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Is a Trust beneficiary also a settlor

November 15, 2019

Family Trusts are used widely in New Zealand; often being viewed as beneficial for asset
protection and to keep assets in the family for future generations. A reason for their popularity
has been the relative simplicity of the legal and tax regime. However, the rules are evolving. In
addition to the widely publicised re-write of the Trust Act, Inland Revenue (IRD) has issued a
recent clarification in relation to whom is classified as ‘settlor’ of a Trust. The settlor is generally
the individual that transfers assets into the trust. At face value, identifying the settlor is an easy
task, as they are often named on the trust deed. However, confusion can creep in when other
individuals inadvertently transfer value to a trust.




Section HC 27 Income Tax Act 2007 states that a settlor is a person who “transfers value to the
trust, for the benefit of the trust, or on terms of the trust”. This definition has long been the source
of debate when applied to a relatively common scenario. Trustees commonly declare
distributions to a beneficiary, but the beneficiary does not draw the cash out thereby giving rise to
an interest free loan to the trust. Is this sufficient to be a ‘transfer of value’ that deems the
beneficiary to also be a settlor of the trust?
IRD have recently provided definitive clarification on the matter. A legislative amendment to HC
27 has been made and a ‘Commissioner’s Operational Position’ has been issued. A beneficiary
will not become settlor if either:
a. the amount owing to them from the trust at the end of the income year is $25,000 or less; or
b. the trust pays interest to the beneficiary at a rate equal to or greater than the prescribed IRD
interest rate.
Hence, if a beneficiary leaves over $25,000 ‘on call’ in the trust, and does not receive sufficient
interest, they will become a ‘settlor’. This new rule becomes effective from 1 April 2020, and does
not have retrospective effect.
Why does this matter? A person becoming settlor of a trust can have an array of unintended tax
consequences. For example, two trusts are ‘associated’ where they have common settlors. This
has wide tax implications if one trust deals or develops land, then the ‘other’ trust could
inadvertently become subject to tax on the sale of its land.
Furthermore, the tax position of a trust is based on the tax residency of the settlor. If a deemed
settlor becomes non-resident for tax purposes, this could unintentionally result in the trust being
deemed a foreign trust, bringing an array of tax complexity and additional compliance obligations.
For the individual themselves, there can be consequences for their social security status, student
loans etc.
Hence, trustees and beneficiaries alike need to pay heed to these new rules to avoid pitfalls.

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