JUNO INVESTING ©

GIFT A LITTLE OR A LOT?

JUNO INVESTING ©
GIFT A LITTLE OR A LOT?

 

 

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WINTER 2015

By Mark Russell, Partner/FATCA Leader, PwC

Find a Kiwi who invests in shares, funds or bonds, and the chances are they own those investments through a trust.  There’s a good chance the family home is in that trust too, and perhaps a couple of rental properties to boot.  We just love trusts!

There are of course sound reasons for transferring wealth into a trust, including:

1.  Protecting wealth from claims by business creditors.

2.  Protection from other personal financial risks.

3.  Managing relationship property.

4.  Achieving more control of how wealth is transferred to subsequent generations.

5.  Splitting incomes to maximise tax effectiveness.

So how do trusts buy assets when the wealth to fund them usually arises from personal savings, the sale of a business or major asset, or an inheritance? 

Invariably the settlor of the trust advances a loan, which the trust uses to acquire the assets.   Historically the main reason for advancing a loan rather than making an outright settlement on the trust was that gift duty would apply to a settlement.  By advancing a loan, and then having the lender forgive (or ‘gift’) $27,000 of the loan each year, an exemption from gift duty applied.  Over time this gifting programme would reduce the balance of the loan, and if the trust was established early enough, eventually the loan would be eliminated.

Gift duty was abolished in October 2011, making New Zealand one of only a few countries with no gift duty or estate duty. The passing of time raises some interesting questions. Has this change had an impact on the way people transfer wealth into trusts?  With no gift duty, should someone setting up a trust or putting more money into a trust simply make a one-off gift?  For those who already have loans to trusts in place, should they simply forgive the full amount in one go?

Large lump-sum gifts do not always make sense for a number of reasons. You’ll need to consider in each case as to what the best method is to transfer wealth into a trust, even when gift duty no longer applies. So what are the factors you need to think about?

Controlling your assets

When you transfer assets to a trust you no longer control those assets – they are controlled by the trustees. Consider your circumstances; is it palatable to hand over control of your family home or business or major investments?  At least when you have a loan to the trust you have some influence as a major creditor.

While New Zealand permits the settlor and beneficiary of a trust to also be a trustee, great care is required if you are relying on your status as a trustee to control the assets.  If you act in a manner that is not consistent with the ownership of the assets having transferred to the trust, you risk the transfer being invalid and the assets remaining available to creditors.

Personal solvency

Unsurprisingly, if you prejudice the position of creditors by making a large gift into a trust, that gift may be able to be clawed back under insolvency and property laws.  It is more secure to make regular smaller gifts at a time when there is no hint of financial difficulty.  It is recommended that a solvency statement is completed at the time any gift is made, and best practice would be to get your accountant to review the statement.

Rest-home subsidies

Should you or your spouse require rest-home care in the future, the Government will only subsidise the costs if your personal assets are below certain thresholds.   Under current rules, when calculating your personal assets you must include certain amounts you have gifted.  Any amounts over $27,000 (referred to above) in a particular year will be clawed back and added to your wealth (reducing significantly for gifts in the five years prior to applying for subsidies).  It is worth noting that the $27,000 limit does not double for couples as it did for gift duty.

Therefore a large lump-sum gift will be largely ignored for these purposes.

Tax on forgiven debt

If you forgive a debt to a trust, this can result in the trust having a tax liability, unless all the beneficiaries are people for whom you have natural love and affection – family members essentially.  Care is required when having companies or other non-family members as beneficiaries. This is still an issue for gifts under a gifting programme, but the risk is magnified if making large one-off gifts.

Tax depreciation clawback

If you transfer a property into a trust where you have claimed tax depreciation, the transfer of that property can result in taxable depreciation-recovery income.

In conclusion, in some circumstances a one-off, lump-sum gift does make sense. But you need to consider all the consequences.  In many cases, a traditional gifting programme designed to prevent gift duty applying continues to make sense even now that gift duty is long gone.

 

Definitions:

Creditor: A person or institution to whom money is owing.

Gift duty: Gift duty is a duty (a bit like a tax) charged on gifts of more than $27,000 made in any one year, before 1 October 2011.

Settlor: A person who creates a trust by donating assets to be managed and administered by a trustee.

Tax depreciation: Up until 1 April 2011, annual depreciation of 3 per cent a year on the purchase price of a rental property could be offset against tax. Since then depreciation can only be claimed on chattels.

Tax liability: The amount of tax owed by a taxpayer.

Trust: A trust is a legally binding arrangement when a person (the settlor) transfers legal ownership of assets to one or more people (trustees) to be held on trust for the benefit of persons named by the settlor (beneficiaries). The trustee legally owns the property, but holds it on behalf of the beneficiaries. In New Zealand a trust is either private (created for the benefit of individuals, for example family members) or charitable (created for the purposes of benefiting a charity).