taxation of different business structures & entities
TRANSCRIPT
Page 1 of Topic 9
TOPIC 9
TAXATION OF DIFFERENT BUSINESS STRUCTURES &
ENTITIES
(A) PARTNERSHIPS
(B)
TRUSTS
LEARNING OBJECTIVES After studying the material for this week you should be able to:
Explain the general nature and principles of taxation of general partnerships
(excluding special/limited partnerships);
Apply special considerations relating to family partnerships;
Examine the main features of the trust tax regime;
Discuss the taxation aspects of trusts:
- taxation of trustee income;
- taxation of beneficiary income.
Demonstrate research skills in relation to the prescribed textbook, NZT for
accessing the required information.
Page 2 of Topic 9
Supplementary Readings
1. Supplementary Readings in this Study Guide:
Page:
(a) Forsyth, T.A. (1982). Introduction to trusts. In A Brief
Outline of the Law Relating to Trusts, Wills, Executors
and Administrators.Wellington: Butterworths.
13
Additional Readings
2. Additional Reading Reference:
Alley, Chan, et al. (2009). New Zealand Taxation (Chap.15). Wellington:
Thomson Brookers.
Page 3 of Topic 9
Topic Nine Outline
A. PARTNERSHIPS
1. The nature and scope of a (general) partnership.
2. The return of partnership income (IR7 form) (but individual
assessment of partners).
3. Calculation of partnership income (or loss).
4. Family partnerships.
B. TRUSTS
5. The New Zealand trust tax regime - main features.
6. What is a trust?
- Qualifying trusts;
- Non-qualifying trusts;
- Foreign trusts;
- Trust income.
7. The Settlor.
8. Trustee Income.
9. Beneficiary Income.
10. Distributions
- Taxable;
- Non-taxable.
11. Summary of tax treatment of trust income and distributions.
Page 4 of Topic 9
Explanatory Notes
A. PARTNERSHIPS
Refer to NZT Chap. 15
1. Nature and scope of partnerships
Refer to NZT 15.2.1, 15.2.2 & 15.2.14
2. Return of Partnership Income
Refer to NZT 15.2.3
3. Calculation of Partnership Income (or loss)
Refer to NZT 15.2.3 – 15.2.8 and 15.2.12.
The income of the partnership is calculated in exactly the same way as for any
other business. The various sources of partnership income - business income,
interest, dividends, rents etc. are added together and the usual business expenses
are deducted.
Briefly:
Income
The interest, dividend and rent income only relates to income earned on
assets owned by the partnership per se. It does not extend to interest,
dividends and rents individual partners earn on their privately owned
assets.
Interest and dividends included in the income of the partnership are
subject to Resident Withholding Tax. These sources of income retain
their nature when included as part of the profit share of the partnership in
the partners‟ individual tax returns and the partners are entitled to a RWT
credit in their individual returns.
Deductions
In addition to the ordinary business expenses a partnership is eligible to
obtain a deduction for specific items such as monetary compensation by
the other partners for misappropriation of funds by a partner. Chapter 15,
NZT provides a list of deductible expenses which a partnership is
eligible to claim and the qualifying circumstances.
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4. Family Partnerships
Refer to NZT 15.2.9 – 15.2.11
4.1 Because partnerships have the effect of spreading income, and can thus
reduce tax liability, there are stringent conditions governing family
partnerships (for example between a husband and wife/de facto/civil
union relationship, or father and son).
4.2 Before the Commissioner will accept that family members are carrying
on business together as a partnership, he will look for clear evidence that
such partnership exists.
If there is a written partnership agreement this will be examined.
If there is no written agreement the Commissioner will examine
the surrounding circumstances - specifically
the source and proportion of capital contributed to the
partnership by each partner (e.g. each spouse);
the profit share of each partner;
the services performed by each partner.
4.3 Stringent conditions are also applied where a partnership employs a
relative of one of the partners.
If the Commissioner considers, having regard to all the circumstances,
that an excessive salary or an excessive profit share has been paid to a
relative he may invoke Sec GB 23 and reallocate the income in the
manner he determines. On application, the Department will provide
details of the basis of the re-allocation: this enables the partners to assess
whether it is reasonable.
The normal provisions regarding objections to assessments by the
Commissioner apply.
B. TRUSTS
Refer to NZT Chap. 15
5.1 Brief History of Trusts
Refer to NZT 15.3.1
The use of trusts has its origin in medieval times. When a person contemplated
action against the King, (e.g. rebellion) he would endeavour to insure against the
confiscation of his property (should his action be unsuccessful and he got
caught!) by transferring the legal rights to his property to a friend to hold in trust
Page 6 of Topic 9
for his family. His family were said to have equitable (or beneficial) rights to
the property. Trusts were also used to avoid feudal dues which were based on
property (especially land) ownership.
Over the years this has developed into a system of providing for the
safeguarding of property for infants, widows, married women, etc. Thus, from
the outset, trusts have been used primarily as a means of protecting the rights
and well-being of an individual‟s family.
5.2 Trust Categories
Refer to NZT 15.3.2
On 16 December 1988, the Income Tax Amendment Act (No.5) 1988 imposed a
new tax regime on trusts. The main features of this trust regime are:
it applies from income year commencing 1 April 1988, i.e. the 1989
income year;
the distinction between specified and non-specified trusts was removed
and in their place trusts are categorised as:
(a) qualifying trusts (under ITA 2007 known as complying trusts; or
(b) foreign trusts; or
(c) non-qualifying trusts (now known as non-complying trusts)
which generally are “off-shore” trusts set up by New Zealand
taxpayers as tax shelters.
Note:
(i) The above tax regime has been designed mainly to catch the last
category (c) of trusts.
(ii) The category determines the way in which taxable distributions
are taxed in the hands of beneficiaries.
while charitable trust has been referred to in the above regime under the
ITA 2007 charitable trust is now clearly categorised as the fourth trust.
residence of the settlor rather than the trustee (as previously) is the main
factor for determining a trust‟s liability to NZ tax on foreign income;
some beneficiaries may be taxed on distributions (called “taxable
distributions”) of accumulated trustee income, capital profits and
property made by the trust as well as on beneficiary‟s income;
disclosure of information of some “off-shore” trusts required from
settlors - time limits are involved for making such disclosures.
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On 22 March 2001 this regime, in terms of the taxation of distributions to minor
beneficiaries, was amended. This amendment is referred to as the “minor
beneficiary rule” [Tax Information Bulletin, Vol. 13 No. 5 (May, 2001), page
28].
Under this rule certain distributions of beneficiary income to a child under the
age of 16 years will be taxed at a flat rate of 33%. It will be treated as trustee
income for tax payment, rate and return purposes. See NZT 15.3.9
6. What is a Trust?
Refer to NZT 15.3.2
A trust is an obligation imposed on one person (the trustee) to hold property or
income on behalf of, and for the benefit of, another person or class of persons
(the beneficiary). A trustee may also be a beneficiary. A trust usually
commences when a person (the settlor) commits or settles property to the trust.
Trust Identification Flowchart - NZT Figure 15.1 p678
No
Yes
No Yes
6.1 Complying Trust [s HC 10]
Since being settled, the trust has been liable to tax in New Zealand on all
trustee income and the trustee‟s obligations in respect of that liability
have been satisfied. See NZT 15.3.2.
Has estate or trust been liable for
and paid NZ income tax on all trustee income (if any) in every
year since trust first settled?
Has a settlor been resident in New
Zealand at any time since the later of 17 December 1987 or date trust
first settled?
Complying Trust Foreign Trust Non-Complying
Trust
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6.2 Foreign Trust [s HC 11]
No settlor has been a resident of New Zealand from 17 December 1987
or the date the trust was first settled, until the date of the distribution in
question, whichever is the later;
Foreign trusts have no connection with New Zealand apart from the
residence of a potential beneficiary in New Zealand.
6.3 Non-complying Trust [s HC 12]
Neither a complying or a foreign trust;
Has a resident settlor and established overseas with non-resident trustees.
Has not been liable to New Zealand income tax on trustee income since it
was first settled.
Note:
The category of a trust is determined each time a distribution is made by the
trustee to a beneficiary.
7. The Settlor
Refer to NZT 15.3.3
Generally, a settlor is any person who directly or indirectly and whether by one
transaction or a series of transactions does any one of the events outlined in
section YA1 (in conjunction with sections HC 27 and HC 28).
The settlement of property etc to a trust is excluded from gift duty. A trust may
have more than one settlor and resident settlors are jointly and severally liable
for any tax on trustee income, as agents for the trustee. Latter applies to trusts
which have been settled or received settlement since 17 December 1987.
8. Trustee Income
Refer to NZT 15.3.4
8.1 A trustee is a person who administers or manages a trust. The definition
includes the Public and Maori Trustees. Trust income is income,
whether from New Zealand or foreign sourced, derived by a trustee in
any income year that is not beneficiary income. It is possible for a
foreign or non-complying trust to be liable for New Zealand tax on
trustee income if the settlor, trustee or beneficiary elects that it be so
liable in order to obtain the status of a complying trust. A non-resident
trustee is liable for New Zealand income tax on foreign sourced income
Page 9 of Topic 9
if any settlor of the trust is resident in New Zealand at any time in that
income year [Sec HC 25]. Trustee income is generally taxed at 33¢ in
the dollar.
8.2 A trust normally comprises trust property which generates income - for
example rental accommodation, investments. The trustee is required to
annually furnish an IR6 form on which he shows:
(1) The total income of the trust
(2) The portion returned and taxed as trustees‟ income
(3) The beneficiaries‟ portion of trust income (each beneficiary‟s
share of income is returned individually).
However, where a trust is settled after 17 December 1987 and no resident
trustee exists then the resident settlor is liable for tax as agent of the
trustees – see NZT 15.3.3.
8.3 “Total income” of the trust is calculated in the normal way. Gross
income from the various sources of income, and the related allowable
expenses are deducted.
In calculating this “total income” the trustees may deduct charges that
relate to the production of annual gross income. They may not deduct
charges relating to the administration of the trust
9. Beneficiary Income
Refer to NZT 15.3.5
A beneficiary is a person who benefits from the trust, i.e. receives distributions
from a trust. Income derived by trusts will either be beneficiary income and/or
trustee income. Therefore, it is important to work out which portion of the
current year‟s trust income is distributed (according to two rules – see NZT
15.3.5) to the beneficiary as the balance is assessed as income to the trustee.
Generally, beneficiary income is taxed at individual‟s marginal tax rates. The
Commissioner‟s practice is to require the trustee to physically pass over the
income to the beneficiary from the trust. If evidence of disassociation cannot be
substantiated then the Commissioner would treat the income as “trustee‟s
income”.
Note:
(1) Distributions, other than beneficiary income, from a complying trust to a
beneficiary are not taxable [ss HC 20 and CW 53].
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(2) Overseas tax credit is allowed to NZ beneficiary in respect of taxable
distributions available only in respect of foreign non-resident
withholding taxes paid.
(3) A minor beneficiary is a natural person who is a New Zealand resident
(for tax purpose), and who is, on the trust‟s balance date, under 16 years
of age. Beneficiary income, which falls within the „minor beneficiary
rule‟ is taxed at 33% and excluded from the minor beneficiary‟s gross
income (as this distribution is treated as trustees income for payment,
rate and return purposes). The tax paid by the trustee on this income is
paid on behalf of the minor beneficiary. See NZT 15.3.9.
10. Distributions
Taxable Distributions - NZT 15.3.7
Non-Taxable Distributions – NZT 15.3.8
11. Summary of tax treatment of trust income and distributions
Refer to NZT 15.3.8, Table 15.1 p689
Page 11 of Topic 9
Work Preparation
Read and study the material required for this week.
Review the following questions.
A. PARTNERSHIPS
1. What must be taken into account when setting up a family partnership?
2. (a) What must occur before a salary can be paid to a working
partner?
(b) Are benefits provided to a working partner subject to fringe
benefit tax?
3. What ingredients are necessary for a bona-fide (partnership) contract?
4. Refer to NZT 2009 Chapter 15 Review Question 1.
B. TRUSTS
5. Tom Tower is a New Zealand resident. He sets up a trust for his three
children, Anna, Sally and Andrew. His wife Tina, brother Eric and
lawyer David Dixon, who are all residents of New Zealand administer
the trust. The accountant Ruth Stone, a family friend, provides free
accounting services to the trust.
During the income year ending 31 March 2009 the following
distributions are made out of accumulated income from childrens
family trust:
$1,500 for Anna (new car)
$7,500 for Sally (varsity)
The trust has an automatic vesting provision of $2,000 for each
beneficiary to be paid out of trust income for that year, totalling
$37,800.
$2,000 Anna; $2,000 Sally; $2,000 Andrew
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On 6 June 2009 $5,000 was paid to Rathkeale College for Andrew‟s
school fees.
On 8 August 2009 $500 was distributed to Sally to help pay her
varsity fees.
On 5 November 2009 a further $500 was distributed to Sally to pay
off her overdraft.
Assume that Andrew the youngest of the children turned 16 on 28
February 2009.
(a) Who is the settlor?
(b) Who are the trustees?
(c) What type of trust is this?
(d) What amount is beneficiary income?
(e) What amount is trustee income?
(f) What amount is taxable distribution?
(g) What amount is non-taxable distribution?
(h) In cases (d) to (g) what is the tax liability?
6. Refer to NZT 2009 Chapter 15, Review Question 6.