The Government has proposed that from the 2024/2025, the tax rate applying to trustee income will increase to 39% to align with the top personal tax rate. Although this change is still in Bill form, it is expected to be law by the end of March.
The increase in the trustee tax rate to 39% has given rise to much interest in restructuring and other activities to reduce exposure to the new rate (which is designed to be the same as the top rate applying to individuals).
Several scenarios have brought concern to some tax commentators as they could be seen as tax avoidance. In the “General Article”, Inland Revenue has commented on several scenarios, all of which are applicable to straightforward situations, but may not apply where there is an element of artificiality or contrivance:
1. A company is owned by a trust and changes its dividend-paying policy
For example, paying a higher dividend than normal to be taxed at 33%, rather than 39% if paid after 1 April 2024. In most cases this would not be tax avoidance. However, it could give rise to concerns where a dividend has been paid by crediting shareholder current accounts, but the company objectively has no real ability to pay those credit balances if it were to be liquidated.
2. A trustee distributes income to a beneficiary so it is taxed to the beneficiary rather than at the trustee tax rate
This should not be tax avoidance but could heighten concerns where, in reality, the beneficiary is not entitled under the trust or will not benefit from the distribution.
3. A trustee adopts a company structure and transfers its income-earning assets to the company
This means company tax of 28% applies to the income rather than the new 39% trust tax rate, however there would be a top-up when the company distributes profits to the trust. Inland Revenue is comfortable this is unlikely to be tax avoidance but could create concerns where a holding company is interposed between an existing operating company and trust, or where personal services income is diverted by structuring revenue-earning activities through a company
4. A trustee chooses to wind up the trust
This should not be tax avoidance.
5. A trustee chooses to invest in a portfolio investment entity
This should not be tax avoidance.
Further scrutiny
Inland Revenue has also suggested the following situations might give rise to further scrutiny:
- Allocating income to a beneficiary taxed at a lower rate under an arrangement in which that amount is resettled back on the trust.
- Allocating income to a beneficiary taxed at a lower rate by crediting the beneficiary’s current account where the beneficiary has no knowledge of the allocation or no expectation of receiving the income.
- Replacing dividend income with loans in an artificial manner such that the loans do not reflect the reality of the arrangement.
- Artificially altering the timing of any taxable or deductible payment.
- Creating or increasing income or expenditure that does not reflect the reality of the structure or arrangement.
Comment
This guidance emphasises that Inland Revenue is interested in transactions with artificial or contrived features, but accepts that undertaking some actions because it gives a better tax result can be permissible. Though there is a fine line between a legitimate transaction and tax avoidance, we are recommending clearing Company retained earnings where a Trust is a shareholder in advance of 31 March.
The Yovich Advisory team will be in contact with your shortly however feel free to contact your Account Manager should you have any queries.