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With the increase in 2021 of the personal tax rate to 39% for anything earned over $180,000, and with rampant inflation now pushing more people’s business incomes over that figure, some people may be looking for ways to change their structure to take advantage of lower tax rates.

One of the methods that some people have used in the past is for an individual who owns the shares in a profitable business to sell all-but-one of their shares in their company to their trust. The trust’s tax rate is still 33% which is 6% lower than the highest marginal tax rate. The one share still held by the individual allows a shareholder salary to be allocated to them.

You need to be careful about these sorts of arrangements. I have outlined some of the issues to consider below. Note that since this article was originally written , the Government in May 2023 has in fact made the proposal to increase the trustee tax rate to 39%, aligning with the top personal tax rate. If this change survives the consultation process and of course the General Election in October 2023 then any tax advantage from utilising a trust ownership structure would come from the ability for a trust to allocate income to beneficiaries. For people who already have a trust structure in place, see our trusts fact sheet :

General anti-avoidance provision of the Income tax Act 2007

The Income Tax Act has a catch-all provision which essentially says that any action taken by the taxpayer where the tax benefit is “more than incidental” is considered tax avoidance. Tax avoidance can attract hefty penalties. Because of this, it is important that there is an economic reason for moving your shares into the trust. A common reason is for asset protection purposes or else for family reasons like sharing assets and income between partners and children

Market salaries

It is important that your company pays you a market based amount for the work that you do and the expertise you have. In the Case of Penny & Hooper vs CIR, two surgeons restructured their sole trader business into a company. The shares of the company were held by their trusts. Penny & Hooper paid themselves a smaller than market salary from their company and distributed the rest of the income to their trusts to take advantage of the lower tax rates. This case went all the way to the Supreme Court where it was finally determined that the tax benefit the surgeons received from their structure was more than incidental and that the arrangement was void. 

Trust disclosure requirements

Since the 2022 financial year, trusts have been required to provide much more information to the IRD when filing their tax return. The return now needs to include names and IRD numbers of settlors and beneficiaries as well as a profit and loss report and balance sheet. This provides the government more visibility about where money goes as up until now, they’ve had none.

It is possible that the government will use the information to consider new ways to tax the income going through trusts.

More about trust reporting and disclosure requirements

Possible increase in tax rate for trusts

With an election in the not too distant future we can expect some changes afoot. It might be considered be an easy-sell to Labour voters that the tax rate for trusts needs to go up so there is no longer a tax gain to be had by shifting income to a trust.  As noted above this proposal has now been made by the government and we will need to wait to see if this is implemented in April 2024.

Allocation income to beneficiaries

In the case of a family trust, it is common that there are family members on lower tax rates. Income can be declared via a dividend from the company to the trust and then distributed from the trust to these individuals. This takes advantage of their lower tax rates. What is important here is that the beneficiaries are actually entitled to take the money that is distributed to them. If you distribute money to a beneficiary for the purposes of using their lower tax rate and they don’t take the money, there will be debt owing to them on the balance sheet that continues to grow. This can pose other risks too as if interest is not being charged on these loan amounts then the beneficiaries can be considered to be “settlors” which can have other tax implications.

Continuity of shareholding

Companies that pay tax in their own name will have a balance of imputation credits. These are credits a company earns by paying tax, that can then be distributed to shareholders when declaring a dividend. This means the income does not get taxed twice, once by the company and then again by the individual.

If the shareholding of a company changes by more than 34% (i.e. moving shares once held personally into a trust) then the company loses those imputation credits. The shareholder will then have to pay more tax on any dividend declared to them by the company. Losing your imputation credits can be a significant and avoidable loss.

Final thoughts

Trust ownership of companies is a complex and changing space. No change in ownership of your company is risk free. The above is not an exhaustive list of issues to consider. It is imperative that you seek advice from your accountant before changing the shareholding of your company.