The recently announced abolishment of gift duty forces one to muse the logic of its existence for an entire 125 years when apparently it was making little revenue for the country. What was the point of it? Does this now place trust structures in harm's way? The abolishment, which comes into force October 2011, has certainly prompted concerned taxpayers to ask whether their assets will still be safe.
Let us consider the background. Earlier this year Finance Minister Peter Dunne informed the nation that a review of the gift duty would be taking place due to the significant compliance costs that outweighed any benefits. It was established that gift duties in New Zealand generated an approximate $70 million dollars per year in compliance costs, while only raising on average $2.2 million dollars in revenue for the Government.
Gift duty was originally implemented to prevent people circumventing estate duty. Estate duties were abolished in 1992, but gift duties remained in place to prevent people from giving away large assets in order to avoid paying creditors, obtain access to Government benefits or avoid tax liability. It has been argued that the abolition of the gift duty will allow people to more easily hide assets in trusts to avoid creditors and tax, and use this opportunity to obtain access to rest home subsidies. This was one of the major concerns in reviewing whether the gift duty should be abolished. But Peter Dunne assures all that there are adequate measures in place to prevent such manipulations and protect creditors. Once the gift duty is abolished, the Government will monitor the effect on the economy and tax system to ensure there are no unintended effects or unexpectedly arising oversights.
The current gifting duty programme, (which will run until the abolishment of the gift duty on the 1st October 2011), imposes a tax for any gift more than $27,000, and therefore the decision to abolish the gift duty has particular relevance to those looking to set up a trust. Trusts have been part of our legal fabric for centuries and essentially represent a future promise or obligation by the trustees to the beneficiaries. A settlor creates the trust by transferring an asset or group of assets to the trustees. Because of gift duty, this transfer of assets traditionally has been gifted to the trustees over a number of years.
Once the gift duty is abolished, new assets can be transferred to a trust without the need for a gifting programme, and existing debts can be forgiven in full. It has been argued that this ensures immediate protection against any future claims from creditors, and trust clients should welcome the decision to abolish gift duty, as it will facilitate the setting up and maintaining of a trust. The abolishment of the gift duty will allow people to simply give their assets to a trust, and where there is an existing gifting regime, to simply gift off the balance of the debt. Trust clients have the potential then, under this new scheme to save significantly.
However, things may not be so clear-cut and as such, perhaps we should not celebrate too early. Government agencies such as WINZ and Inland Revenue could potentially establish new rules and procedures for how gifts to family trusts are treated. This could mean a trust settlor may not be able to simply gift their assets in one transaction and then expect wider benefits to accrue as a matter of course. The Courts and centre Government will likely apply more scrutiny to the substance of trust arrangements, particularly in regard to the intention of the trust creation. Bona fide arrangements are essential, with "alter ego" trusts treated with more scepticism and open to "trust busting" legislative attack.
"Trust busting" is essentially the power and willingness to look through the legal form of the trust to the essence of transactions and arrangements where they exist for reasons principally other than the creation of a trust. This could lead to a willingness of the Court to force beneficiaries to place pressure on trustees as has recently occurred in the UK Court of Appeal. This may reduce the power and control trustees have over trust assets and further, undermine the intentions of the settlor. There is potential here then for trust assets to be exposed and used by the Courts and Government as a means of meeting costs or fines accrued by beneficiaries for example. If such power exists for trusts to be used in this way there could also be an impact on the actions of trustees who may neglect their responsibilities to the trust and may not remain true to the trust deed.
As the new law comes into force, and settlors continue gifting, one needs to be cautious and consider these issues. Trustees play an important role in the process and need to stay true to the trust deed and maintain good record keeping. Trustees are equally responsible for any decisions made in regard to the trust assets and often it is wise to appoint independent trustees where possible. Independent trustees are valuable in that they can identify personal assets from trust assets. As they have no personal interest in the outcome of any decision, they can be relied upon to act in the best interests of all the beneficiaries and are unlikely to act in the interest of one over another. Furthermore, alter ego arrangements must be avoided at all costs as the Court will render a trust void if it is found to be either a sham or an alter ego trust. This would make assets of the trust available to third parties. Bona fide arrangements then are crucial in creating trusts as it likely to ensure little interference from the Courts or Government bodies.
The new legislation abolishing gift duty will not be imposed until October 2011, so any gifting between now and then will continue under the current regime, and settlors should thus continue to monitor their gifting closely. However, once the new law comes into force, we should exercise caution over the perceived benefits. Pressure from third parties will ensure that structures will come under greater scrutiny than ever before, supported by the Courts and Government agencies motivated by a clear preference for "substance over form". Bona fide arrangements, independent trustees, good record keeping and disciplined management are all essential elements in ensuring the trust structure meets and maintains its original purpose of benefit and protection to the beneficiaries.
Thanks Hornby Law for your professional and helpful advice. Especially to Jim (Eddy) for all your work with the purchase of our house. It is nice when everything runs smoothly.
Cymon Allfrey Architects Ltd