Personal Asset Planning

January 2001

The controversial Property (Relationships) Amendment Bill which covers married, de facto and same-sex couples has now been approved by Parliament in a conscience vote. It is only one of three recent or proposed changes to the law of which our clients should be aware.

Division of Relationship Property

The environment in which a couple seek to protect their personal and family wealth for themselves and for their children and successive generations is a constantly changing one.

We are reminded of this as we consider the Property (Relationships) Amendment Bill which has recently been approved by Parliament in a conscience vote. The Bill draws together a number of interrelated threads that are to form the fabric of laws dealing with property rights between couples.

One Act for all

It is the Government's intention to have one Act that addresses property division rights for married, de facto and same-sex couples. The existing Matrimonial Property Act 1976 will be superseded by new provisions to be contained in an updated Act called, perhaps somewhat inelegantly, the Property (Relationships) Act 1976. The new legislation will generally take effect from 1 December 2003 with the Government intending to conduct a public information campaign beforehand to explain its effect.

Significant features

In essence, the legislation provides for one law covering both married and non-married couples (including couples of the same-sex). Except in very limited circumstances, all couples will have a three-year qualifying period before the property-split regime will apply.

The regime will provide that on the division of relationship property, each of the partners will be entitled to share equally in the family home, the family chattels and any other relationship property. This approach will also apply on the death of one of the partners.

Couples will be free to contract out of coverage under the property division laws and the Court will be required to give greater force to such contracts than has been the case in the past. The Court will need to be satisfied that the agreement would cause serious injustice before overturning it. In the absence of any such agreement, the presumption will be that the relationship property will be divided equally between the couple unless the Court considers that there are extraordinary circumstances that would make equal sharing repugnant to justice. In such cases the shares of the partners will be determined in accordance with the contribution each has made to the partnership relationship.

The new legislation also seeks to address the issue of economic disadvantage suffered by a non-career partner when a relationship breaks down. The Court in certain circumstances will be empowered to award compensating lump sum awards or transfers of the other partner's relationship or separate property. Broader recognition may also be given to the rights of a partner where he or she has directly or indirectly contributed to an increase in value of his or her partner's separate property. In the case of a de facto partner dying without a will, the surviving partner will share in the deceased partner's estate, irrespective of the duration of the relationship.

Implications of a wider property division regime

Clients have obvious concerns about the implications of breakdown of relationships. The new legislation will give added impetus to people in all forms of relationships seeking to protect their position by contracting out of the new regime through property sharing agreements.

Another concern focuses on the relationships of the client's children and the potential for dissipation of family wealth from breakdowns of those relationships. With broader forms of relationships about to receive statutory recognition in terms of division of property, the need for careful planning and asset protection becomes increasingly important.

For many clients, the fundamental objective is to preserve family wealth for the current and future generations of the family. This is often the basis for protecting assets against creditors, the Government and disgruntled family members. Trusts have been used both historically and in contemporary times to address this need for protection of family wealth. Trusts continue to provide an effective vehicle for continuity of ownership of assets through successive generations.

As a general rule, if family assets are placed within a trust by parents, for the benefit, use and enjoyment of children then that property will fall outside the ambit of the existing and proposed relationship property legislation. The level of protection provided can be considerably enhanced if steps are taken to transfer assets to trusts prior to the commencement of relationships.

Distributions of beneficiary income from trusts to minors

The Taxation (Beneficiary Income of Minors, Services-Related Payments and Remedial Matters) Bill was introduced on 16 October 2000. The Bill raises the tax rate applicable to distributions of beneficiary income from trusts to minors from 19.5% to 33%. The Bill has now been referred to the Finance and Expenditure Committee for the hearing of submissions on the proposal.

The Revenue Minister, the Hon Dr Michael Cullen, has stated that this legislation is aimed at ensuring that families with a trust do not gain a tax advantage over families without a trust.

Increasingly, trusts have sometimes been used to split income. By placing income earning assets in a trust and then distributing the income to minors as beneficiary income, the income is taxed at the child's marginal tax rate.

Key features of the Bill

The 33% tax rate will apply only when the minor beneficiary receives income derived from property which was settled on a trust by a relative or guardians of that minor or a person associated with a relative or guardian of the minor.

The rule will apply to beneficiary income distributed to minors from both discretionary and fixed trusts. It will also apply to beneficiary income distributed to minors from qualifying, non-qualifying and foreign trusts.

The measure will apply only to children under the age of 16. Originally the issues paper stated that the preferred age was 18.

Beneficiary income that is subject to this rule will be taxed at the trust level at a final tax rate of 33% on behalf of the beneficiaries. Therefore beneficiary income subject to the rule will not be included when calculating the minor's tax liability. If a trustee fails to deduct tax at 33% from beneficiary income that is subject to the rule then the trustee will be liable for the tax and any penalties will lie with the trustee.

If the beneficiary income is $200 or less, and would otherwise be subject to this rule, the minor beneficiary rule will not apply.

The Bill also makes provision for beneficiary income to be excluded from this rule in certain circumstances where the Government perceives there are limited opportunities for income splitting. These exceptions include situations where beneficiary income is:

• derived from property if the settlor received that property as an agent for the beneficiaries from someone other than a relative, guardian or his or her associates;
  
  
• derived from property when the settlor has been ordered by a court to pay damages or compensation to the child;
  
  
• derived from property settled on the trust under the terms of a will, codicil, intestacy or by variation of these by a court, if the minor was alive within 12 months of the date of the settlor's death;
  
  
• derived from a group investment fund;
  
  
• distributed to a non resident minor;
  
  
• distributed to a disabled minor for whom the child disability allowance is paid; or
  
  
• distributed to a minor from the Maori Trustee or a Maori authority.

Comments on the Bill

The Bill has been subject to criticism. For example, a potential anomaly exists when a child's income from a trust is taxed at a flat rate of 33% and income a child receives from a bank account is taxed at the child's marginal tax rate, which may be 19.5%. The Government's response to this anomaly is that beneficiary income distributed from a trust to a minor is often not that child's income, whereas it is unlikely that significant sums of family wealth are deposited in a child's bank account. This proposition is incorrect. Trust law has established that legal ownership of the assets of a trust is with the trustees as these assets are held by the trustees solely for the benefit of the beneficiaries. Any income distributed by the trustees to the beneficiaries is their income at law and the taxation of these distributions should be reflected accordingly. Further, this ignores the principle that, generally, individuals are taxed according to the level and not the source of the income that they have derived.

There are also reasons other than merely tax incentives for preferring to use a trust. Often a settlor would like a beneficiary to have the benefits of trust property without having actual control of the property themselves. This is particularly the case in respect of children.

Another inconsistent feature of this legislation is that only beneficiaries under the age of 16 are the focus of the Bill. It will still be possible for the trustees of a trust to make distributions to other beneficiaries whose marginal tax rates are less than 33%. This means that a beneficiary under the age of 16 could effectively be paying a higher tax rate than his or her non-working parent if that parent's income is under $38,000 and the parent is taxed at the rate of 19.5%.

The Government intends the measure to apply from the start of the 2001-2002 income year.

Service companies - new provisions

In October 2000 Parliament passed legislation which prevents taxpayers from avoiding the 39% top personal tax rate by placing an entity between their employers and themselves. The new service company provisions in the Taxation (GST and Miscellaneous Provisions) Act apply where one person or entity (a company, trust or partnership) sells services during an income year worth more than $5,000 to another person and the services are actually carried out by a third person.

The new attribution rules

In the case of a company, the rules apply where at least 80% of the company's income for the income year is derived from the sale of services to one person, or to parties associated with that person and at least 80% of the company's income for the income year is derived through services personally performed by the service provider and the service provider's net income is greater than $60,000. For these purposes, "associated persons" is widely defined, and includes for instance, the situation where the person providing the services, or a relative, has a voting interest in the company of only 25%. It would therefore be almost impossible to avoid the provisions by setting up a complex company structure.

The new rules also cannot be avoided by interposing the company between the individual and a family trust. The company is the entity that is required to attribute that part of its income derived from the sale of the taxpayer's services.

Substantial business assets

The only clear situation in which the new provisions will not apply is where the company has "substantial business assets". The term is defined principally to mean depreciable property that costs either at least $75,000 or 25% of the company's gross income from services for the income year and is not used for private use or enjoyment. The definition of "substantial business assets" includes depreciable property where there is less than 20% private use and enjoyment (calculated in accordance with the fringe benefit tax rules).

How the attribution is calculated

Where attribution applies, normally the company's net income for the income year is attributed to the service provider. The following amounts are, however, treated as deductible expenses in calculating that net income to be attributed:

• monetary remuneration paid to the service provider during the income year.
  
  
• the taxable value of any fringe benefit provided to the service provider during the income year and the fringe benefit tax payable on any such benefit.
  
  
• any dividends, beneficiary income or distributed partnership profits to the service provider.

These deductions mean that the income concerned is not taxed twice, both in the hands of the company and the service provider.

Once attributed, any income will be taxed at the individual taxpayer's marginal rate, which, in the case of income over $60,000 is 39% (compared to the current flat rate of 33% on company profits).

Should incorporation be encouraged?

Despite the changes, it would appear to be beneficial to a taxpayer who provides services to incorporate in these situations:

• to limit liability;
  
  
• where there are substantial business assets, as outlined above; and
  
  
• where the service provider wishes to deduct expenses from income.

As far as the third situation is concerned, incorporation would allow service providers to make deductions for allowable expenditure, which are not permitted to an employee.