The Trust Distribution and the 39% Rate
The Ngatai family trust has two trustees, Mere and Hemi, and three beneficiaries: their adult daughter Aroha, who earns $180,000 as a lawyer, their son Tama, aged 16 and at school, and a charity. The trust earned $250,000 from a rental property and a share portfolio. In March the trustees resolved to distribute $120,000 to Aroha and $40,000 to Tama, with the rest retained. Aroha is on the top 39% rate. Tama has no other income. The trust deed allows discretionary distributions to beneficiaries. Inland Revenue is auditing the trust and questioning whether the distributions are genuine and whether the trustee income has been correctly taxed.
1. Analyse the tax treatment of the distributions to Aroha and Tama, including the trustee income position.
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Trustee income is taxed at 39% unless distributed to a beneficiary, in which case it is taxed to the beneficiary at their marginal rate. Distributing to Aroha at 39% produces no rate advantage, so the benefit is timing and flexibility rather than rate. Distributing to Tama is more sensitive: a minor's income from a trust may be subject to the minor beneficiary rule, which taxes certain distributions to minors at 39% unless an exception applies. The exception for a minor's income from a trust does not apply to a beneficiary who is a minor and the distribution is not from a family trust? In fact, the minor beneficiary rule applies to distributions to minors under 16 from a trust, taxed at 39%, with exceptions for certain disabled beneficiaries and for income derived from a beneficiary's own services. Tama is 16, so the rule may not apply if he is 16 or over at the relevant time, but the trustees must check the date. If the rule does not apply, Tama's marginal rate applies and the tax is lower.
2. Identify the audit risks and the records the trustees should hold.
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Inland Revenue will look at whether the trustees actually resolved to distribute, whether the beneficiaries had the legal right to the income, and whether the money was paid or credited. A resolution that is backdated, unsigned, or inconsistent with the deed is a risk. The trustees should hold signed minutes, the deed, financial statements, and bank records showing payment or credit. The distribution to Aroha at 39% is not tax-effective, and the auditors may ask why it was made. The distribution to Tama must be tested against the minor beneficiary rule and the date of his 16th birthday. If the trust retains income, it is trustee income taxed at 39%, and the trustees must file an IR6 return. Penalties may apply if the distributions were not genuine or if returns were incorrect.