Whither (or wither) New Zealand Foreign Trusts?
A little heralded aspect of the Government’s BEPS proposals has been to apply the hybrid mismatch rules to tax the foreign source income of NZ foreign trusts. These are trusts with a NZ resident trustee but no NZ settlor. The possibility of taxing such income in NZ was raised in the September 2016 consultation document dealing with hybrid mismatched arrangements. Until now the possibility has not been to the forefront of debate about the application of BEPS rules. The proposal turns the current treatment of such income on its head and very probably means that the foreign trust industry that has developed because of the NZ tax exclusion for such income will wither and die.
The trust taxation regime as it has applied to date is based on a different taxation view of the world than prevails now. At the time it was introduced, the driver of the regime was a focus on the existence of a NZ resident settlor. If such a settlor existed, then the theory went that the relevant trust was likely to be controlled from here and so the income of the trust would be taxed to the resident settlor, if it was not taxed here to the trustee.
If the settlor was tax resident somewhere else, then NZ really did not care about the income that the trust might derive from non-NZ sources. That income was excluded from our tax net. As a result, a trust could be settled on a NZ resident trustee by a non-resident settlor and, as long as there were no NZ beneficiaries to whom income was distributed, income from sources outside this country was not taxed here. New Zealand foreign trusts thrived as a result, and because their reporting obligations were, until recently, relatively light handed.
However, the income excluded from the NZ tax net was often also not subject to tax in the jurisdiction whence it was derived. In the modern world of international tax cooperation this gave rise to so-called “double non-taxation”. This is regarded by tax authorities as infinitely worse than double taxation: if there is income, after all, it should be taxed somewhere. New Zealand is now saying, if it is not taxed elsewhere, we will clip the ticket, even if the income does not arise here.
Why would NZ say that? The answer lies in the new world taxation order to which many countries, not just ours, have signed up. This new order is driven by the OECD. It is the result of the huge financial strain countries faced following the Global Financial Crisis. Shrinking national treasuries led desperate OECD members (NZ included) to work with each other to sort out how to carve up the international taxation pie between them, so that everyone gets something that might be regarded as a fair share of available tax revenues.
The recommendations that have been to Cabinet are for NZ to adopt a suite of rules that, apart from minor local adjustment, replicate all of the OECD’s recommendations for combatting international corporate tax strategies. The new order can no longer tolerate as irrelevant the income of a non-NZ settlor that is not taxed outside this country. NZ has assumed a new duty to be sure that, if another country has not taxed the income derived outside NZ, we should. We will do that by using the complex proposed “reverse hybrid” rules to attribute the untaxed foreign income, not to the offshore settlor who will normally be beyond NZ’s reach, but to the NZ trustee. The settlor regime is redundant. It no longer serves the purpose of being sure that if there is income anywhere in the world we should be contributing to it being taxed at least once, even if it has no economic connection with NZ or any connection through a resident settlor/controller of a trust.
The cabinet proposals deal both with foreign source income that is not distributed to beneficiaries (usually called trustee income) and such income that is distributed to beneficiaries outside NZ. If the beneficiary is not taxed in their home jurisdiction because the laws of that country treat the income as being derived by the NZ resident trustee and not the beneficiary, but not being taxable to the NZ trustee, then we will impose the tax at this end.
There are proposed de minimis rules, though they are unlikely to offer any material relief. If foreign source income is more that the greater of $10,000 or 20% of total income, the rules will apply. Because the foreign trust industry has just faced a round of new compliance cost as a result ramped up disclosure rules, it is thrown the bone of a proposed starting date of 1 April 2019.
Eighteen months to close down, turn off the lights and leave the building?
© G D Clews 2017