Commissioner’s Operational Position - New section HC 27(6) – treatment of a beneficiary as a settlor in certain circumstances

The purpose of an Operational Position is to outline the legal position that the Commissioner considers is correct for an issue identified and the approach the Commissioner will be taking to applying that position in practice.

1. The law around whether a beneficiary who leaves distributions in a trust is regarded as a settlor has been unclear, and Inland Revenue has expressed differing views on the issue.
2. In December 2013 Inland Revenue wrote to NZICA (as it then was) and advised that merely leaving funds available at call in a trust current account did not result in a beneficiary becoming a settlor. The letter relevantly said:

Whether a beneficiary of a trust can be deemed a settlor under tax law comes down in the end to a factual enquiry. However, we have concluded that a beneficiary, who simply has money vested in interest or in possession, where such sums remain with the trustee, does not become a settlor under s HC 27(2) Income Tax Act 2007 on that basis. The existence of an amount that is “beneficiary income” in relation to a particular beneficiary, which is (for example) held by the trustee in a current account that contains amounts to be distributed to that beneficiary, does not make that beneficiary a settlor. The fact that the amount could be called for by the beneficiary, and would be provided by the trustee if they did, does not make the beneficiary a settlor on the basis of deciding not to do so.

…

However, a beneficiary who has taken possession and enters into a contract to lend the money back to the trust may be deemed a settlor under s HC 27(2) if he or she:

1. Contracts to be paid nil or below market-rate interest, or
2. Contracts to receive interest but does not make demand for such interest or defers demand, or
3. Does not demand repayment of capital.

3. This view appears to have been circulated, but not formally published by Inland Revenue.
4. In the course of preparing a public statement on this matter the issues were reconsidered and ultimately different views were reached, namely:
   • simply leaving funds on call in a current account (without market interest being paid) would result in a beneficiary becoming a settlor, and
   • if funds were loaned to a trust at less than market interest rates the beneficiary would also become a settlor.
5. Given the differing views, and the variety of approaches being adopted by affected taxpayers, a legislative clarification was proposed and ultimately enacted by section 67 of the Taxation (Annual Rates for 2019–20, GST Offshore Supplier Registration, and Remedial Matters) Act 2019. That section enacts an amendment to section HC 27 of the Income Tax Act 2007. That amendment provides that when a beneficiary of a trust is owed an amount by the trust, the beneficiary does not become a settlor of the trust if —
   1. the trustee pays to the beneficiary in the income year interest on the amount owing at a rate equal to or greater than the prescribed rate of interest:
   2. the amount owing at the end of the income year is not more than $25,000.
6. This amendment comes into force on 1 April 2020, and does not have retrospective effect.
7. Given the lack of retrospective effect, and the differing communications by Inland Revenue, some taxpayers may be uncertain about which interpretation Inland Revenue will apply until 1 April 2020 (when the new law takes effect).

Operational position

8. So as to provide greater certainty and to minimise compliance costs, the Commissioner has exercised her care and management power, to provide that up to and including 31 March 2020, Inland Revenue will continue to allow taxpayers to rely on the existing public position, as set out in paragraph 2 of this Operational Position.