Tax rate for trusts to go to 39%

Tax distortions are increasing.

A short while ago the top tax rate for both an individual and a family trust was 33 percent. When this was increased to 39 percent for the individual, there was an obvious incentive to retain as much income in a trust as possible.

If you have a trust, click here to read the whole article …

This led to the former government proposing an increase to 39 percent tax on trusts, effective from 1 April 2024. At this stage the new government has made no comment regarding the previous government’s proposed 39% flat tax rate for trusts. The Bill covering this lapsed when Parliament recessed for the election. 

If we assume the new government follows through with this and your taxable income is less than $180,000 (the threshold for the increase to 39 percent tax) it would pay to distribute as much of the trust income to you or any other beneficiary whose income is below $180,000. You would be paying tax at 33 percent whereas the trust would be paying tax at 39 percent. Remember, if you allocate income to a beneficiary to save some tax, you must also pay that beneficiary the money, at some stage.

There is just one problem. One of the prime reasons for setting up a family trust is to protect family assets so they can’t be sold up by creditors, if you’re ever sued. So, if the trustees of your trust distribute income every year to you and you don’t spend it, those savings would not be protected from someone suing you. Whereas the assets remaining in your family trust do not belong to you and would not be available to pay your debts.

As you can imagine, the income distributed from your family trust to save tax could accumulate to quite a large sum. If you give it back to the trust, ie its gone in a circle, Inland Revenue could say you only distributed it to avoid tax. It’s very difficult to predict when IRD will use the avoidance provisions they have at their disposal– please take our word for it being a risk.

Companies pay tax at the rate of 28 percent. Therefore, if you accumulated your savings within a company, you would pay a lot less tax than you would by doing so through a trust. You wouldn’t have the protection a trust offers, but that that might not necessarily matter to you.

The only time you would pay more than 28 percent is when you wanted to use some of the money. You would need to declare a dividend, which would then become part of your income.

When you retire and your income falls, you might find the distributions from a company ultimately get taxed at a lower rate than 28 percent and you actually get some tax back, depending on your other income.

It’s unlikely the government would consider putting up the company tax rate because New Zealand companies would not be competitive with those overseas.

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Cash flow problems are a common concern for businesses. Spiraling debtor days and awkward “please pay us” conversations limit your potential to plan for the future, or worse, put you out of business.

As a business we are always looking at ways to improve and when we received the email from Xero about their price increases we wondered how we could better manage the process of collecting the subscriptions without you having to change automatic payments, or updating your internet banking.

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If you are already using Xero … When you receive a payment from your customer, Xero marks the invoice as paid and reconciles the payment automatically. Xero will record the GoCardless fee as an expense. GoCardless transfers the payout to your account automatically.

So we are keen! We’ll be contacting you once we have it sorted our end for your ONLA regular payments; and once we do it we’ll be able to help or advise you if you think it’s right for your business too.

Interest and rentals

The Government has produced a 143-page discussion document to try and sort out the complications arising from disallowing an interest deduction on residential rental property.

A typical complication is where the residential property is owned by a company and only forms a small part of the company income. Funding for the company can be constantly changing, so how do you know how much to allocate to the residential rental property?

Another one is the person who takes in a boarder or lets out part of their main home as an Air B&B. In these cases, the proposal is to allow a proportionate interest deduction.

For those who owned property before the law change, the deduction is to be scaled down over four years. The first reduction occurs at October 1 this year. The claim for interest is calculated on the basis of it being incurred. This means if you paid interest to, we will say September 25, you would also be able to claim the interest through to the end of September, even though you will not be paying it until after October 1.

Inland Revenue makes a meal of expenses

Inland Revenue has produced their interpretation of the tax law IS 21/06 on the subject of meal expenses.

The interpretation is based on case law.

The general principle is the self-employed can’t claim meal expenses, but shareholder employees of companies can. Why?

A company is a separate legal entity. It’s allowed to reimburse its staff, including the owner of the business, when they are away from work, for refreshments they could have received at work.

If an employee has to have a meal, due to having to work at a long-distance from the company base, the cost can also be tax deductible to the company. For example, a company employee has to work so remotely from the company base that it’s not until 9pm that they get home. It would be reasonable for an employer to pay for dinner. This would be tax deductible and it would not be income for the staff member.

A private individual running a business is treated differently. The legal starting point is that any food or drink is a personal cost because it’s necessary to maintain life.

Taking the example of getting home at 9pm, if the self-employed person bought a meal before travelling home, this would still be considered a personal expense.

There can be extreme examples. For example, a self employed person has to go to the Chatham Islands and stay the night. The only accommodation he can get into is the Waitangi Hotel. Although there is a supermarket, there is no self-catering at the hotel so he has to buy his dinner.  The excess cost of the meal over what he would normally pay, is tax deductible.

Note: If this person was running a company they would be an employee and the entire cost of dinner would be tax deductible.

What if the self-employed person has a couple of employees? Because they are away from their business base, the employer buys coffee and doughnuts for all three for morning tea. The expenditure on the employees is a tax-deductible cost. The expenditure for the employer is a personal cost and not tax deductible.

Instead of reimbursing, can an employer just pay a fixed allowance for morning and afternoon teas when the employee is working in a place away from their work place?  Yes.

One of the illustrations has an employee living in Upper Hutt and working all day in Wellington, about 30km away. Inland Revenue has used a reimbursement figure of $15.

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