If You or Your Trust Own Property – You Need to Read This

Grant, a self employed marketing consultant, set up a family trust many years ago. As is common, he was the settlor and one of the trustees of that trust.  His Trust owned his family home and late last year bought a holiday home.

He was also a property investor and had a company which held other investment properties.  Grant’s investment property strategy was to buy dated houses, renovate and then sell them at a profit.   

Unfortunately Grant’s marketing consultancy lost a big contract and all of a sudden cashflow was tight.  So when the Family Trust received a good offer and sold the holiday home his accountant informed him that the transaction may be subject to new tax laws.  He had thought that because it was owned by the Family Trust, the beach house was protected from tax on any profits.  Grant was wrong.

Late last year there were very significant changes made to the Income Tax Act 2007.  Those changes amended the definition of an “associated person” with the intention of catching those persons who previously avoided tax by using multiple entities to own property.  Under the changes more property investors could now be liable for extra tax for being “associated” with other entities or structures owning their property. 

How it was …

New Zealand does not have any capital gains tax and in the past a person in Grant’s situation would not incur a tax liability on the sale of their holiday home or investment property.  This was unless:

• The person bought a property with the intention of on-selling it for a profit;
• The person was a builder, developer or trader;
• The person undertakes a development or subdivision of the land; or
• The value of the land has increased because of a zoning change or a granting of a resource consent (e.g. for a particular activity to occur on the land.)

And now …

Under the changes, examples of those who can now be “associated” are:

• The settlor of a trust and the trustees of that trust;
• Two trusts with the same settlor;
• Two companies where more than one shareholder is associated and between them hold 50% or more of the shares in the company;
• The settlor of a trust and the beneficiary of that trust;
• A trust and the person with the power to appoint and remove trustees.

The new legislation also creates a new three way test whereby if person A is associated with person B, who is in turn associated with person C, then person A is seen as being associated to person C.  Spouses and de facto partners can also now be seen as associated, depending on the circumstances.  In the example above Grant was associated with his company and his Trust so when the Trust sold the beach house Grant was personally targeted and taxed on the profit from the sale.

Generally speaking the changes widen the range of persons who can be classified as associated and means that many more transactions will be subject to income tax.  The intention is to indirectly close up perceived “loopholes” in the associated persons definition.  What was previously a tax free capital gain has now become taxable income.

One slight relief for investors is that the changes are not retrospective.  The rules in relation to land came into force on the date of enactment in October 2009.

If you have structures in place for ownership of your property which worked for you under the old regime, now is a good time to talk to your lawyer and accountant about whether you need to reassess your structures.  Your current structure may not protect you under the new regime in the way it previously did.