As a tax professional, my work Christmas wish was for a slowdown in the pace of legislative change. 2021 was a busy year for tax with a number of significant developments with very broad application, from the change in the top personal tax rate to 39 percent, to the changes in the interest deductibility and brightline rules, to the ill-conceived proposal to do away with the concept of GST tax invoices!
The 39 percent tax rate came into effect on 1 April 2021, but the flow on effects of this will continue into 2022 and beyond.
While the top personal tax rate is now 39 percent the trust tax rate remains at 33 percent, but recent developments from Inland Revenue show that they are keeping a careful watch on taxpayer behaviour which could force their hand.
As a reminder, this is not the first time that the top personal tax rate didn’t align with the trust rate. The last time the top personal tax rate was 39 percent was from 2000 to 2010, and the trust tax rate was 33 percent during this time. As a result we saw a lot of taxpayer activity in the use of trusts as a way to divert income to lower taxed beneficiaries.
This was a focus of Inland Revenue audit activity though this period, resulting in high profile and successful tax avoidance cases where the taxpayers were held to have implemented business structures in a way that had an intention of avoiding tax.
The Inland Revenue have identified around 120,000 individuals who earned close to $180,000 in the previous years and have been monitoring in real time the monthly employment and investment information reported in relation to these individuals.
Tax rates misaligned
Now, with the top personal tax rate once again misaligned with the trust tax rate, Inland Revenue has stepped up their game and is using sophisticated data analytics to monitor the behavioural changes of taxpayers around reporting of the income and the use of trusts.
We have known for a while that Inland Revenue has been developing its data analytics capabilities and that the changes that have been made to their IT systems, as well as gathering significant amounts of data from external domestic and offshore sources, have allowed them to really beef up what they can do in this space.
They have identified around 120,000 individuals who earned close to $180,000 in the previous years and have been monitoring in real time the monthly employment and investment information reported in relation to these individuals.
They are looking for trends that might indicate some restructuring has taken place to avoid the top tax rate change. Around half of this group of taxpayers are salary and wage earners, and around half again are related to their employer – for example as shareholders or as beneficiaries of trust shareholders.
This group in particular may be seen as being able to influence the amount of income they receive from their business personally compared to income that may be diverted to related parties and taxed at a lower rate.
While it is acknowledged that there can be legitimate reasons for restructures or other changes, and that Covid-19 has had an impact on many businesses, Inland Revenue needs to be comfortable that tax is not driving the changes they are seeing. They are taking an educational approach in the first instance and are likely to contact taxpayers they have concerns about to discuss the reasons behind any changes that have been made.
Source of data for IR
The changes to the trust reporting rules that apply from the current tax year will provide Inland Revenue with another valuable source of data relating to taxpayer use of trusts. Consultation recently closed on two documents that describe the information that Inland Revenue expects to see filed alongside trust tax returns.
As well as needing to prepare financial statements that must comply with set minimum standards, trustees are now required to disclose a lot of additional information each year. This includes, among other things, disclosure of settlors and appointors of the trust, details of cash and non-cash settlements received and distributions made (including capital distributions) and information about transactions with associated persons.
It is understandable that Inland Revenue is wanting to get a better picture of how people are extracting wealth from trusts, but at what cost to taxpayers? These changes are likely to force significant additional compliance costs on trustees and we are hopeful that we may see some scaling back of the level of information required to be filed.
This new trust reporting, along with the data analytics work being done, will help drive audit activity as well as inform any policy decisions regarding a future change in the trust tax rate.
If the data indicates that the trust regime has been exploited, we could well see an increase in the trust rate to 39 percent to align with the personal tax top rate for this year’s Christmas present from the taxman.
Related: Professional advice may be required