Many migrants arrive in New Zealand with a connection to an existing trust established outside New Zealand (i.e., a cross-border trust). They may have made contributions to such trust, may be a trustee – or may become a trustee after moving to New Zealand – or they may be a beneficiary of the trust. In some cases, they may be all three.
New Zealand’s trust tax rules are complex, and unusual by international standards in that New Zealand seeks to tax trusts on their worldwide income if a trust settlor (i.e., a person who contributed to the trust) is tax resident in New Zealand. Without careful management, cross-border trusts that have a New Zealand connection can be subject to double tax, ultimately to the detriment of the beneficiaries.
In our practice, we regularly advise migrants who face unexpected tax complications arising from New Zealand's trust taxation rules. In this article, we outline some common pitfalls for new migrants with cross-border trusts, and how these can be minimised or avoided.
Issues impacting trust settlors
As noted, New Zealand’s trust tax rules focus on the tax residence of settlors. If a settlor of a trust is a tax resident in New Zealand, the trust will often be exposed to that New Zealand income on its worldwide income. This can apply even if the trustees are not resident in New Zealand.
Where a settlor of a cross-border trust moves to New Zealand, one option is for the trust to elect to be a ‘complying trust’ (–i.e., a trust that pays tax in New Zealand on its worldwide income). One benefit of making such an election is that distributions from a complying trust (other than distributions of current year income) are tax-free for the beneficiaries. The decision to convert an existing cross-border trust to a complying trust is relatively straightforward if all settlors and beneficiaries are New Zealand residents, and if a New Zealand resident trustee can be appointed. However, if the trustee or someone else connected to the trust is also taxed on the trust’s worldwide income in another country, a complying trust election can lead to double tax.
If a settlor does not make a complying trust election, the trust will be a ‘non-complying trust’. This is potentially disadvantageous, in two key ways:
- Settlor liability. If a migrant makes a 'settlement' on a non-complying trust after becoming a New Zealand resident, they become personally liable for the New Zealand tax obligations of the trustees. Those tax obligations are determined as if the trustees were New Zealand residents even if the trustees are resident elsewhere. The definition of a “settlement” for the purpose of New Zealand’s trust tax rules is broad and settlements can arise in many ways. For this reason, new migrants should take care to ensure they do not inadvertently make any settlements on existing cross-border trusts after becoming New Zealand residents.
- Tax on distributions to beneficiaries. Distributions made to New Zealand resident beneficiaries of a non-complying trust (other than distributions of current year income) are generally taxed at a penalty rate of 45% - even if the distributed amounts have previously been taxed overseas. Distributions of current year income are taxed at the beneficiary’s marginal tax rate. This can result in a very high combined tax burden (without appropriate planning).
Issues impacting trustees
New Zealand’s rules are relatively friendly to New Zealand resident trustees of trusts with non-resident settlors, known as ‘foreign trusts’. Despite being New Zealand tax residents, trustees of foreign trusts are generally exempt from New Zealand tax on income sourced outside New Zealand, provided that certain requirements are met. This can be useful for new migrants who are not settlors of a cross-border trust, but who act as trustees of that trust (or wish to do so). This scenario commonly arises when a migrant acts as the trustee of a cross-border trust established by their non-resident parents.
To qualify for this exemption, the trust must be registered as a 'foreign exemption trust' in New Zealand. Once registered, the New Zealand trustee must file an annual return detailing any settlements on, and distributions by, the trust during the year, along with financial statements. These requirements can catch migrant trustees off guard-particularly if the trust is treated as 'transparent' for tax purposes in the trustee’s home country (for example, a US grantor trust).
While the reporting obligations themselves are straightforward, the consequences of non-compliance can be unfortunate. The tax exemption only operates for a period in which the trust is registered and the trustee complies with their reporting requirements. New Zealand law does not currently allow trustees to correct past failures retroactively. If the trust's income was also taxed in another country during the relevant periods, as is often the case, the loss of the tax exemption in New Zealand can result in significant double tax.
Issues impacting beneficiaries
New Zealand’s trust tax rules often result in some degree of double tax on distributions to New Zealand resident beneficiaries of cross-border trusts. The extent of this risk largely depends on whether the settlor has ever been tax resident in New Zealand:
- If the settlor has always been non-resident in New Zealand for tax purposes such that the trust is a ‘foreign trust’, the double tax risk is generally limited to distributions of income that has already been taxed overseas. In some cases, beneficiaries may be able to claim a credit for foreign tax paid, but this relief is tightly restricted.
- If the settlor has been tax resident in New Zealand at any time since the trust was settled, and the trust is not a complying trust, the double tax risk extends to almost any distribution that is sourced from amounts that have already been taxed within the trust.
These rules can be harsh where the New Zealand beneficiary is just one of many (for example, a trust set up by a non-resident parent for multiple children and grandchildren), or where the trust fund consists largely of income that has accumulated over many years and already been fully taxed elsewhere.
Strategies to mitigate double tax
Our experienced team has developed a range of strategies to reduce and manage double taxation risks arising from cross-border trusts. We work with clients to develop practical solutions tailored to their circumstances, including, where necessary, making voluntary disclosures to address any past non-compliance. If you have questions about your tax obligations in relation to a cross-border trust, please contact a member of our team.
If you have any questions about this article, please get in touch with the contacts listed or your usual Bell Gully adviser.
Disclaimer: This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.
