Death and Asset Transfers

2005 rules clarify the treatment of 'in kind' or 'in specie' distributions from companies, trusts, gifts, and transfers of assets/liabilities on a taxpayer's death.

Subpart FI and sections CZ 6, EC 4, EE 34, EE 38, EE 40, EH 5, EH 19, EH 50, EH 67, EW 29, EW 36, EW 39, EW 41, EW 44, EX 55, FB 3, GD 2 and GD 14 of the Income Tax Act 2004 and the definition of "date interest starts" in section 120C(1) of the Tax Administration Act 1994

Generic rules have been introduced to clarify the income tax treatment of "in kind" or "in specie" distributions from companies and trusts, gifts, and transfers of assets and liabilities on a taxpayer's death. Such distributions, gifts and transfers are treated as disposals and acquisitions at market value. The new rules have implications only to the extent the property is inside the tax base to start with.

The effect of the new rules on the estates of deceased individuals is that there will generally be two market value transfers: one at the time of the taxpayer's death, and one on the subsequent distribution of the assets to beneficiaries. A

number of exclusions to the market value rule reduce compliance costs.

Background

Tax law in the area of "in kind" distributions from companies and trusts, gifts and transfers on the death of a taxpayer has been neither clear nor consistent. Cases in recent years highlighted this lack of clarity, and there have been repeated calls to clarify the tax treatment of assets and liabilities on the death of a taxpayer and their subsequent distribution to the beneficiaries. For example, a beneficiary had no depreciation cost base for assets distributed by a trust, although the trustees were required to treat the distribution of the assets as a disposal at market value. These issues were raised by the Valabh Committee in its 1992 report, Tax accounting issues.

An officials' issue paper, Tax implications of certain asset transfers, was published in April 2003, and the proposals in that paper were modified as a result of submissions received.

Key features

The new generic rules are provided by new subpart FI of the Income Tax Act 2004. Assets and liabilities distributed or transferred are deemed to be a disposal and acquisition at market value.

Unless an exception applies, there will be two valuation points in respect of each deceased individual's estate: one at the date of death, and the other when the estate is distributed. The exceptions are:

  • Section FI 4 provides that assets and liabilities that pass to a spouse or de facto partner of a deceased person can be transferred at their tax book value, as long as all assets of the deceased that were in the tax base pass to the spouse or de facto partner or another person who is a relative within the second degree of relationship. (Transferring assets at their tax book value is known as rollover relief.)
  • Section FI 5 provides for simple estates when assets are left either to charity or to relatives within the second degree of the deceased taxpayer. Rollover relief will apply on the distribution of the estate. The transfer of the assets from the deceased to the administrator or executor of the estate will be at market value, unless any of the other exceptions apply.
  • Both of these exceptions will continue to apply if there are legacies to third parties of assets that are not in the tax base.
  • Section FI 6 provides rollover relief both on the date of death and when the estate is distributed for forestry assets if the beneficiaries of the estate are relatives to within the second degree of relationship to the deceased.

In addition, to reduce compliance costs, certain assets can be valued at cost rather than market value:

  • Section FI 8 provides that unexpired accrual expenditure continues to be valued at cost. The valuation date is treated as the end of the income year.
  • Section FI 11 provides that when an estate is a cash basis holder, financial arrangements are valued at cost both on the date of death and when the estate is distributed.

Generally, a taxpayer's death does not, in itself, lead to an asset being brought into the tax base. While the rule applies to all assets, it has relevance only to the extent the assets are already in the tax base. A particular example of this is the treatment of land held on capital account, the proceeds of which would be assessable if the property was sold within 10 years of acquisition. Section FI 7 ensures that death by itself does not trigger this 10-year rule.

Use-of-money interest will not be imposed on a deceased individual's tax liability in the year of death, so long as all tax due is paid by the due dates.

Sections FI 9 and FI 10 are transitional provisions that ensure that the tax treatment of past deaths and distributions from trusts and estates are not to be disturbed when:

  • the tax base is protected by the position that was taken, either because the tax book values of assets and liabilities were rolled over, or because a market value exercise was done; and
  • the beneficiaries of the trust or estate are limited to persons that are New Zealand-resident for tax purposes and are not exempt from income tax because they are charities; and
  • the underlying law was not clear.

Application date

The new rules apply prospectively and come into force on 1 October 2005.

Detailed analysis

Section FI 1: Disposals and resulting acquisitions to which subpart FI applies

To ensure comprehensive and generic rules, the new subpart provides a disposal value and an acquisition cost price of property that includes:

  • distributions from a trustee to the beneficiary of a trust;
  • "in kind" or "in specie" distributions from a company to a shareholder that are dividends;
  • gifts;
  • transfers to an administrator or executor or trustee of a deceased estate;
  • distributions by an administrator, executor or trustee of a deceased estate to a beneficiary; and
  • a settlement from one trust to another.
Section FI 2: Disposal and resulting acquisition of property treated as occurring at market value

Distributions and transfers to which subpart FI refers are treated as disposals and acquisitions at market value. The same market value that is used for the disposal must be used for the acquisition.

Section FI 3: Date on which disposal and resulting acquisition are treated as occurring

The date of the disposal and acquisition for tax purposes will generally be the date the person disposes of the property.

Subsection (2) provides that transfers upon death are treated as occurring immediately before death.

Section FI 4: Disposal and resulting acquisition of property by spouse or de facto partner of the deceased taxpayer

Assets and liabilities that pass to a spouse or de facto partner on the death of a taxpayer are transferred at tax book values as long as the beneficiaries of the rest of the property that is in the deceased's tax base are limited to family members who are within the second degree of relationship to the deceased person. It does not matter who receives assets that are not in the tax base. Property that is within the tax base is:

  • revenue account property;
  • an interest in a foreign investment fund;
  • financial arrangements which were not accounted for by the deceased taxpayer as a cash-basis person; and
  • assets upon which depreciation has been claimed.

The rationale for this relief is that it appropriately replicates the Property (Relationships) Act 1976.

Section FI 5: Distributions of property to close relatives and charities

When certain conditions are met, a distribution from the administrator or executor to the beneficiaries is transferred at tax book values. The conditions for this exception applying are:

  • the only beneficiaries of an estate are persons related to the deceased to the second degree, or are charities; and
  • the estate does not establish any life interests; and
  • the terms of the will or intestacy require that no property of the deceased taxpayer be held in trust; and
  • in the tax year during which the property is subject to administration or executorship or in which the property is held in trust for this purpose, the net income of the estate is distributed beneficially to the maximum extent possible.

This relief will not be affected if there are legacies of assets that are not in the tax base to persons who are not relatives. The spouse or de facto partner relief takes precedence over this relief, except when charities receive assets that are within the tax base. It is intended to reduce compliance costs.

Section FI 6: Disposal and resulting acquisition of property that is standing timber

When timber, standing timber, or a right to take timber owned by a deceased person is left to a person who is related to the second degree, the transfer to the administrator or executor of the estate and the
subsequent transfer to the beneficiary is at the tax book value.

This exclusion recognises that immature forests, in particular, are difficult to value.

Section FI 7: Relationship of section FI 2(2) to subpart CB

The subpart CB 10-year "tainting" rules (sections CB 7, CB 8, CB 9 and CB 12) do not apply to the transfer of assets and liabilities to the administrator or executor of the estate (section FI 1(3)(d) transactions) and the subsequent transfer to the beneficiaries (section FI 1(3)(e) transactions) if the property passes to a person who is related to the deceased taxpayer within the second degree of relationship.

If the relief provided by section FI 8(1) and (2) does not apply, section FI 8(3) provides that a deduction will be allowed against the proceeds of the property, for the original cost of the land to the deceased person, plus all other costs incurred by the deceased person, the administrator or executor or the beneficiary.

Section FI 8: Relationship of subpart FI to unexpired prepayments

Property that is subject to section EA 3 (Prepayments) is valued at cost, rather than market value, when it is transferred to the administrator or executor and when it is subsequently transferred to the beneficiary. The valuation date is treated as the end of an income year.

This provision will reduce compliance costs.

Section FI 9 and 10: Death or trust distributions before 1 October 2005

Section FI 9 and 10, when read together with the general savings rule in the Income Tax Act 2004 (subpart YA), provide that certain past tax treatments are saved, generally when the past treatment was uncertain and the tax base is not at risk.

Section FI 9 applies when the following criteria are met:

  • The taxpayer died before 1 October 2005.
  • The beneficiaries are New Zealand-resident for tax purposes and are not exempt from income tax because they are charities.
  • The Income Tax Act does not explicitly specify a treatment for both the deceased taxpayer and the executor or trustee.

If the same valuation method was used for both the disposal by the deceased taxpayer and the acquisition by the administrator or executor, and that valuation was either at market value or a rollover, it will be accepted as appropriate.

Section FI 10 provides the same rules for distribution from trusts.

Section FI 11: Disposal of certain financial arrangements on death

Financial arrangements will be valued at cost, both upon the death of the taxpayer, and at the time of distribution to beneficiaries, if the deceased taxpayer's estate is a cash-basis person. For the estate to be treated as a cash-basis person, the deceased taxpayer would need to be a cash-basis person at the date of death.

Use-of-money interest

The definition of "date interest starts" in section 120C of the Tax Administration Act 1994 has been amended to restrict the imposition use-of-money interest on a deceased taxpayer's tax liability in the year of death, as long as provisional and terminal tax payments are made by due date. Although the amendment provides that the concession will apply only to dispositions to which section FI 4 (disposal and resulting acquisition of property by spouse or de facto partner) of the deceased taxpayer applies, the policy intention is that it should apply to all estates. This will be corrected in the next tax bill.

This is a concessionary measure which ensures that estates will not incur unexpected use-of-money interest liabilities when a taxpayer's death triggers a tax liability.

Consequential amendments

Subpart FI is a comprehensive set of rules which provide for the tax treatment of "in kind" or "in specie" distributions, including the transfer of assets upon a taxpayer's death. Accordingly, a number of specific provisions which address specific transactions have been repealed. Other sections are being amended to make them consistent with the new rules.

Sections CZ 6(3), EC 4, EE 40(7), EW 29(13), EW 36(1)(b)(i), EW 39, EW 41(1)(b)(i), EW 44, EX 55, and GD 2 have been repealed. Sections EE 34, EE 38, EH 5(4), EH 19(2), EH 50(2), EH 67(4), FB 3, and GD 14(3)(c) are amended.

Section EE 34 provides that a taxpayer who acquires depreciable property from an associated person cannot claim more depreciation on that property than the associated person would have been able to had they retained the property. Subject to certain exceptions, the taxpayer's depreciation base is limited to the original cost of the property incurred by the associated vendor for anti-avoidance reasons.

As death is not a planned event there is no concern about anti-avoidance. When a rollover does not apply, the estate should use market value if that is appropriate. New subsection (6) has been added to section EE 34 to ensure this.

If property is disposed of for less than its market value, section EE 38 deems the consideration to be the market value of the property. New subsection (2B) provides that the market value rules do not apply if either of the rollover provisions, sections FI 4 or FI 5 apply.

Sections EH 5(4), EH 19(2), EH 50(2) and EH 67(4) are amended so that they continue to operate as if section FI 3 (date on which the disposal and resulting acquisition is treated as occurring) had not been enacted.

Section FB 3 is amended to make it clear that it does not apply when the rollover provisions of sections FI 4 to FI 6 apply.

Section GD 14(3)(c) is amended because subparagraph (ii) is no longer necessary, given the new rules for distributions.