Inland Revenue’s numbers, the remaining 89% of trusts will be overtaxed.

Proposal to increase trustee tax rate to 39% - The “why” and at “what cost”

Trusts and their use have been viewed with suspicion in some quarters. There is an underlying assumption that they are formed to circumvent the top personal tax rate, yet taxation is often not a consideration in trust formation. Trusts are formed for a variety of reasons including asset protection, intergenerational wealth preservation and transfer, business continuity and succession, privacy and confidentiality, providing for the welfare of beneficiaries, and charitable giving.

The proposal to increase the trustee tax rate to 39% is a blunt instrument which will lead to further over taxation for many trusts and any change should be better targeted. When the proposal to increase the trustee tax rate to 39% was announced there was a presumption that over taxation at the trustee level could be mitigated by way of income allocation to beneficiaries. However it is not always possible or appropriate to distribute income to beneficiaries:

  • Trustee obligations are determined by common law, the Trusts Act 2019, and the terms of the trust deed.
  • Trustee decisions must be made in the best interests of the beneficiaries and cannot be driven by tax considerations (for example it would not be appropriate to distribute funds where the trust was formed for wealth generation/accretion or asset protection).

Our solution: A two-tier tax rate – The “fix”

If the proposal to increase the trustee tax rate proceeds, a two-tier tax rate structure based on a de-minimis rule should be introduced. A trustee tax rate of 33% should be retained for trusts with trustee income (before any allocations) of $100,000 or less. Targeted and optional exclusions (to enable taxation at 33% or lower) could then be provided as appropriate.

Why a two-tier tax rate is needed by the numbers (trusts impacted and income levels):

  • 23% of trusts required to make disclosures to Inland Revenue had taxable income (before allocation to beneficiaries) below $1,000 in the 2022 tax year
  • 83% had taxable income below $100,000 and 89% below $180,000 in the 2022 tax year
  • Put another way, only 11% of trusts required to make disclosures to Inland Revenue had taxable income above $180,000 (the threshold for the top marginal tax rate of 39% applicable to individuals)
  • This group (the 11%) did however account for 81% of total taxable income for trusts required to make disclosure to Inland Revenue in the 2022 tax year
  • There was a similar distribution in the 2021 tax year. The announcement to increase the trustee tax rate to 39% in Budget 2023 included the following statement: “This change will mainly affect the super-trusts of the super-wealthy. In the 2021 tax year, 5% of all trusts that earned some income earned 78% of all trustee income.”

The proposed 39% tax rate is a blunt non-targeted mechanism to tax the 11% of trusts that earned 81% of trust income. Based on Inland Revenue’s numbers the remaining 89% of trusts would be overtaxed. The suggestion that income can be allocated to beneficiaries to mitigate overreach is itself overstated and the proposed exemptions are inadequate.

There is a need to “right size” tax rate alignment. Our proposal would:

  • still enable the top tier of trusts to be taxed at a higher rate, subject to exclusion where considered appropriate (for example continued use of the 33% tax rate for widely held trusts with community assets)
  • mitigate overreach for most trusts (acknowledging that some overreach already exists but is tolerated at the 33% rate)
  • substantively reduce the need to provide multiple disparate exemptions and should be preferred from the perspective of design efficiency
  • provide certainty, simplicity and minimise compliance costs - all key components of good tax policy

A 2-tier tax rate structure is easy to implement. Adopting a tax cliff (where every dollar of income is subject to tax at the higher rate if the threshold is breached) instead of a marginal rate (where only the additional income above the threshold is taxed at the higher rate) will have less fiscal cost and is likely to be more palatable to Government. This acknowledges that it will now be difficult to move the dial as the additional projected revenue from the proposed 39% rate for all trustee income will have already been included in budget forecasts (i.e. banked).

A de minimis threshold set at $100,000 provides an appropriate balance - mitigating taxation overreach for most (83%) trusts whilst providing a sufficiently wide gap to curtail gamesmanship that could arise if nearer to the $180,000 threshold which triggers the top marginal tax rate for individuals. This should alleviate concerns that multiple trusts could be formed to take advantage of the de-minimis rule given that the 6% tax saving ($6,000 at this threshold) would be outweighed by the costs to set up and administer multiple trusts – ongoing professional fees and annual costs to prepare financial accounts, tax returns and disclosures. An anti-avoidance aggregation rule could be introduced to allay any residual concerns.

CA ANZ’s proposal provides a pragmatic solution which “by the numbers” attempts to balance the potential over taxation of 89% of trusts with the previous government’s desire to align the trustee tax rate with the top individual marginal rate, clearly focusing on the 81% of total trust income derived by the top 11% of trusts.