Using a company to circumvent paying trust tax at 39 percent

Inland Revenue has released GA 24/01, which says setting up a company to hold income-earning assets – mainly to take advantage of lower tax rates – is generally not considered tax avoidance, unless it involves artificial or contrived features.

Here’s an example

Let’s say you inherit a large sum of money and decide to donate it to your family trust. Instead of putting it straight into the trust, you can set up a company and have the trust own all its shares. The company would pay 28% tax on income earned from the money, compared to the trust’s 39% tax rate.

If that sounds good, there are still a few things to keep in mind:

• The money would count as a loan to the company unless it’s used as share capital. If you later forgive the loan, the company will have to pay tax on it.
• If you want to access the income from the company, you’d need to pay a dividend before the end of the tax year. That dividend would be taxed at 39% in the trust, but the company’s 28% tax already paid would count as a credit.
• You could minimise the 39% trust tax by distributing the dividends declared to beneficiaries with lower tax rates.
• You can’t backdate dividends. If you realise after the tax year ends that you want to pay out a dividend, it’s too late. You have to plan ahead.
• Setting up and running a company comes with extra admin costs.
• Depending on what kind of asset you’re transferring, there might be tax complications.

Be careful with Inland Revenue’s mention of “artificial or contrived features”. This isn’t a DIY project – if you’re thinking about using a company to hold income-earning assets for a trust, get professional advice.

There are other ways to manage the 39% tax on trusts:

• If you have children aged over 16, you can distribute trust income to them, which could help cover things like university costs. For children aged under 16, you can distribute up to $1000 per child before triggering trust tax rates.
• Adult beneficiaries with lower tax rates can also receive distributions to minimise overall tax.

Also consider:

Consider investing in Portfolio Investment Entities (PIEs), which are taxed at 28% with no extra tax owed.

The bottom line?

There are ways to reduce the 39% tax on trust income, but careful planning is essential. Get expert advice before making any big moves.