By Tammy McLeod*
With the advent of the new Trusts Act 2019 and some erosion over the past few years of the reasons why people might establish trusts there have been many people considering whether they need their trust anymore and then taking the steps to wind up.
Those who are considering winding up are often those who had really only set their trust up to avoid paying for their own rest home if they went into care or those who had a business at one time, but that business has now been sold and the risk they once had no longer exists and so they no longer need the trust.
There are also a handful of people who set trusts up simply because that was the thing to do at the time and there really is no good reason for the trust to continue.
My rule of thumb when advising those clients who wish to wind up, is establishing whether, if they came to me today without a trust asking if the needed one, would I recommend that they need a trust. If the answer is no, then often we look at winding up. However, there are a number of factors that need to be taken into account before making the decision to wind up.
The first is considering who the beneficiaries are of the trust and if it is wound up, who would receive the assets of the trust. In many cases the beneficiaries are simply the husband and wife and their children.
The childrens’ expectations are that they would only benefit in the event that their parents died. In that case, subject to what I say below, it might be quite a simple thing to wind up the trust and distribute the assets back to the husband and wife. However, now with the new Trusts Act and the obligations on the trustees to advise beneficiaries over the age of 18 that they are beneficiaries of the trust and that they are entitled to see a copy of the trust deed, know who the trustees are and other information relating to the trust, including perhaps financial information, the question is begged as to whether beneficiary consent to the winding up of a trust needs to be obtained before the winding up occurs.
This will be particularly important in blended family circumstances, or the situation where a parent has died and the surviving parent has remarried. The trust may be part of an asset protection mechanism to protect the assets for the children. If the trust is wound up and the assets pass to the surviving parent, that could defeat the asset protection plans that had been put in place initially.
Tax implications must also be taken into account. If the family home is transferred from the trustees to beneficiaries of the trust, there will usually be no tax consequences, as the family home is exempt from most tax on property transfers.
However, if the trust owns a holiday home or rental property and that is distributed to beneficiaries as part of a wind up, the brightline test is re-started. Now that the brightline test has been extended from five years to ten, this could have serious consequences. For many people, they may know what they are doing in the next five years and can accept if they wind up their trust, they cannot sell a property within that timeframe without suffering a tax consequence. However, for many people the ten-year horizon pushes beyond what they can easily comprehend and they do not know what they will be doing in ten years, and as such don’t want to take the risk of paying tax in the event that the property is sold within ten years of winding up the trust.
Because the winding up of a trust is treated like a sale for tax purposes, there may be other tax consequences in winding up a trust. Another factor from a tax perspective includes paying back the tax on depreciation. If a trust has claimed depreciation on a property in the past, then if that trust is wound up and the property distributed to beneficiaries, the tax relief claimed at the time will need to be repaid.
Likewise, if transferring shares in a closely held company from a trust to a beneficiary needs to occur as part of a winding up, continuity of shareholding needs to be taken into account, so that accumulated losses or imputation credits are not lost. Without taking tax advice this could have dire cashflow effects for closely held companies.
There are lots of trusts in New Zealand that are no longer needed, but before making the decision to wind up, it is important to get both legal and accounting advice.
Tammy McLeod is the managing director at Davenports Law, specialising in the areas of personal asset planning, trust law and Property (Relationships) Act.