Here's how high-earners might avoid new top tax rate

Friday, 30 October 2020

Trusts have historically been set up to protect assets. Could they be used to protect against higher tax also?

Tax experts say taxes on trust should be raised to match the proposed new top personal tax rate for high-income earners.

At the moment, trusts are taxed 33 per cent, the same as the top personal tax rate above $70,000.

But Labour has pledged to return the top personal tax rate to 39 per cent once people earn more than $180,000.

That would create an 11 percentage point difference between individuals and companies or PIE funds, which are taxed 28 per cent, and a six percentage point gap with trusts.

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Tax consultant Terry Baucher says the tax proposal might make people think again about ditching their trusts.

The gulf was reason enough for many high earners to direct income above $180,000 into a trust, tax consultant Terry Baucher said.

''In many ways, the worse thing the Government could do is leave the trust rate unchanged … That would definitely encourage behaviour they don't want to see.''

Alternatively, high earners could shift their wealth into property, or into Australasian shares or PIE funds, which accrued less tax.

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''Our problem with not having a capital gains tax is our rather patchwork approach to capital taxation are going to get worse,'' Baucher said.

The other way of mitigating against the higher personal tax rate was to have a company and retain, rather than pay out, all their dividends.

Baucher said the proposed tax change ''arrives at an interesting time''. Tighter trust laws coming into force next January were expected to trigger the wind-up of many trusts because of increased compliance and liability.

But the tax situation could prompt people with trusts to reconsider. One of the key attractions was the way dividends were treated.

''Both companies and trusts can act as a tax deferral point. The trust is a better point, so to speak in that once it's been taxed in the trust it can be distributed tax-free. Whereas with the dividend coming out of the company, you would be liable for the top-up tax,'' Baucher said.

High salary earners would bear the brunt of the tax, since they would not be able to escape it, although ''there is a lot of wealth there,'' he said.

And Palmerston North accountant Ashley Short said it was not just high-salaried employees who would be caught out.

Self-employed businesspeople who were sole traders or in partnerships still made up a sizeable portion of the New Zealand business sector, and he believed that the trust tax should rise or they should be exempted.

Otherwise, ''it follows that a lot of existing entities will now have to sell their business to a company and set up a trust to own their shares to avoid the anomaly the Government is creating''.

Short said sole traders and partners were taxed on their net profit, irrespective of whether the capital they left in the business was for working capital or the purchase of new assets, he said.

A company might do so for the same reasons but only paid tax of 28 per recent.

And Short said it needs to be remembered that the more a person earned, the more tax they paid.

''Someone earning $100,000 pays tax of $19,200 whereas someone earning $500,000 pays $155,920 in tax.

''Rather than the Government acknowledging their achievement they instead want to penalise them a further $19,200 increasing their tax to $175,120.'

''I would like to say to the PM … to rethink her tax policy and so congratulate the risk-takers and achievers, rather than penalise them.''

According to experts, changes to the top personal tax rate could come in as soon as next April.

Baucher said an alternative to raising the trust tax rate was anti-avoidance rules, but he believed they were the ambulance at the bottom of the cliff.

''Anti-avoidance rules in my view don't tackle the source problem.''