Qualifying trust and corpus
2008 case note – Section BD 1 (2) of the Income Tax Act 1994 includes reference to section 242 (c) of the 1976 Income Tax Act - qualifying trust, corpus.
Section BD 1 (2) of the Income Tax Act 1994 includes reference to section 242 (c) of the 1976 Income Tax Act.
A family trust was set up in 1985 by four children for the benefit of their parents. They each granted a sum of money of US$99,750 to the trust which they termed as an interest free loan. The sole trustee of the trust, one of the children, resided in the United States. The other three children resided in New Zealand.
On 16 January 2004 the death of the children's widowed mother meant the assets of the trust were vested in equal shares in each of the four children. The vesting was treated as repayment of the loans.
It was accepted by the parties that the vesting attracted income tax liabilities for the three children residing in New Zealand and that the amount of tax depended on whether the trust was a "qualifying trust" or a "non-qualifying trust".
The issue of the qualifying trust, in this case, turns on the question of whether the provision excludes foreign-sourced income and non-residence, namely section BD 1(2) [as amended by the Taxation (Core Provisions) Act 1996] in section OB 1 of the Income Tax Act 1994 which picks up the former definition of a qualifying trust in section 242 (c) of the Income Tax Act 1976. If this applies, then the trust is looked at from 1985 to determine whether it is subject to New Zealand income tax in its life time. On the other hand if it does not, the trust is looked at from 1997 and section HH 4(3A) in the 1996 Act [as in section 228 (3) of the 1988 Act] becomes relevant as it deems foreign-sourced income of a non-resident trustee subject to New Zealand income tax if there is a resident settlor.
The Authority held that BD 1 (2) referred to section 242 (c) because section YB5 (4) of the 1994 Act permitted reference to it. This was held to be permissible in this case notwithstanding that section YB 5 (4) did not cover certain income periods of the trust in the legislative scheme of looking back at the life of the trust.
That being the case, it was held that the trust was not subject to New Zealand income tax from 1986 to March 1988 and therefore it was not a qualifying trust.
In the context of taxable distribution of the trust, the corpus is a value excluded in its calculation. The definition of corpus means "an amount equal to the market value at the date of settlement of any property".
It was accepted by both parties and was held by the Authority that there were multiple settlements on a yearly basis because of the interest-free nature of the loan.
The taxpayers' method of valuing the corpus was to treat the loan like a commercial loan attracting compound interest on a quarterly basis. At the end of 2004 they estimated the corpus to be $4,048,919. The Commissioner's approach was to take the original amount of the loan in 1985 and to treat the foregone interest of the amount for each year as settled to the trust. He estimated the corpus to be $1,414,174.
The Authority agreed with the taxpayers' methodology but could not accept their figure and invited parties to negotiate or make further submissions.
Tax Administration Act 1994(TAA), Income Tax Acts 1976 and 1994