Matt’s Frequency Series (Opinion) - Where is the Trust Tax Rate Going?

Where is the Trust Tax Rate Going?

This question hit the news the other day when the government announced it would fund the IRD to look at how “the wealthy” used Trusts. This is seen as building a factual case to justify higher taxes.

Taking the longer view, the last time the top personal tax rate was 39% delivered a clear lesson. That lesson was “make sure your top rates are aligned across individuals, companies, and trusts”. Without that alignment it was like asking water to flow uphill.

To stop that water finding its own level with the last set of different top tax rates we had the snappily named new rules ‘Personal Services Attribution Rules’ (still in force) and eventually a decade later the Penny and Hooper case which gave rise to the IRD’s Revenue Alert 11/02, recently re-released as Revenue Alert 21/01.

It seems that advice about keeping the top rates all the same has not been forgotten. While offered by officials it seems to have been deliberately not followed when the personal tax rate went to 39% recently. One observer said they thought the limited increase in top tax rates was the minimum nod in the direction of addressing the politics of jealousy that could be made.

But the question was where is the Trust tax rate going? and the answer of course is that no one really knows, however I will work through my thoughts on where it might go and why below.

There is quite a bit of uncertainty around tax at the moment with the interest deductibility “rules” being introduced with a four page press release, and now followed by a 143 page discussion document. All of that is following a increasing trend of erratic un-signalled tax changes legislated in arrears. Not a good look.  As a number of commentators have pointed out that the core housing issue is land use policies. That is hard to fix through taxation of income.

So a more useful question than where tax rates are going might be “would it cause me issues I don’t need to have” if the Trust tax rate did go up?

Well in fact the answer is “quite possibly”.

Currently the top tax rates for individuals is 39% above $180,000 of taxable income. For Companies there is a flat rate of 28%, and for Trusts a flat rate of 33%. If the same individual, company, or Trust invests in a PIE fund, then their top tax rate on that PIE income is only 28%. I’m sure you can see the disconnect between the rates.

There are a few factors as to why the 39% rate only in the hands of the individual are fairly ineffective at the moment:

First would be the ability to allocate income from companies to shareholders for work done, the ‘Shareholder Salary.’

Second would be the ability of companies to hold onto their retained earnings, currently only taxed at 28%, by delaying dividends. When passed to shareholders those dividends require the company to step the tax up to 33%.

Third would be the ability of Trusts to pass on their income in any year to their beneficiaries.

Taken together there is very little need for anything other than income from personal exertion to be paid at the higher tax rate of 39% under the current rules. If you also follow the rule of generally being personally worthless the shocks of the current or new proposed Brightline tests will also fall at lower tax rates. 

So the most likely place a change in Trust Tax rate will cause problems is undistributed retained earnings in companies. These are sitting taxed at only 28%, avoiding a step up to 33% in the meantime.

That 39% personal tax rate only applied from 1 April 2021. With new clients arriving all the time we are already seeing where individual company owners cannot now access previous years retained earnings from companies without lifting the tax rate to 39%. Many of these had no need to keep the money in the company, or worse were already borrowing money from the company. The penalty of that poor management of retained earnings is around $8,333 of tax for each $100,000 of retained earnings shown on the balance sheet.

If your company is substantially owned by your trust, and we think it legitimately should be for asset protection purposes, then you may face a similar unnecessary tax of $8,333 per $100,000 of retained earnings shown on your balance sheet if the Trust tax rate goes up.

So those are the main pain points of a potential increase in the Trust tax rate to 39%.

Personally, I think tax rates will increase, and that the Trust tax rate is one of those tax rates going up. Why do I think this? The move of the personal top tax rate being put to 39% was called out by all the officials as reopening well known loopholes from well before the Penny & Hooper case was brought in 2011.

I think this is a careful setup for more moral outrage about the absolutely predictable. I’m not sure what the current figures are, but in 2019 tax from individuals was the lions share of all tax paid. 12% of individuals paid just under 50% of that tax. The politics of jealousy never go out of fashion, and if the Trust tax rate goes up I just can’t see the 80-90% of people paying the other half of the tax being upset about it.

If anything in this opinion piece causes you concern over your own situation or you are unsure and would like to discuss it further please feel free to contact us today!