Articles by The Professional Trustee Team
Christmas Grinch versus Santa Claws
When it comes to giving, they say it's the thought that counts. Unfortunately, not many people apply this truism when it comes to gifting to the Family Trust. I expect lots of New Zealanders will, in the next little while, rush in where angels fear to tread and make gifts to their Trusts. They will forgive all debt owing to them and will feel happy that the new law permits them to bring their protracted gifting programmes to an end. Very little thought will be spared on what the implications of this move are or the enormous loss of wealth it could cause. In a bid to help you, I thought I'd share what I've been thinking lately …
a new landscape for trusts
On 1 October 2011 the Government introduced law which abolished Gift Duty. This legislative move was made after a review had been conducted which showed adequate mechanisms existed to protect creditor rights. The review also brought to light that little Gift Duty was ever collected thus the tax was ineffective and furthermore, the actual completing and filing of gifting documentation placed significant costs on the Government and the persons making gifts.
The result of the new legislation is that the Gift Duty regime as we have known it is now an historic beast. The practice of selling your assets, at market value to a Trust and getting a Deed of Acknowledgment of Debt (IOU) back from your Trustees and annually forgiving $27,000 of that IOU debt is now a thing of the past. Individuals are free to make one or more gifts (including debt forgiveness) of any value, without incurring and paying Gift Duty, from 1 October 2011. Wonderful I hear people say. Finally, I can wrap up my affairs and conclude this long drawn out affair I've had with gifting. But before you do just that, read on.
1. potential creditor claims
Many people, especially those in business, borrow funds from an arms length party such as a Bank. At the time of borrowing they sign loan documents which state they must remain solvent at all times. Often once an individual has the funds from the Bank, they on lend them to a Trust they have created. In turn, the Trustees of the Trust give them a Deed of Acknowledgment of Debt evidencing they owe them the money they have just received. In effect this means the individual remains solvent as the IOU balance noted in the Deed constitutes a personal asset to them. Accordingly the person's asset and liability position is balanced.
Forgiving the debt owed by the Trustees of the Trust however may mean the individual becomes technically insolvent. This is because all assets will be owned by the Trust and the individual will merely owe a liability back to the Bank without having any corresponding asset owed to them.
Being technically insolvent could amount to a breach of the covenants in the Bank loan documents and that could give rise to the Bank demanding repayment of the debt the individual owes them.
For this reason, an individual should always consider what their personal asset and liability position will be in relation to any covenants they have given to a lender before they complete gifting. This matter is particularly important if an individual is intending to complete any lump sum gifting.
2. relationship property issues
When individuals in marriage or de-facto relationships transfer their joint assets to a Trust, they are in effect transferring relationship property. When they obtain Deeds of Acknowledgment of Debt back from the Trustees of the Trust for the relationship property they have transferred, the debts noted in those Deeds are also relationship property. The actual assets that have been transferred however become Trust assets. In other words, the transferred assets change their legal classification. Ordinarily this is not an issue if the relationship between the individuals continues and if both individuals are Appointors, Trustees and Beneficiaries of the Trust.
Problems can however arise if lump sum gifting has occurred, the relationship breaks and one of the individuals does not hold the positions of Appointor and Trustee. This happens because if assets have been fully gifted to a Trust there is no debt owed back to the parties. Therefore there is no relationship property which can be shared. Additionally if only one party in the demised relationship holds the powerful positions of Appointor and Trustee, the individual not in these power seats may find they have to apply for a Court Order in order to gain access to the Trust's assets on the basis that the Trust has deprived them of their relationship property rights. This can be an expensive and stressful experience.
Clearly full consideration of this issue needs to be given and canvassed with Professional Advisors before debt is forgiven in its entirety.
3. ability to call for funds from the trust
When a person transfers assets to a Trust and obtains a Deed of Acknowledgment of Debt from the Trustees of the Trust, this gives them the ability to demand from the Trustees partial or full repayment of the IOU balance stated in that Deed. If however the IOU balance has been forgiven in full, it means an individual loses this right of repayment.
An important consequence of this is that when an individual no longer has an ability to call up repayment of their outstanding loan balance, they become reliant on the Trustees. One would hope the Trustees would exercise their discretion and provide funds back to the individual.
To avoid the above scenario and retain some control over Trustees, it may be wise to leave a portion of debt owing back by Trustees to an individual. This point should be given some thought before all debt is forgiven.
4. inadequate trust attention – sham trusts
The law is quite clear when it comes to Trusts - in return for asset protection that Trusts bestow, Trustees must satisfy their duties and run the Trust properly. Failure to do this can result in a myriad of unwanted consequences including Sham Trust allegations.
Completing of annual gifting has in the past given Trustees an ability to come together and review how the Trust has been run. Frequently annual Trustee Reviews and Financial Statement Reviews were completed at the time annual gifting was undertaken. Outstanding Trust administration was consequently identified and caught up on.
Because may people will choose to forgive debt balances owing to them in one lump sum, the opportunity that annual gifting historically afforded to review the affairs of the Trust and catch up with Trust administration work will no longer exist. Thus there is a real fear that regular and proper Trust administration will no longer occur and opportunities to bring allegations of Sham will arise.
Additionally, now that Gift Duty has been abolished, it's thought the transferring of assets to Trusts will become even more popular. Correspondingly so will the scrutiny from creditors and other potential claims such as the Ministry of Social Development.
What one should take from the above is that at all times the need for regular and correct Trust administration is present. In point of fact, this need is likely to increase over time. Simply adopting a 'gift and forget' attitude about the Trust will put the Trust and its assets in jeopardy. Therefore, if debts in their entirety are to be forgiven, Trustees must be mindful to still take the time to annually (at least) satisfy their legal duties and responsibilities.
5. loss of wealth
Many people will be under the misapprehension that because legislation has repealed Gift Duty, they should immediately transfer all assets into a Trust and complete the forgiveness of all debts owing to them, thereby immediately qualifying for eligibility for the Residential Care subsidy. This view is however incorrect.
It is the Inland Revenue Department which was charged with the collection of Gift Duty. So the new legislation abolishing Gift Duty has an effect on this particular Government Department. It does not however affect the Regulations and policies the Ministry of Social Development applies and which WINZ implement, when an individual applies for a rest home care subsidy.
Before I tell you about the current rules the Ministry has, I should advise you that these Regulations and policies will undoubtedly change in the years to come.
At the time of writing however the process is that once an application for a Residential Care subsidy is received, WINZ conducts an asset assessment on the applicant.
As at July 2011, an individual is permitted to have $210,000 in personal wealth plus their personal effects plus a $10,000 pre paid funeral expense account in order to be eligible for a rest home subsidy. This applies where the applicant is single or where the applicant has a spouse/partner that is living in residential full time care.
Alternatively, where an applicant has a partner but that partner/spouse is not in residential care, the applicant is allowed to have the same $210,000 in personal wealth plus their personal effects plus a $10,000 pre paid funeral expense account.
If the applicant does not wish to apply this test, they are able to use another test. This is often referred to as the Alternative Test.
The Alternative Test will apply where an applicant has a partner but that partner/spouse is not in residential care. In such a case, the applicant is allowed to have $115,000 in personal wealth, plus a home plus a car. In other words, the individual applying for the subsidy is able to have cash of up to $115,000 and their home and car is exempt from the asset assessment, irrespective of the value of that home and motor vehicle. The home and car must however be owned by them and not held in a Trust.
All gifting that is completed by the applicant within a 5 year period immediately before an application for a rest home subsidy is made, will be taken into account when calculating an applicant's personal wealth.
Additionally, any gift an applicant's spouse/partner has made within the 5 year period year immediately before the application is made, will be taken into account when assessing how much an applicant has in personal assets.
The news is not all bad. Under current Regulations and policy regime, WINZ permits an applicant to claim a 'rebate' of $6,000 per annum during the 5 year period, providing excess gifting exists.
WINZ also has the ability to go further back than 5 years and as at October 2011 under current policy, can factor in gifts made by the applicant and their spouse/partner by looking back indefinitely and clawing back the gifting that both the applicant and their spouse/partner have completed.
An allowance for any gifting completed by an applicant and his spouse/partner totalling $27,000 in any one year will be given by WINZ when they complete their calculation.
If you think the above rules sound complicated you are not alone. Trust and Tax experts have all stretched their grey cells considering a variety of potential positions that could befall an applicant.
In an attempt to make a difficult subject somewhat clear, I am gong to give you the following example of how WINZ might calculate an applicant's personal wealth.
In 2003 Mr and Mrs Cavell transferred their family home to a Trust. The market value of the home at the time was $750,000. They each received from the Trustees of the Trust a Deed of Acknowledgment of Debt for $375,000. In the following years, they progressively forgave $27,000 each of this debt per annum. Once their annual gifting was completed in August 2010, the Trust owed each of them $159,000. In 2011, Mr and Mrs Cavell forgave the remaining loan balances owed to them of $159,000 each.
In 2015 Mr Cavell applied for a Residential Care subsidy. Mrs Cavell would however remain living in the home owed by the Trust.
Under the prevailing legislation at the time, Mr Cavell was permitted to have $250,000 in personal wealth plus personal effects plus a $10,000 pre paid funeral expense account.
Mr Cavell actually had very few personal assets. He did however have $20,000 in a savings account.
WINZ conducted an assessment and determined Mr Cavell to have $551,000 of personal wealth. This amount was ascertained as follows:
Because WINZ assessed Mr Cavell's personal wealth above the $250,000 permitted legislative threshold, his application for the Residential Care subsidy was declined.
You should take from the above example a few points. First, despite the law change that has now occurred, you should really think through the issues that I've mentioned above. Simply divesting yourself of assets to a Trust will not necessarily make you an eligible recipient for a Residential Care subsidy. Secondly, the forgiving of debt in one lump sum may not serve your best interests nor for that matter will completing annual gifting of $27,000. Possibly a better way is plodding through a gifting programme at an annual combined rate of forgiveness of the usual $27,000 amount. Finally, WINZ rules are complex and likely to change. Because of these points it is vital you obtain advice from your Professional Advisors before transferring assets to a Trust and gifting, whether it be partial forgiveness of debt or gifting balances in their entirety.
That of course is where we come in. We are all things money. We are able to help you evaluate your choices and make your decisions. With respect to evaluating your gifting choices, we have developed a system helps you decide what's best for you. If you need any assistance, just call us. Remember there's only one name in the money game. That's GRA.
Finally my Christmas wish for you is short spendings and long earnings as the Russian Money Barons say.
Professional Trustee Services
Gilligan Rowe + Associates LP
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© Gilligan Rowe & Associates LP
Disclaimer: This article is intended to provide only a summary of the issues associated with the topics covered. It does not purport to be comprehensive nor to provide specific advice. No person should act in reliance on any statement contained within this article without first obtaining specific professional advice. If you require any further information or advice on any matter covered within this article, please contact the author.
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