Family Trusts – To Amend, To Wind Up Or Not Wind Up

18 August, 2020 | Peter Smith

History of Family Trusts in New Zealand since the early 90s

Family trusts in New Zealand have undergone huge changes since the current wave of family trusts was initiated in the early 90s.

In 1991 Government introduced what it called a “Residential Care Subsidy” for those people who were over 65 and about to go into permanent care in a rest home or hospital.  Prior to that time, permanent hospitalisation or rest home care for the elderly was free of charge.

The Residential Care Subsidy is asset tested.  In other words, if an applicant’s assets are greater than a threshold as designated by WINZ from time to time, then the applicant is obliged to pay for their own rest home or hospital care.

The post war generation protested against this new law because they had been guaranteed by the Government of the day, after the Second World War, that they would receive free hospital treatment from cradle to the grave.

It was Law 101 to circumvent the Residential Care Subsidy threshold.  All a person had to do was to form a discretionary family trust and transfer their assets by way of sale to the family trust.  The sale price became a loan owing by the family trust to the person establishing the trust and that loan was gifted away at $27,000 per person.  The $27,000 figure was the maximum amount that could be gifted in any rolling 12 month period without paying gift tax, which was a significant tax imposed during the period up to 2010 when it was abolished.  By having their assets in a Trust those assets are deemed at law to be the property of the Trust and not the person who established the Trust, with the result that such a person qualified for the Residential Care Subsidy by virtue of having little or no significant assets in their own name.

As a result of the asset testing for the Residential Care Subsidy, literally thousands of trusts were established in New Zealand, the main purpose for which was to protect the family assets from the impact of not receiving the Residential Care Subsidy and in fact, having the Government pay for the rest home care of the persons establishing the Trust.

Another motivating factor for the establishment of discretionary family trusts in the 90s was the election of the Labour Government in 1999.  That Government imposed a tax surcharge of 6 cents in the dollar for every dollar earnt over $80,000 per year.  Under $80,000 per year the top rate of tax was 33 cents in the dollar.

The maximum tax rate payable by trustees on behalf of a trust was 33 cents.  It then became a tax saving measure to form a family trust and transfer a person’s income producing assets (properties, shares, investments) into the family trust so that the income from those assets was taxed at the maximum rate of 33 cents in the dollar.

In 2005, New Zealand First held the balance of power after the 2005 election.  New Zealand First had been elected on a promise to the elderly (the Grey Power) that they would amend the law relating to rest home subsidies so that people no longer had to form trusts.  As with many political promises, a compromise had to be reached between the aspirations of New Zealand First and the more working class philosophy of the Labour Government which was that the so called “well off” should be paying for their own hospital and rest home care.  The compromise that emerged from the 2005 election was a two-fold test.

For a husband and wife or couple, they could elect to have their house and modest savings (approximately $80,000 a year increasing at the rate of inflation) exempted from the asset testing threshold or they could have a single threshold of approximately $180,000 (increasing at the rate of inflation each year) all assets counted.^[1]

Unfortunately the legislation that introduced the New Zealand First compromise was badly drafted and resulted in litigation.  After years of going through the Courts, the legislation was clarified by the Court of Appeal in 2013 when it ruled effectively, that WINZ had the right to have their own gifting rules, which rules were different from those which the Inland Revenue Department abolished in 2010.  The Court of Appeal ruled that the effect of the legislation was that the gifting rules for WINZ permitted maximum gifting to a family trust of $27,000 per couple ($13,500 per person) or $27,000 for a person who was not married or in a permanent relationship.  This Court of Appeal ruling was backdated.

The effect of the Court of Appeal ruling was that for all couples the amount that they had gifted was halved for the purposes of qualifying for the Residential Care Subsidy.  By way of an example, if a couple had gifted $500,000 to their trust by way of gifts at the rate of $54,000 per year, $250,000 of that gifting was ruled as ineligible for the Residential Care Subsidy threshold and as a result, if one of that couple was admitted to a rest home or hospital for permanent care, then they would not qualify for the subsidy.

No doubt emboldened by their victory in the Court of Appeal, WINZ then focussed their sights on what they called, income deprivation.

The theory behind income deprivation is that if the income from a trust (bank interest, dividends from shares etc) that would otherwise be paid to a beneficiary resident in a rest home or hospital is diverted to other members of their family, or accumulated and not paid to the beneficiary in care, that income is deemed to be deprived from that beneficiary and the beneficiary’s rest home subsidy will be reduced by virtue of the amount of the deprived income.  In other words, if one is successful in obtaining a rest home subsidy using the asset test, then that subsidy may well be reduced using the income deprivation rules.

As a result of the difficulties with achieving the required asset threshold to be successful with a Residential Care Subsidy application, most people who set up their trusts in the early part of this century when we had a spike in property values, will not qualify for the Residential Care Subsidy.  Further, the current political thinking in terms of income tax is to have a “level playing field” (the income tax surcharge was removed in 2009) so that the motivation to set up or maintain discretionary family trusts has waned, to the point that activity in this area is virtually at a trickle.

Another movement in the law has discouraged the use of trusts.

The significant wealth of many family trusts has meant that when family relationships have broken up, sophisticated lawyers have attacked family trusts in the Courts on behalf of spouses who would otherwise be disadvantaged in a matrimonial property or relationship property case.

Some of the matrimonial/relationship property legislation has been fertile for legal argument with the result that some aggrieved spouses have  been able to claim considerable amounts from family trusts, in circumstances where, at first blush, it was thought that they did not have a claim.

Another major impact on trusts has been the increasing numbers of retirees among the “baby boomers” – the sons and daughters of those who returned from World War II, who comprised the main generation that was encouraged to establish family trusts.  This generation of people is now retiring and are saying to themselves:

• “We no longer are facing the risks of being in business and accordingly we no longer need a Trust to protect our assets;”
• “We no longer qualify for a rest home subsidy;”
• “The cost of maintaining our trust in annual accounting and legal fees is significant;” and
• “Our position is such that we should wind up our trust.”

Compliance costs and the disclosure regime as set out in the Trusts Act 2019

Two other issues have impacted on discretionary family trusts.

Anti-money laundering legislation

In 2018 the anti-money laundering legislation^[2] was progressively introduced to the clients of lawyers, accountants and real estate agents.

Trusts are captured structures under the anti-money laundering legislation with the result that every time trustees involve themselves in matters legal, accounting or the sale of real estate, anti-money laundering due diligence and risk assessment has to be completed. This comes at a cost.

Disclosure regime under the Trusts Act 2019

The Trusts Act 2019 represents an effort by the Government to set out in legislation the law relating to the administration of discretionary family trusts.  The Act clarifies the obligation of trustees to give beneficiaries basic trust information.  Under the Act and from 1 January 2021, trustees must advise all beneficiaries of the fact that those persons are beneficiaries of the trust.  The beneficiaries must also receive the name and contact details of the trustees and the occurrence of and details of each appointment, removal and retirement of trustees as they occur.  The beneficiaries must also be advised that they have the right to request a copy of the terms of the trust or trust information.

Trust information under the Act means any information regarding the terms of the trust, the administration of the trust or the trust property, and such information as it is reasonably necessary for the beneficiary to have, to enable the trust to be enforced.  Trust information does not include the reasons for trustees’ decisions.

Most family trusts are run, in the first instance, for the benefit of the people that set the trust up.

For example, the vast number of discretionary family trusts are set up by husbands and wives and/or partners who, with the help of independent trustees, run the trust for their benefit while they are alive, and on the basis that their children or other beneficiaries will benefit from the trust upon the death of both of the settlors.  The settlors in this example never intended that their children be involved until after their death.  The issue of having to disclose trust information to children and grandchildren is yet another handbrake on the formation and maintenance of discretionary family trusts.  Solicitors are being asked to become innovative in their drafting of trust deeds (and amending existing trust deeds) so as to severely restrict the categories of beneficiaries to whom disclosure is required.

Case by case basis

The decisions to wind up a trust or to amend a trust deed can only be made on a case by case basis because the circumstances of each trust and the families that established the trust are different in every case.

It is most important that experienced legal advice be sought in respect of the winding up or amendment of a trust.

The partners of Smith and Partners have been involved with trust advice for almost 50 years.  It is most important that if you have a discretionary family trust or are thinking about forming a discretionary family trust that you have the correct advice.  The lawyers at Smith and Partners are able to give you that advice.  Smith and Partners welcomes your phone call or email to enable an appointment with one of our lawyers.

 

[1]     The writer has been unable to confirm the exact figures for the two threshold options introduced by the Government in the first decade of the Millennium, so that the figures in paragraph 10 are approximate only.

[2]     The banking and finance industry was subject to the anti-money laundering legislation for several years prior to 2018.