Taxing Distributions

How Are Distributions From a Trust Taxed?

The tax treatment of distributions will depend on what three factors:

1. Whether or not a distribution has been made - this will determine if it is trustee income, beneficiary income, or a taxable distribution 

   • The concept of a 'taxable distribution' only applies to foreign and non-complying trusts.
      
2. What type of trust exists, and
3. What type of distribution is being made. 

Trusts are required to file income tax returns in which will disclose the taxable income (or loss) for the financial year. 

Trusts are classified for tax purposes only at the time distributions are made. In determining what type of trust exists, it is the settlor's tax residence that is important - the residence tests are found in s YD 1 of the Income Tax Act 2007. 

What Type of Trust Do I Have? 

There are three types of trusts:

1. Complying Trusts  

2. Foreign Trusts

3. Non-Complying Trusts 

Identifying what type of trust exists is crucial as they are subject to different tax treatment. 

In most circumstances, the family trust will typically be a complying trust. However, if the trustee does not perform all of its duties, it is very easy for the trust to become a non-complying trust. 

Distributions from a Complying Trusts  

Where a Trust has derived income in the financial period, the tax treatment will depend on what the trustees do with the income. If the trustees do not make any distributions, the income that has been derived will be taxed as trustee income (at 33%). If income is taxed as trustee income, no further tax will be payable, so any future distributions of this income to beneficiaries will be exempt from tax. 

However, if distributions are made, they will be taxed at the beneficiaries' marginal tax rate (either 10.5%, 17.5%, 30%, or 33%), unless the beneficiary is a minor beneficiary (16 years or younger on the trust's balance date, in which case it is taxed as trustee income). 

Other distributions from a complying trust such as distributions of corpus and capital gains are exempt from tax. 

Distributions from Foreign Trusts

A foreign trust exists where the settlor is not a tax resident in New Zealand. This can occur where

1. You settle a family trust and later move overseas culminating in the loss of tax residency in New Zealand, or
2. Where a non-resident settles a trust and later becomes resident in NZ. However, the trustee can elect to be treated as a complying trust. 

Trustee income is taxed at 33% while distributions of beneficiary income, non-arms length capital gains and accumulated income are taxed at beneficiary’s marginal rate. Distributions of corpus are exempt.  

Distributions from a Non-Complying Trusts

A non-complying trust is defined in the negative and is a trust that is not a complying trust, nor is it a foreign trust. Usually, a trust will be non-complying where the trustee has not met all the trustee's tax obligations.

Both trustee and beneficiary income are taxed in the same manner, however other distributions such as distributions of accumulated income, or capital gains will be taxed at a penal rate of 45%. This penal rate will apply as there is a presumption that non-complying trusts have either deferred or avoided prior tax obligations. 

Trust Losses

If a Trust has a taxable loss in the period, the losses cannot be passed onto the beneficiaries, rather they remain in the trust and can be offset against future income.