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Tax change could snare homes in family trusts

By Deborah Hill Cone

Friday 19th September 2003

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Inland Revenue is considering a change that could find people with their homes in family trusts hit by tax rates of 45% for the benefit they receive, tax experts warned yesterday.

The IRD has put forward a proposal, ED47, that would see qualifying or "good" trusts reclassified as non-qualifying or "bad" trusts if they are found to have any outstanding tax to be paid, even inadvertently.

They would then have to pay 45c in the dollar on any distributions ­ including retrospectively if it took the IRD several years to challenge their tax return.

But trust specialist Bill Patterson said the sting in the tail of the proposal was that this could also catch people living rent free or at below market rent in a home owned by their family trust.

That is because the definition of a "distribution" for a non-qualifying trust is different from that of a qualifying trust and benefits such as accomm odation would be classified as a distribution.

Mr Patterson said tens of thousands of trusts could be affected by the change ­ and under the proposal, beneficiaries could be hit by 45% tax on the use of the home if they "stuffed up" their tax return in any way or had their tax adjusted.

PricewaterhouseCoopers tax partner John Shewan backed up Mr Patterson's interpretation, adding it was easy for people to make a genuine error when calculating their taxable income.

"It's a bit of a worry when making an inadvertent error could result in a whole new ballgame," Mr Shewan said. "That's scary for trustees."

With people self-assessing their own tax, it was common for the IRD to take issue with a tax return several years down the track "and you may not know that for three or four years," Mr Patterson said.

During that period you would become liable to pay 45% tax on all distributions, possibly including rent for living in a home owned by the trust.

The distinction between qualifying and non-qualifying trusts was made in the late 1980s and was intended to punish people who were shifting income-producing assets offshore into lower tax jurisdictions or tax havens.

In that case the trust would be deemed to be non-qualifying and would be pinged by a 45% tax rate.

But Mr Patterson said this latest proposal went against the intent of that legislation.

"It was never ever envisaged that non-qualifying trusts should apply to Joe Blow Kiwi," Mr Patterson said.

The IRD seemed to be taking a particularly aggressive approach on this and some other issues, he said.

But Chapman Tripp tax partner Craig Elliffe said there was an upside to the proposed change, because non-qualifying trusts would be able to be regain their status as qualifying trusts, which was not possible in the past.

The tax officials have a deadline of the end of next month for submissions on the suggested change.

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