Gift duty was introduced over 125 years ago to prevent people from giving away their assets before they died to avoid payment of estate duty.
Estate duty was abolished in 1992 but, due to uncertainty regarding how its abolition might impact on income tax and targeted social welfare assistance, gift duty was not abolished at the same time.
The Taxation (Tax Administration and Remedial Matters) Bill was introduced late last year. The Bill, when enacted, will abolish gift duty from 1 October this year. The abolition of gift duty is supported by Inland Revenue. Gift duty no longer raises any significant revenue and the regime imposes considerable compliance costs on private individuals and on IRD.
Areas of concern associated with the abolition of gift duty such as creditor protection, social welfare eligibility, relationship property, child support and state housing (among others) have been reviewed in consultation with the relevant government departments. None of the departments has expressed any opposition to gift duty being repealed.
Trusts under increasing scrutiny
The transfer of assets to trusts following the removal of gift duty will be simplified. The past compliance costs associated with gifting programmes to forgive debt owed by trusts following the transfer of assets to trusts will no longer always be necessary. A transfer can now involve only one gift. The abolition of gift duty is therefore likely to result in a significant increase in the establishment of trusts by New Zealanders.
If you already have a trust you can expect that it will be subjected to increased scrutiny. It is important to be aware of some important trust related issues when considering whether you should establish a trust or if you have an existing trust.
First, the Law Commission is currently undertaking a review of trust law in New Zealand. As part of that process, the Commission released its first issues paper in November last year. That paper focuses on the history and development of trusts. A second issues paper which focuses on concerns about the use of trusts in New Zealand was released in December last year. A third issues paper to be published by the Commission early this year will deal with issues related to the variation of trusts and the length of time for which a trust can run.
The broad purpose of the Commission's review is to consider the various uses of trusts where legal ownership of property is transferred to a trust but control and enjoyment of that property is retained. Part of the first stage of the Commission's review will look at problems with the use of trusts, including issues relating to relationship property, creditor protection, qualification for government assistance and sham trusts.
The Law Commission is looking closely at what protection is presently in place for creditors, for relationship property claimants and for sustaining the integrity of our welfare system and other areas where there might be an incentive for owners of assets to transfer assets (and the income stream from them) to a trust. Following the abolition of gift duty, we can expect to see an increased focus on trusts and the transfer of assets to trusts by the Ministry of Social Development, when a person's eligibility for social assistance is being assessed.
Areas of social assistance which could potentially be affected by the repeal of gift duty include:
Residential Care Subsidy;
Working for Families tax credits and Student Allowances;
Other areas potentially affected by the removal of gift duty unrelated to social assistance but which are of concern as a matter of public policy include:
relationship property disputes.
Along with the Law Commission's review of trusts, there has been a sharp increase in the number of ‘trust-busting’ cases coming before the courts. Claimants are trying to access assets in trusts by showing that the trust is a sham, or that assets have been transferred to a trust in an effort by the person establishing the trust to deprive a claimant of access to those assets. The people who are making claims against trusts or challenging their legitimacy are generally creditors, Inland Revenue, and relationship property claimants. Trusts are increasingly coming under attack. With the ease of transferring assets to trusts after the abolition of gift duty it must be assumed that claimants will continue to look for ways to access trust assets.
Establishing a trust and transferring assets to a trust will be much easier from 1 October 2011. However, it is going to be important that the trust deed establishing the trust is very well drafted and very important that administration of the trust is in accordance with best practice. Failure to draft the trust deed appropriately or lax trust administration may mean the trust won't withstand the increased scrutiny that trusts are likely to be subjected to. This may result in the beneficiaries of the trust being unable to benefit from the trust in the manner that is intended.
Good trust drafting and best-practice administration are essential if your trust is to be able to withstand challenge or claims in the future and the trustees are to protect themselves from possible personal liability.
What your trust deed should provide for
The drafting of a trust deed should never be a ‘fill in the gaps’ exercise as the deed should be tailored to the specific circumstances and objectives of the person establishing the trust.
Careful thought should be given to selection of trustees, the extent and nature of powers given to the settlor (the person establishing the trust), the exercise of powers given to the trustees under the trust deed and the purposes for which the powers are being exercised.
The trust should be future-proofed by inclusion of provisions to allow sufficient flexibility to permit the trust to be varied to accommodate changing circumstances and family situations. It is important, however, that trustees don't use powers given to them to vary the trust deed in a way which changes the substance of the trust so that in effect a new trust is created. To do so, could have serious implications for the integrity of the trust.
Selection of appropriate beneficiaries is also very important. A narrower, rather than wide, class of beneficiaries is generally preferable for ease of administration and to limit the risk of potential trust claims by named beneficiaries (or unnamed people who form part of a class of beneficiary referred to in the trust deed) who were never likely to receive a benefit under the trust. Settlors need to remember that any beneficiary of a trust is entitled to certain information regarding the trust and its income and assets. Consideration should be given to whether there should be power to add or remove beneficiaries and who should hold this power.
Provision needs to be made for trustees to be appointed and power to remove trustees. These powers are often retained by the settlor (the person creating the trust) but the implications of the settlor holding these powers, particularly in light of other powers which the settlor might hold under the terms of the trust deed, should be weighed up as part of the initial consideration of the terms of the trust. If the settlor retains too much control then the trust can be at risk of being challenged as a ‘sham’. The extent of the settlor's powers is a balancing exercise which requires the settlor's wish for involvement and ‘control’ to be weighed up against the need for the settlor to be able to show he or she has properly passed on the legal ownership and control of the assets to the trustees.
The trust deed should specify whether the trustees can act if they have a conflict between their own interests and those of the beneficiaries of the trust.
If it is intended that the trust hold essentially a single asset (eg the house occupied by the settlor of the trust) the trustees need to be protected against allegations that they failed to diversify investments.
These are other wider issues which must also be considered when a trust is created to give the best possible protection against legal challenge. These include existing solvency issues, existing relationship property interests and taxation issues which can give rise to potential claims or financial consequences affecting the integrity of the trust or result in considerable expense to the settlors.
In this new trust environment good trust drafting is critical for new trusts. People with established trusts should be seeking advice now as to whether their existing trust deed is appropriately drafted. Existing trusts, particularly older ones, often have wide or inappropriate classes of discretionary beneficiaries and leave too many powers in the hands of the settlors, resulting in too much settlor ‘control’. Many older trusts do not offer sufficient flexibility to ‘future-proof’ the trust. Now is the time to review an existing trust deed and, if necessary, to consider options for varying or re-settling the trust to correct any defects.
The scrutiny of trusts will not be limited to the terms of the trust deed. Many trusts in New Zealand are very poorly administered. The settlor of the trust may continue to deal with trust property as if it is their own. The ‘independent’ trustee may not be involved in trustee decision-making and may just sign any papers put in front of them. Trust assets may be dealt with in ways that are not permitted under the terms of the trust deed. The needs and interests of all beneficiaries may not be considered or taken into account in decision-making. Inadequate administration or, worse, treating the trust assets as if they are not in a trust, leaves a trust exposed to claims that it is a sham and that the assets are really the assets of the settlor. Never underestimate the importance of good trust administration practice. If you are unsure whether the administration of any trust in which you are involved (whether as settlor, trustee, or beneficiary) is optimal, advice should be obtained on best-practice trust administration.
All trusts are not created equal. Trust law is a specialised, complex and rapidly evolving area of law requiring the involvement of a legal adviser who has specialist knowledge of trust law. A badly drafted trust deed, inadequate trust administration by the trustees, or exercise of control by the person establishing the trust will leave the trust vulnerable to challenge by third party claimants and the trustees at risk of liability to aggrieved beneficiaries.
If you have been considering establishing a trust, would like your trust reviewed or would like to know more about trusts generally consult a lawyer specialising in trust law.