It's a question we get asked from time to time: "My family trust only owns the house, nothing else. I've never had financial statements done for it; is it really necessary?"

Well, your lawyer may tell you no, we but our view is "Yes! Absolutely!"  To explain why, please see this excerpt from from Family Trusts 101 by Janet Xuccoa, Chartered Accountant, GRA:

*** start of excerpt ***

Pg 117

FINANCIAL STATEMENTS

It never fails to amaze me the number of Trustees that don’t have annual financial statements prepared for the Trust they are administering.

How can a Trustee meet one of their fundamental duties of accounting to a Beneficiary if they do not possess up to date financial knowledge of the Trust’s affairs?  Furthermore, a Trustee has a duty to meet the tax obligations of the Trust and these obligations can’t possibly be identified and satisfied if a Trustee doesn’t know the financial position of the Trust. So in my view, the rule is financial statements should be prepared for Trusts.

Sometimes a Trustee will ask me if the above rule applies to a Trust which does not receive or earn income. I think it does.

If a Trust is a recipient of income then financial statements and tax returns must by law be prepared and lodged with Inland Revenue. If a Trust does not however earn or receive any income, then I still believe financial statements should be prepared because by doing so three things are established

First, the loans owed back to the Settlor/s (if any) can be identified and a correction (if needed) can then be made. Furthermore, a decision with respect to gifting can be formed.

Secondly, the assets and liabilities of the Trust will be noted in the financial Statements which helps Trustees conduct an Annual Financial Statement Review and an Annual Trustee Meeting.  If you read ahead you will understand why this Review and Meeting are important and the role the financial statements play.

Lastly, by completing financial statements Trustees are put in a position of being able to meet the duties they owe to the Beneficiaries.  In other words, the Trustees are able to account to the Beneficiaries and will be able to identify and satisfy the Trust’s tax obligations.

Pg 118

FINANCIAL STATEMENT REVIEW

I think a great aid in avoiding a successful sham Trust allegation is the performing of a Financial Statement Review. This Review should be conducted annually, once the financial statements for the Trust are to hand. 

I recommend the Professional Trustee conduct the review.  Once performed, the Professional Trustee should report back to their co-Trustees on the matters that need attention.

In particular, the financial statement review should cover:

• The checking of the transactions and balances noted in the financial statements against the records held for the Trust
  
• A decision with respect to Gifting
  
• The establishment of loan balances and the checking of all Deeds of Acknowledgement of Debt, Variable Interest Loan Agreements and other loan contracts; and
  
• The noting of any Beneficiary distributions made and the confirmation that appropriate and timely Resolutions have been passed by the Trustees.
  

Lastly, I expect a Professional Trustee’s review to determine what documentation, if any, is required to bring the administration of the Trust up to date.  This could include the preparation of Resolutions, Deeds of Acknowledgement of Debt and Variable Interest Loan Agreements to name but a few documents.

*** end of excerpt ***

We thoroughly recommend purchasing Janet's excellent and easy to read book on Family Trusts.  Click here to purchase. Thanks to Janet for permission to publish this information here.

That's a good question, and it depends a lot on what entity incurs the loss.  Let's break down the various types and what effect they have.

If you are a shareholder in a Look-Through Company (LTC) and that company makes a loss, then you get to carry that loss through to your personal tax return (usually an IR3).  There are a few rules and limitations which we won't go into here.

Let's assume you're a salaried employee, and so you've had PAYE deducted from your wages.  Well, at the end of the financial year a wash-up is done on your personal tax return. The above-mentioned loss is deducted from your gross (pre-tax) wages.  It might look something like this:

 $85,000 Wages 
-$  5,000 Loss from LTC
- - - - - - -
$80,000  Net taxable income

We then calculate (a) how much tax you have paid, and (b) how much tax you should have paid. If (a) is more than (b) then you get a tax refund.  If the other way around, you have tax to pay.

Ok this situation is totally different. If the LLC makes a loss, then it can't be passed on to anyone. Not the shareholders, not the directors: no one.  

Instead, it carries that loss forward to the following financial year. If there is taxable profit, then the loss can be offset against that profit.  It might look something like this:

 $85,000 Net taxable profit
-$  5,000 Losses brought forward from previous years
- - - - - - -
$80,000  Net taxable income

If there is no profit, then you just keep carrying the losses forward, year to year.

If you have a trust it's the same as an LLC with respect to losses. They can't be distributed out to the beneficiaries. Rather, they get carried forward until there is profit to offset them against.

A partnership works in a similar way to a Look-Through Company essentially.  Losses are distributed to each partner, according to the rules of the partnership.

Sometimes you might combine some of these structures. 

For example, a trust might own all the shares in a Look-Through Company. The LTC makes a loss.  What happens then?  In this case, the losses flow through to the Trust. They are then dealt with as explained above.

In the meantime, please contact us with any questions, or talk to your tax professional.

The Two Main Types of Trust
There are generally two types of trusts that we do the accounting for: 

1. A trust with no rental income, and which doesn’t need to file tax returns with Inland Revenue, but does need to produce annual financial statements.  The work is generally very low volume in terms of transactions, and there is usually some gifting; 
   
2. A trust with income of some sort, usually rental, which needs to file tax returns. The work is the same as that of an LTC with a rental, but there is the slight complication of gifting and loans from the Settlor as well as the bank.

The concepts
A trust is an arrangement between three groups of people: the Settlor, the Trustees and the Beneficiaries. The Settlor of the trust sells his property to the Trust.  To acknowledge this, a Deed of Acknowledgement of Debt is usually drawn up.  The Trustees must then manage the property on behalf of the Beneficiaries of the Trust.  (Any legal documents including bank statements should actually be issued to the Trustees, but sometimes you will see bank statements and invoices issued to the Trust).  A person may be the Settlor, a Trustee and one of the Beneficiaries.

Now, usually the Trust has no income, so the Settlor pays the mortgage to the bank on behalf of the Trust.  This creates more advances (loans) from the Settlor to the Trust.  Usually an Agreement to Occupy is drawn up, and this basically says that the Trustees can live in the house rent free, so long as they pay for the upkeep of the property. 

Note that if the Settlor (assuming he is living in the house and is also a Trustee) does improvements on the house, then this is also considered an advance to the Trust (this is because it is not the sort of an expense that a “tenant” would pay for; rather, an improvement is a landlord’s expense and in this case the Trust is the “landlord”, even though no rent is charged to the “tenant”). 

This is where gifting comes in: the Settlor is owed money by the Trust (he sold the property to the Trust) but he decides to progressively forgive this debt, usually no more than $27,000 per year (here’s why people usually don’t gift more than that amount).  This gifting is recognised by Deeds of Forgiveness of Debt, which are typically drawn up annually.  In the past these had to be registered with IRD but not anymore. Sometimes the Settlor will forgive all of the debt at once.  The decision on whether to do this or not is best taken under legal advice.

Why do people set up trusts? 
The benefit of a trust is that a person gets to use its assets, thus controlling them, without having legal ownership of them. People do this to protect themselves from being sued by creditors and losing everything.  Most commonly people put the house they live in into a Trust.

Here is everything we’ve written on trusts: http://www.epsomtax.com/blog/category/trusts Please feel free to browse; there are a couple of videos and articles which you’ll find  helpful.

Where to from here?
We hope that this gives you an overview. For more information please contact your lawyer.  

In this, the third of three videos in the series, Garreth Collard, Principal of EpsomTax.com addresses APIA members on the Sham Trusts.  Learn about how your "family" trust might be a sham, what this could mean for you, and how to prevent (and fix) the situation!  The video is 12 minutes long, so make sure you're comfortable...

Click here for a copy of the handout being used at the presentation.  The other two videos in the series are:COMMON RENTAL OWNERSHIP STRUCTURES [VIDEO]
WHICH OWNERSHIP STRUCTURE SHOULD I USE FOR MY RENTAL PROPERTY? [VIDEO]

You might also be interested in:
COMMON MISCONCEPTIONS ABOUT FAMILY TRUSTS
FAMILY TRUST ACCOUNTING - WHAT DO I NEED TO DO?
RESIDENTIAL CARE SUBSIDY AND GIFTING

If you've got 5 minutes, make yourself a hot cuppa and enjoy this video presentation by Garreth Collard, Principal of EpsomTax.com in which he addresses APIA members on the pros and cons of the most common Rental Ownership Structures. Click here for a copy of the handout being used at the presentation.  

See this insightful 3-minute video presentation by Garreth Collard, Principal of EpsomTax.com in which he explains the nuts and bolts of the most common rental ownership structures to APIA members. Click here for a copy of the handout being used at the presentation.  

Disclosures: EpsomTax.com does not claim endorsement by APIA.  Garreth Collard was invited to speak to APIA members by APIA.  Garreth was not remunerated for this.

Note: Some partnership agreements do allow annual adjustments to distribution of losses/profits; check the wording of your agreement with your lawyer if you are not sure.

Which structure is best?  Although not exhaustive, we hope that this chart will give you an overview of the four most commonly-used structures and their pros and cons.

Note that some partnership agreements do allow annual changes in distribution of income or losses; check the wording of your agreement if you're not sure.

Check out our other articles which discuss these in more depth, such as

• TRUST VS LTC FOR RESIDENTIAL INVESTMENT PROPERTY
• SHOULD YOU FORM AN LTC TO OWN YOUR RENTAL INVESTMENT PROPERTY? and
• RENTAL INVESTMENT PROPERTIES & LTCS – A GOOD MATCH? [video]

Feel free to contact our experienced team on 0800 890 132. Please see the desktop version of this website if the chart does not display on your mobile device. This page uses a script from SCRIBD to display the PDF.

Many people set up a trust, but then are not advised correctly thereafter.  They may think that they can be a passive trustee (a misnomer) or leave it all up to their lawyer.  They may even think that because the trust “only” owns the family home that they don’t have to do anything.  Or you may have heard it said that you don't have to gift anymore. None of these misconceptions could be further from the truth.

Let's look at each of these one by one:

(1) My lawyer does it all. I'm just a passive trustee
As a trustee, you have a legal fiduciary duty towards the beneficiaries to care for the assets in a proper way, manage the trust, make sound decisions and inform the beneficiaries as required (see this article for details).  The beneficiaries have the legal right to be informed and to be considered, and as a trustee you must prove that you have consistently done this.  In other words, there is no such thing as a "passive" trustee.  

People have tried to tell the courts that... and the courts have taken a rather dim view of it.  See this article, for instance.  The court ruled:

Equity simply does not recognise the concept of an "active" trustee or a "passive" trustee.  All trustees are accountable to the beneficiaries of the trust and must account to them for its proper administration. 

So, you can't leave it to your lawyer.  You need to be involved. You need to prove that you have acted in accord with the trust deed and are not in breach of trust.

(2) My trust only owns the family home so we don't have to do anything
Irrespective of what assets the trust owns or doesn't own, this does not change your legal obligations as a trust.  The trust could own a souvenir coffee mug worth $2, or a house worth $500,000.  The legal obligation to use the assets of the trust in a proper way, taking the beneficiaries' interests into account remains unchanged.

(3) You don't have to gift anymore
Ahh, what you may be getting confused with is that Gift Duty was abolished in October 2011.  Previously, if you gifted over $27,000 per person per year, the IRD would expect duty or tax on that gifting. They eventually realised that the scheme cost more to run than it made, so they abolished it.

However, this law change doesn't change the need to gift.  Why?  Well, when the trust is set up (and assuming it is your usual "family" trust*) generally the purpose is for it to take over the assets of the Settlor/s.  To do this, the trust buys the home off the Settlor/s.  So, a Deed of Acknowledgement of Debt is drawn up. This needs to be gradually forgiven by a gifting process. You can do this yourself, but most people get their lawyer to help them.  Annually, Deeds of Forgiveness of Debt are drawn up and signed, and gradually the house is fully gifted to the trust.#

So, if there is no gifting, the trust never really serves any purpose. You have spent thousands of dollars setting it up, but it is of no use to you. Hence, gifting is very much still necessary.

If you'd like more information about all of this, best to talk with your lawyer.

* The most common form of so-called family trust in New Zealand is a Express Written Intra Vivos Discretionary Trust.  Express because the Settlor has expressed a wish to create a Trust, Written, not verbal, Intra Vivos in that it exists whilst the person is still alive, and Discretionary in that the trustees have discretion as to what to do with the assets.

# With the abolition of gift duty, some decide to gift their assets all at once. Talk to your lawyer about whether this is right for you or not. See here for the implications of "excessive" gifting.

Credits: Martelli McKegg Lawyers; IRD. EpsomTax.com does not claim any endorsement, representation or relationship by or with the quoted sources.

See our three-video series:
SHAM TRUSTS: COULD YOUR FAMILY TRUST BE A SHAM? 
COMMON RENTAL OWNERSHIP STRUCTURES
WHICH OWNERSHIP STRUCTURE SHOULD I USE FOR MY RENTAL PROPERTY?

You might also be interested in:FAMILY TRUSTS: BASIC CONCEPTS
FAMILY TRUST ACCOUNTING - WHAT DO I NEED TO DO?
RESIDENTIAL CARE SUBSIDY AND GIFTING

Your lawyer has possibly mis-advised you - although in good faith.  Why do we say that?  Well, here's a quick checklist before you start panicking:

Quick checklist 

1. Do you have a trust?
2. Have you done any gifting?
3. Are you worried about getting residential care subsidies in future?
   • If not, you can stop reading here
   • If you are, keep reading
   • If you are not sure what I mean, see below for an explanation
4. Have you (and your partner if applicable) gifted $27,000 per year or $54,000 per year?

The gist of it
Previously, the country's lawyers had advised people to gift no more than $54,000 per couple per year so that they wouldn't be accused of excessive gifting when it came time to be assessed for a residential care subsidy.  If your assets come under certain figures the Govt. will subsidise your rest-home care.  People generally gradually and cautiously gift their house to their trust so that anything they do doesn't stray into excess.  

BUT!  A recent series of court decisions, upheld all the way to the Court of Appeal, has now said 

Gifts of more than $27,000 per year, per application made before the five year gifting period, may be added into the assessment. For couples, gifting is $27,000 in total – not per person.

​See this page on the WINZ website for more info

What does this mean for you?
Here's what the Law Society of NZ said:*

The result of the High Court’s decision is that many people who have undertaken a gifting programme to a family trust may now unexpectedly find themselves ineligible for the residential care subsidy. This will come as an unwelcome shock to many. It will also likely cause many members of the profession concern at the prospect of claims from disgruntled clients for previous advice on gifting programmes.

The long and the short of it is that if you have already gifted more than $27,000 per annum to your trust, then this is now viewed by MSD as excessive gifting.  If you acted on legal advice, then I suggest you approach your lawyer about making a claim against them.  The NZ Law Society makes this comment to lawyers:

Lawyers may wish to consider whether there is a need to notify professional indemnity insurers in respect of the risk of potential claims for previous gifting advice. Some brokers are encouraging practitioners to notify insurers of the risk of potential claims. Practitioners are encouraged to check their particular circumstances with their broker/insurer.

Here's the judgement of the Court of Appeal:

http://my.lawsociety.org.nz/in-practice/the-changing-law/case-commentary/bridgford-as-executor-of-the-estate-of-elva-bridgcorp/Gary-Bridgford-as-Executor-2013-NZCA-410.pdf

Note that lawyers throughout NZ advised people based on the then-understanding of $54,000 per couple per year, and so acted in good faith.  But, at the end of the day, the advice has been misleading, as this recent judgement has shown.  It's not pleasant for anyone.

Yes, but?!
Yes, but didn't the IRD change the law or something?  What you might be referring to was the repeal of gift duty.  What happened was that the Government passed a law change, meaning that you could gift your entire house to your trust, without incurring gift duty.  Previously there was a limit of $54,000 per couple per year.  Anything above that had gift duty applied to it.  BUT (and here's the key point), the MSD's view of excessive gifting didn't change.  If anything, it has tightened up, as explained above.

Further reading
Gifting and entitlement to residential care subsidies (HarknessHenry Lawyers)
Residential Care Subsidy (WINZ)
FAMILY TRUST ACCOUNTING - WHAT DO I NEED TO DO? 

Help!
What to know more?  Call us on 0800 890 132 or email us.

* Note that the quoted blog post from the NZ Law Society is dated Jun 21, 2013, which was before the Appeal Court had made its ruling.  This Court ruling has now confirmed MSD's view, as stated above.

See our three-video series:
SHAM TRUSTS: COULD YOUR FAMILY TRUST BE A SHAM? 
COMMON RENTAL OWNERSHIP STRUCTURES
WHICH OWNERSHIP STRUCTURE SHOULD I USE FOR MY RENTAL PROPERTY?

And the following blog articles:FAMILY TRUSTS: BASIC CONCEPTS
FAMILY TRUST ACCOUNTING - WHAT DO I NEED TO DO?
COMMON MISCONCEPTIONS ABOUT FAMILY TRUSTS

Image courtesy of Idea go at FreeDigitalPhotos.net

How and why should you account for your family trust?  The first thing to consider is that there are whole teams - firms - of lawyers dedicated to unraveling and breaking apart trusts. 

"What?!  Who would do such a thing?" you might ask. Lots of people: MSD, IRD, WINZ, creditors etc. They may try to prove that your trust is simply a false front to make you "poor on paper." (a) 

How do you prevent this? Simply put, you need to manage it well. (b) How? 

• Involve all trustees in decisions. 
• Have regular minuted meetings of trustees. 
• Don't treat the assets as if they were your own: Pay Trust bills from a Trust bank account. 
• Have annual accounts drawn up - or at least a statement of assets and liabilities. 
• Don't mix your personal assets with Trust assets. 
• Insure Trust assets, e.g. the house it owns. 
• Keep good records. 
• Consider having a Professional Trustee

Other sources of info
So, what are the news media saying about all of this? See this article at the NZ Herald website.  See also this article: 

Excerpt: "A key recommendation in the review was that courts would be able to find that a trust had not been established and had no legal standing if the person who established it continued to manage the assets it held "as if they are their own personal property."

and this article:

Excerpt: "The proposed new law would clearly set out the core characteristics of trusts and duties of their trustees. It would also firmly underline that a trust could be found invalid if the trustees were not steering it towards its ultimate purpose, the benefit of its beneficiaries."

Some FAQs:
I want a second opinion!
Certainly.  See The Trouble With Trusts at www.grownups.co.nz. 

OK. Now I know. I haven't done any financial statements in the past. Can I just ignore the past and carry on from here?
Honestly, that's risky.  Scores of court decisions have shown that the threshold for trustees not breaching their duty is quite high.  In our opinion, the best thing is just to bite the bullet and get them done.  You'll be grateful later in life that you had the foresight to spend a small amount now to preserve the enormous assets that your Trust owns.

Oh but our Trust only owns the family home so we don't need all that.
With respect to financial statements for the Trust, Janet Xuccoa of the well-known property accountant firm GRA writes on page 117 of her book Family Trusts 101: “It never fails to amaze me the number of Trustees that don’t have annual financial statements prepared for the Trust they are administering.  How can a Trustee meet one of their fundamental duties of accounting to a Beneficiary if they do not possess up to date financial knowledge of the Trust’s affairs? Furthermore, a Trustee has a duty to meet the tax obligations of the Trust, and these obligations can’t possibly be identified and satisfied if a Trustee doesn’t know the financial position of the Trust. So in my view, the rule is financial statements should be prepared for Trusts.”  She then goes on to list three reasons why your Trust needs annual financial statements even if it doesn’t receive an income.

Hmm, so where to from here?
What should you do now?  We recommend that you read Martin Hawes' book and Janet Xuccoa's book. Or if you don't have time for that, at least look at this blog article from LegalBeagle. Get a good accountant who has expertise in trust accounting and can do your annual accounts at reasonable prices (us!).  Speak to your lawyer. 

When should I start?  
Now! (c)

I'm overwhelmed by all this. Is there anyone out there who can help me?!
Yes. Us!  Contact us today on 0800 890 132!

References: Family Trusts by Martin Hawes. (a) Page 164 (b) Chapter 7 (c) Chapter 9.  This blog does not claim any specific endorsement by Martin Hawes, Janet Xuccoa or GRA.

Videos
SHAM TRUSTS: COULD YOUR FAMILY TRUST BE A SHAM? 
COMMON RENTAL OWNERSHIP STRUCTURES
WHICH OWNERSHIP STRUCTURE SHOULD I USE FOR MY RENTAL PROPERTY?

Blog Articles
FAMILY TRUSTS: BASIC CONCEPTS
COMMON MISCONCEPTIONS ABOUT FAMILY TRUSTS
RESIDENTIAL CARE SUBSIDY AND GIFTING