Eyes on Tax: Trust tax rate changes – Lessons from Inland Revenue’s latest guidance

Update - March 13: In February, Finance Minister Nicola Willis indicated the Government wanted to exempt some trusts from paying the 39% tax rate and may introduce a two-tier tax rate on trusts. The Finance and Expenditure Committee, reporting back on the Bill containing the increase to the Trust tax rate, has broadly agreed that a de minimis threshold should apply to trusts. See more on this in our article here.

It is not yet law, but we fully anticipate the increase in the trustee tax rate to 39% will apply from the start of the 2024/25 tax year. This will be from 1 April 2024 for most trusts. 

Unsurprisingly, the increase in the tax rate has led to many questions about tax planning: 

  • Should we pay a dividend from a company owned by a trust prior to 1 April 2024? 

  • Does the dividend actually have to be “paid”? 

  • Can I restructure my affairs? 

To help us all think carefully about tax planning, Inland Revenue recently released a General Article GA 24/01. While we welcome the further clarity provided, we note it offers high-level guidance only on Inland Revenue’s interpretation of the law. This makes it a useful steer on what Inland Revenue may regard as acceptable and what may not be acceptable. But as each case needs to be considered on its own facts and circumstances, specific advice should be obtained prior to making any decisions.  

To summarise GA 24/01: 

  • Taxpayers should be able to change their dividend policy to accelerate the payment of dividends before the proposed increase (or even a change reducing dividends), where the change is aligned with the funding needs and timing of when the trust needs the funds.   

  • Tax avoidance is unlikely to be raised if you pay a dividend and credit funds to the trust’s shareholder current account, except where it is evident the company has no real ability to pay the credit balance should the company be liquidated. Given the company needs to satisfy the solvency test under the Companies Act when paying a dividend, it is implied that a dividend of this nature, in the absence of other factors, may have been declared predominantly to get a benefit from the reduced trustee rate.  

  • A payment of a dividend to a trust and subsequent distribution to a beneficiary as beneficiary income on a lower marginal tax rate will be acceptable when the funds go to the beneficiary.  

  • If the beneficiary income is not enjoyed by the beneficiary, for example if the beneficiary resettles the amount back on to the trust, then in the absence of mitigating factors, the dividend may be challenged. This would be an issue irrespective of the 39% tax rate. 

  • Inland Revenue may question allocating an amount as beneficiary income, where the beneficiary has no knowledge or expectation of receiving the income (notwithstanding beneficiaries have full access to information by law). If you are allocating beneficiary income to children (not being minor beneficiaries) that is over and above looking after their ordinary welfare, you’d be wise to continue to document and quantify this - for example, noting down university fees, their first car and so on - to demonstrate they received the benefit.  

  • Inland Revenue may accept the transfer of income-earning trust assets to a company (we assume the trust is the shareholder of the company) to benefit from the lower 28% corporate tax rate unless there is an element of artifice or contrivance involved. 

  • Interposing a holding company between an existing company and trust where it creates a dividend strip was, and is, a problem with or without the 39% trustee tax rate. That does not mean you can’t restructure to holding companies from a commercial perspective; you just need to be careful how this is done. 

  • Winding up the trust to avoid the 39% rate will be acceptable.  

  • A trust may choose to invest in a PIE (as opposed to other investment alternatives) to benefit from the 28% PIE tax rate. It is good to be assured this is not regarded by Inland Revenue as avoidance, but we question whether it is good policy to have differential tax rates influencing trustee’s investment decisions.  

  • Artificially replacing dividend income with loans will be subject to increased scrutiny as to whether the loans are genuine loans (commercial terms, interest rates and repayment plans) and not income under ordinary concepts.  

  • Similarly, artificially accelerating income - so that you can pay a higher dividend to be taxed at the lower rate - or artificially deferring expenditure - to reallocate the deduction to a higher tax rate - may be challenged.   

Our thoughts: 

  • We are happy with the guidance on dividends credited to current accounts to clear retained earnings in advance of the rate change. This is good common sense. The lead-in between signalling the rate change and application would surely mean this was expected. There is also an argument that rather than tax avoidance, this accelerates taxation liabilities (through resident withholding tax) that were otherwise deferred when dividends were not paid.  

  • The guidance around the loans creates some ambiguity and may require further clarification.  

  • Perhaps, going forward, it would pay to put more rigour around beneficiary current accounts and demonstrate that value can be expected, is received, and is known about. 

  • Be careful with holding companies. It can be easy to inadvertently miss the dividend strip. 

The issue of the GA 24/01 highlights many acceptable situations where dividends may be paid, credited to account, or taxpayers' affairs restructured prior to 31 March without constituting tax avoidance – provided there is no element of artifice and/or contrivance. Care should be taken, and advice obtained. 

Contact your BDO Adviser for guidance when considering how the change in the trustee tax rate might impact you.