Trading Trusts: Beware

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Clients from time to time enquire about the efficacy of Trading Trusts.  The Trust Deed that establishes a Trading Trust is very similar to a discretionary family trust Deed with the important difference being that the Trustee is a Company whose sole purpose is to be the Trustee of the Trust.  The Settlor of the Trust is usually the sole Director and Shareholder of the Trustee Company. 

Tax
The main benefit of the Trading Trust is that the income earnt by the Trust can be taxed either in the hands of the Trustee (current rate 33c in the dollar) or the income can be taxed in the hand of the beneficiaries.

If the beneficiaries (often wives and children) are over 18 years of age then often the tax paid on income distributed to them is at a much lower rate than the trustee rate.  Trading Trusts accordingly have an apparent tax advantage over companies which have many more rules around them in relation to the distribution of profit and the tax payable on that profit. 

Greater IRD Scrutiny
Because of the tax advantages available through Trading Trusts, the Commissioner of Inland Revenue looks carefully at the financial statements of Trading Trusts to ensure that the income received from Trading Trusts has been dealt with properly. 

The leading decisions on Trading Trusts all confirm that income that can only be earnt from plying ones trade or profession cannot be earnt by a Trading Trust.  For example, a trading trust controlled by a lawyer cannot give legal advice to the lawyer’s clients and charge for it.  Accordingly, the income derived from that advice cannot be diverted to the Trading Trust and taxed under the Trading Trust tax regime. 

Great care should be taken to ensure that the income declared on behalf of a Trading Trust is income that could properly be said to be earned by the Trading Trust (such as investment income)

Creditors
The other issue with Trading Trusts is the issue of creditors being able to identify whether or not they are dealing with a Trading Trust.  This is important from the perspective that the assets of a Trading Trust are held in the name of the Trustee on behalf of the Trust, the assets are not owned by the Trustee Company simpliciter.  This means that if a Creditor sues a Trading Trust, and the Trustee Company has limited its liability to the amount equal to the net assets of the trust, then the Trustee Company is unable to be liquidated by its Creditors. 

A (regular) Company that is not a Trustee Company on the other hand is both the legal and beneficial owner of its assets and accordingly if there are insufficient assets to meet Creditors so that a company is insolvent, then the Creditors are able to have the Company liquidated. 

It is important a Trustee Company of a Trading Trust should hold itself out to be the Trustee of that Trading Trust so that Creditors dealing with the Trustee Company know that they are dealing with a Trading Trust and not a (regular) Company as described above.

Company owned by a Family Trust
The alternative structure to a Trading Trust is for the shares in a Company to be held by Trustees so that dividends representing the profits made by the Company can be distributed to a Trust. 

The Company is a completely different creature from a Trading Trust and it will not suffer the same scrutiny from the Inland Revenue Department and Creditors as will a Trading Trust and is a widely accepted vehicle for the ownership of business assets.

If you wish to discuss Trading Trusts and Companies, or the best legal vehicle for your business please contact Peter Smith by email on
peter.smith@smithpartners.co.nz or phone 09 837 6882. 

Peter Smith on 09 837 6882, email
peter.smith@smithpartners.co.nz
or
Wade Hansen on 09 837 6885 or email
wade.hansen@smithpartners.co.nz