Understanding Beneficiary Rights and Trust Obligations.

It was set up on the recommendation of their accountant and while there was some asset protection reasons, the main driver at the time was tax efficiency. The trust owned their family home and the shares in their company which was a successful car mechanic business with a number of branches across Auckland.

The business had provided great cashflow over the years, and on the recommendation of their accountant, they had used the trust to their advantage and allocated income to the beneficiaries. Their accountant had explained that trust income can be taxed in two different ways. Either the trustees pay tax on the income at the trustee rate which is currently 33% and then most often the trustees can make tax free capital distributions to beneficiaries. Or, the trustees can allocate income to the beneficiaries at the beneficiaries’ personal tax rates and the beneficiaries then declare the income in their tax returns and pay the tax at their marginal rates.

As Dianne wasn’t working, for many years the trustees had allocated income received by the trustees to her to take advantage of a lower tax rate. They had also allocated income to Geoff and Dianne’s two children, Jane and Tom, once they reached the age of 16. However, more often than not, rather than actually distributing the cash to Jane and Tom, the trustees would simply allocate the income to them and then use the actual cash to pay down trust debt. The trustees then ended up owing Jane and Tom what had been allocated to them. This was reflected in their beneficiary current accounts in the trust’s financial statements.

Over the years because of the profitability of the business, Jane and Tom had ended up with sizeable current accounts. Jane was owed just over $175,000 and Tom, as he was younger, $152,000. With the changes to the Trusts Act, Geoff and Diane understood that as their children were now over the age of 18, they had to know that they were beneficiaries of the trust, but they also could ask for a copy of the trust deed and the financial statements for the trust. If either Jane or Tom asked to see the financial statements for the trust, they would then be able to see that the trust owed them both large sums of money and could potentially ask for those amounts to be paid to them. Neither Geoff nor Dianne wanted this to happen.

Geoff and Dianne were actually not too concerned about Jane. Jane was a in a stable relationship with her husband of five years and Geoff and Dianne felt that even if Jane did see that the trust owed her $175,000, they would be able to explain the tax nuances to her and she would be able to see the bigger picture. Their accountant even suggested that they could ask Jane to gift her beneficiary current account to the trust in order to clear the balance.

Tom on the other hand was more of a concern. Geoff and Dianne were not that keen on Tom’s partner. They thought that she influenced Tom in a way that made him quite focussed on money and she was always hinting to Geoff and Dianne that she thought that they could be helping her and Tom with a deposit on a house. Even though Geoff and Dianne’s business had been successful they didn’t have the ready cash for that kind of assistance and were firmly of the view in any event, that the children should be forging their own paths. They were very concerned that if Tom knew that the trust owed him $152,000, then he would tell his partner who would then encourage him to call up the loan.

Geoff and Dianne were in a tricky situation. They really needed to get some advice as to how they might be able to restrict the information that the trustees had to give the children if asked. However, that would still not get around the fact that the trust did owe their children that money.

As we move into a new tax year, it is an opportune time for trustees to review beneficiary current accounts, take specialist legal and tax advice and decide how to deal with them in the context of the new law.