TAXATION OF DIFFERENT BUSINESS STRUCTURES & ENTITIES

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TOPIC 9

TAXATION OF DIFFERENT BUSINESS STRUCTURES &

ENTITIES

(A) PARTNERSHIPS

(B)

TRUSTS

LEARNING OBJECTIVES After studying the material for this week you should be able to:

Explain the general nature and principles of taxation of general partnerships

(excluding special/limited partnerships);

Apply special considerations relating to family partnerships;

Examine the main features of the trust tax regime;

Discuss the taxation aspects of trusts:

- taxation of trustee income;

- taxation of beneficiary income.

Demonstrate research skills in relation to the prescribed textbook, NZT for

accessing the required information.

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Supplementary Readings

1. Supplementary Readings in this Study Guide:

Page:

(a) Forsyth, T.A. (1982). Introduction to trusts. In A Brief

Outline of the Law Relating to Trusts, Wills, Executors

and Administrators.Wellington: Butterworths.

13

Additional Readings

2. Additional Reading Reference:

Alley, Chan, et al. (2009). New Zealand Taxation (Chap.15). Wellington:

Thomson Brookers.

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Topic Nine Outline

A. PARTNERSHIPS

1. The nature and scope of a (general) partnership.

2. The return of partnership income (IR7 form) (but individual

assessment of partners).

3. Calculation of partnership income (or loss).

4. Family partnerships.

B. TRUSTS

5. The New Zealand trust tax regime - main features.

6. What is a trust?

- Qualifying trusts;

- Non-qualifying trusts;

- Foreign trusts;

- Trust income.

7. The Settlor.

8. Trustee Income.

9. Beneficiary Income.

10. Distributions

- Taxable;

- Non-taxable.

11. Summary of tax treatment of trust income and distributions.

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Explanatory Notes

A. PARTNERSHIPS

Refer to NZT Chap. 15

1. Nature and scope of partnerships

Refer to NZT 15.2.1, 15.2.2 & 15.2.14

2. Return of Partnership Income

Refer to NZT 15.2.3

3. Calculation of Partnership Income (or loss)

Refer to NZT 15.2.3 – 15.2.8 and 15.2.12.

The income of the partnership is calculated in exactly the same way as for any

other business. The various sources of partnership income - business income,

interest, dividends, rents etc. are added together and the usual business expenses

are deducted.

Briefly:

Income

The interest, dividend and rent income only relates to income earned on

assets owned by the partnership per se. It does not extend to interest,

dividends and rents individual partners earn on their privately owned

assets.

Interest and dividends included in the income of the partnership are

subject to Resident Withholding Tax. These sources of income retain

their nature when included as part of the profit share of the partnership in

the partners‟ individual tax returns and the partners are entitled to a RWT

credit in their individual returns.

Deductions

In addition to the ordinary business expenses a partnership is eligible to

obtain a deduction for specific items such as monetary compensation by

the other partners for misappropriation of funds by a partner. Chapter 15,

NZT provides a list of deductible expenses which a partnership is

eligible to claim and the qualifying circumstances.

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4. Family Partnerships

Refer to NZT 15.2.9 – 15.2.11

4.1 Because partnerships have the effect of spreading income, and can thus

reduce tax liability, there are stringent conditions governing family

partnerships (for example between a husband and wife/de facto/civil

union relationship, or father and son).

4.2 Before the Commissioner will accept that family members are carrying

on business together as a partnership, he will look for clear evidence that

such partnership exists.

If there is a written partnership agreement this will be examined.

If there is no written agreement the Commissioner will examine

the surrounding circumstances - specifically

the source and proportion of capital contributed to the

partnership by each partner (e.g. each spouse);

the profit share of each partner;

the services performed by each partner.

4.3 Stringent conditions are also applied where a partnership employs a

relative of one of the partners.

If the Commissioner considers, having regard to all the circumstances,

that an excessive salary or an excessive profit share has been paid to a

relative he may invoke Sec GB 23 and reallocate the income in the

manner he determines. On application, the Department will provide

details of the basis of the re-allocation: this enables the partners to assess

whether it is reasonable.

The normal provisions regarding objections to assessments by the

Commissioner apply.

B. TRUSTS

Refer to NZT Chap. 15

5.1 Brief History of Trusts

Refer to NZT 15.3.1

The use of trusts has its origin in medieval times. When a person contemplated

action against the King, (e.g. rebellion) he would endeavour to insure against the

confiscation of his property (should his action be unsuccessful and he got

caught!) by transferring the legal rights to his property to a friend to hold in trust

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for his family. His family were said to have equitable (or beneficial) rights to

the property. Trusts were also used to avoid feudal dues which were based on

property (especially land) ownership.

Over the years this has developed into a system of providing for the

safeguarding of property for infants, widows, married women, etc. Thus, from

the outset, trusts have been used primarily as a means of protecting the rights

and well-being of an individual‟s family.

5.2 Trust Categories

Refer to NZT 15.3.2

On 16 December 1988, the Income Tax Amendment Act (No.5) 1988 imposed a

new tax regime on trusts. The main features of this trust regime are:

it applies from income year commencing 1 April 1988, i.e. the 1989

income year;

the distinction between specified and non-specified trusts was removed

and in their place trusts are categorised as:

(a) qualifying trusts (under ITA 2007 known as complying trusts; or

(b) foreign trusts; or

(c) non-qualifying trusts (now known as non-complying trusts)

which generally are “off-shore” trusts set up by New Zealand

taxpayers as tax shelters.

Note:

(i) The above tax regime has been designed mainly to catch the last

category (c) of trusts.

(ii) The category determines the way in which taxable distributions

are taxed in the hands of beneficiaries.

while charitable trust has been referred to in the above regime under the

ITA 2007 charitable trust is now clearly categorised as the fourth trust.

residence of the settlor rather than the trustee (as previously) is the main

factor for determining a trust‟s liability to NZ tax on foreign income;

some beneficiaries may be taxed on distributions (called “taxable

distributions”) of accumulated trustee income, capital profits and

property made by the trust as well as on beneficiary‟s income;

disclosure of information of some “off-shore” trusts required from

settlors - time limits are involved for making such disclosures.

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On 22 March 2001 this regime, in terms of the taxation of distributions to minor

beneficiaries, was amended. This amendment is referred to as the “minor

beneficiary rule” [Tax Information Bulletin, Vol. 13 No. 5 (May, 2001), page

28].

Under this rule certain distributions of beneficiary income to a child under the

age of 16 years will be taxed at a flat rate of 33%. It will be treated as trustee

income for tax payment, rate and return purposes. See NZT 15.3.9

6. What is a Trust?

Refer to NZT 15.3.2

A trust is an obligation imposed on one person (the trustee) to hold property or

income on behalf of, and for the benefit of, another person or class of persons

(the beneficiary). A trustee may also be a beneficiary. A trust usually

commences when a person (the settlor) commits or settles property to the trust.

Trust Identification Flowchart - NZT Figure 15.1 p678

No

Yes

No Yes

6.1 Complying Trust [s HC 10]

Since being settled, the trust has been liable to tax in New Zealand on all

trustee income and the trustee‟s obligations in respect of that liability

have been satisfied. See NZT 15.3.2.

Has estate or trust been liable for

and paid NZ income tax on all trustee income (if any) in every

year since trust first settled?

Has a settlor been resident in New

Zealand at any time since the later of 17 December 1987 or date trust

first settled?

Complying Trust Foreign Trust Non-Complying

Trust

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6.2 Foreign Trust [s HC 11]

No settlor has been a resident of New Zealand from 17 December 1987

or the date the trust was first settled, until the date of the distribution in

question, whichever is the later;

Foreign trusts have no connection with New Zealand apart from the

residence of a potential beneficiary in New Zealand.

6.3 Non-complying Trust [s HC 12]

Neither a complying or a foreign trust;

Has a resident settlor and established overseas with non-resident trustees.

Has not been liable to New Zealand income tax on trustee income since it

was first settled.

Note:

The category of a trust is determined each time a distribution is made by the

trustee to a beneficiary.

7. The Settlor

Refer to NZT 15.3.3

Generally, a settlor is any person who directly or indirectly and whether by one

transaction or a series of transactions does any one of the events outlined in

section YA1 (in conjunction with sections HC 27 and HC 28).

The settlement of property etc to a trust is excluded from gift duty. A trust may

have more than one settlor and resident settlors are jointly and severally liable

for any tax on trustee income, as agents for the trustee. Latter applies to trusts

which have been settled or received settlement since 17 December 1987.

8. Trustee Income

Refer to NZT 15.3.4

8.1 A trustee is a person who administers or manages a trust. The definition

includes the Public and Maori Trustees. Trust income is income,

whether from New Zealand or foreign sourced, derived by a trustee in

any income year that is not beneficiary income. It is possible for a

foreign or non-complying trust to be liable for New Zealand tax on

trustee income if the settlor, trustee or beneficiary elects that it be so

liable in order to obtain the status of a complying trust. A non-resident

trustee is liable for New Zealand income tax on foreign sourced income

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if any settlor of the trust is resident in New Zealand at any time in that

income year [Sec HC 25]. Trustee income is generally taxed at 33¢ in

the dollar.

8.2 A trust normally comprises trust property which generates income - for

example rental accommodation, investments. The trustee is required to

annually furnish an IR6 form on which he shows:

(1) The total income of the trust

(2) The portion returned and taxed as trustees‟ income

(3) The beneficiaries‟ portion of trust income (each beneficiary‟s

share of income is returned individually).

However, where a trust is settled after 17 December 1987 and no resident

trustee exists then the resident settlor is liable for tax as agent of the

trustees – see NZT 15.3.3.

8.3 “Total income” of the trust is calculated in the normal way. Gross

income from the various sources of income, and the related allowable

expenses are deducted.

In calculating this “total income” the trustees may deduct charges that

relate to the production of annual gross income. They may not deduct

charges relating to the administration of the trust

9. Beneficiary Income

Refer to NZT 15.3.5

A beneficiary is a person who benefits from the trust, i.e. receives distributions

from a trust. Income derived by trusts will either be beneficiary income and/or

trustee income. Therefore, it is important to work out which portion of the

current year‟s trust income is distributed (according to two rules – see NZT

15.3.5) to the beneficiary as the balance is assessed as income to the trustee.

Generally, beneficiary income is taxed at individual‟s marginal tax rates. The

Commissioner‟s practice is to require the trustee to physically pass over the

income to the beneficiary from the trust. If evidence of disassociation cannot be

substantiated then the Commissioner would treat the income as “trustee‟s

income”.

Note:

(1) Distributions, other than beneficiary income, from a complying trust to a

beneficiary are not taxable [ss HC 20 and CW 53].

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(2) Overseas tax credit is allowed to NZ beneficiary in respect of taxable

distributions available only in respect of foreign non-resident

withholding taxes paid.

(3) A minor beneficiary is a natural person who is a New Zealand resident

(for tax purpose), and who is, on the trust‟s balance date, under 16 years

of age. Beneficiary income, which falls within the „minor beneficiary

rule‟ is taxed at 33% and excluded from the minor beneficiary‟s gross

income (as this distribution is treated as trustees income for payment,

rate and return purposes). The tax paid by the trustee on this income is

paid on behalf of the minor beneficiary. See NZT 15.3.9.

10. Distributions

Taxable Distributions - NZT 15.3.7

Non-Taxable Distributions – NZT 15.3.8

11. Summary of tax treatment of trust income and distributions

Refer to NZT 15.3.8, Table 15.1 p689

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Work Preparation

Read and study the material required for this week.

Review the following questions.

A. PARTNERSHIPS

1. What must be taken into account when setting up a family partnership?

2. (a) What must occur before a salary can be paid to a working

partner?

(b) Are benefits provided to a working partner subject to fringe

benefit tax?

3. What ingredients are necessary for a bona-fide (partnership) contract?

4. Refer to NZT 2009 Chapter 15 Review Question 1.

B. TRUSTS

5. Tom Tower is a New Zealand resident. He sets up a trust for his three

children, Anna, Sally and Andrew. His wife Tina, brother Eric and

lawyer David Dixon, who are all residents of New Zealand administer

the trust. The accountant Ruth Stone, a family friend, provides free

accounting services to the trust.

During the income year ending 31 March 2009 the following

distributions are made out of accumulated income from childrens

family trust:

$1,500 for Anna (new car)

$7,500 for Sally (varsity)

The trust has an automatic vesting provision of $2,000 for each

beneficiary to be paid out of trust income for that year, totalling

$37,800.

$2,000 Anna; $2,000 Sally; $2,000 Andrew

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On 6 June 2009 $5,000 was paid to Rathkeale College for Andrew‟s

school fees.

On 8 August 2009 $500 was distributed to Sally to help pay her

varsity fees.

On 5 November 2009 a further $500 was distributed to Sally to pay

off her overdraft.

Assume that Andrew the youngest of the children turned 16 on 28

February 2009.

(a) Who is the settlor?

(b) Who are the trustees?

(c) What type of trust is this?

(d) What amount is beneficiary income?

(e) What amount is trustee income?

(f) What amount is taxable distribution?

(g) What amount is non-taxable distribution?

(h) In cases (d) to (g) what is the tax liability?

6. Refer to NZT 2009 Chapter 15, Review Question 6.

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TAXATION OF DIFFERENT BUSINESS STRUCTURES & ENTITIES

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