Beneficiary income distributed to a minor will be taxed at a final rate of 33% when that income is derived from property which was settled on that trust by a relative or guardian of that minor or a person associated with a relative or guardian. (Section HH 3A-3B of the Income Tax Act 1994)
	A minor for the purposes of this rule is defined as a person under the age of 16 years. (Section HH 3A)
	Beneficiary income will be excluded from the rule in certain circumstances. (Section HH 3B)
	The rule will not apply if beneficiary income is $200 or less in an income year. (Section HH 3A)
	Beneficiary income subject to this rule will be taxed at the trust level (on behalf of the beneficiary). (Section HH 3A)

 

EXAMPLE 1 - THE TAX LIABILITY OF A FAMILY WITHOUT A TRUST
Mum	Tax liability
$80,000
$40,000 (income from salary/wages)	$8,070	$0-38,000 taxed at 19.5% $38,001-40,000 taxed at 33%
$40,000 (income from rental properties and dividends)	$14,399	$40,000-60,000 taxed at 33% $60,001-80,000 taxed at 39%
Dad	Tax liability
Income from salary/wages before tax
$70,000	$18,569	$0-38,000 taxed at 19.5%
		$38,001-60,000 taxed at 33%
		$60,001-70,000 taxed at 39%
The after-tax income of the family from salary and wages and from rental properties and dividends equals $108,962

 

EXAMPLE 2 - THE TAX LIABILITY OF A FAMILY WITH A TRUST A family with exactly the same income places the income-earning assets of rental properties and shares in a family trust of which their two children are the beneficiaries.
Mum	Tax liability
Income from salary/wages before tax
$40,000	$ 8,070	$0-38,000 taxed at 19.5% $38,001-40,000 taxed at 33%
Dad	Tax liability
Income from salary/wages before tax
$70,000	$18,569	$0-38,000 taxed at 19.5% $38,001-60,000 taxed at 33% $60,001-70,000 taxed at 39%
Children	Tax liability
Income from rental properties and dividends distributed to the children as beneficiary income
$20,000 child 1	$3,900	$0-20,000 taxed at 19.5%
$20,000 child 2	$3,900	$0-20,000 taxed at 19.5%
The after-tax income of the family from salary and wages and rental properties and dividends amounts to $115,561.

Detailed analysis

Therefore the family with a trust has an extra $6,599 with which to meet the family's expenses, even though it has identical income from identical sources as the family without a trust.

The scope of the minor beneficiary rule

The minor beneficiary rule is not aimed at all situations in which a minor receives beneficiary income, but rather at the particular situation where families can gain a tax advantage by use of a trust. Consequently, the rule will only apply when the beneficiary income of a minor is derived from property which was settled on that trust by a relative or a guardian of that minor or a person associated with a relative or guardian.

The existing definition of a "relative" in section OB 1 of the Income Tax Act 1994 will be adopted for this purpose. Under this section, individuals are regarded as relatives when they are connected by:

 

	blood relationship (which includes persons within the fourth degree of relationship);
	marriage (which includes not only persons married to each other but also those with a blood relationship to their spouse); and
	adoption.

Including settlements made by a person associated with a relative or guardian ensures that settlements made by a family company, for example, are included within the rule.

For the purposes of this rule, the existing definition of "settlor" in section OB1 is being amended to ensure that a relative, guardian or his or her associate who provides services to the trust is not deemed to be a settlor. An example would be where damages for the benefit of the child are settled on a trust and the parent of the child provides free accounting services.

The minor beneficiary rule will apply to beneficiary income distributed from both discretionary and fixed trusts. It will also apply to beneficiary income distributed from a qualifying, non-qualifying or foreign trust.

The definition of a minor

The rule will apply only to children under the age of 16 years.

In determining whether the rule applies the trustee will look at the child's age as at the balance date of the trust. If the minor is under the age of 16 throughout the income year, the rule will apply to all income derived in that year. If the minor turns 16 in that income year, the rule will not apply to any income derived in that income year.

Distributions of beneficiary income which will be excepted from the rule

There are a number of exceptions from the ambit of the rule to ensure that the rule focuses on particular situations where a family can gain a tax advantage by having income distributed as beneficiary income to a child. These include:

 

	beneficiary income derived from property if the settlor received that property as agent for the beneficiary from someone other than a relative, guardian or his or her associate;
	beneficiary income derived from property when the settlor has been ordered by a court to pay damages or compensation to the child;
	beneficiary income derived from property settled on the trust under the terms of a will, codicil, intestacy or any variation of these by a court, if the minor was alive within twelve months after the date of the settlor's death;
	beneficiary income from a group investment fund;
	beneficiary income distributed to a non-resident minor;
	beneficiary income distributed to a disabled minor for whom the Child Disability Allowance is paid under the Social Security Act 1964; and
	beneficiary income distributed to minors from the Maori Trustee and Maori authorities.

Minimum threshold

If beneficiary income would otherwise be subject to this rule but is $200 or less in an income year, the minor beneficiary rule will not apply. If that income is over $200, all of that beneficiary income will be subject to the rule.

Operational aspects

Beneficiary income subject to this rule will be taxed at the trust level at a final tax rate of 33%, on behalf of the beneficiary. Consequently, beneficiary income subject to this rule will not be included when calculating the minor's final tax liability.

The trustee is required to take all reasonable steps to ascertain whether the minor beneficiary rule applies. If it clearly does apply, or if doubt exists, the trustee must withhold tax on the beneficiary income of that minor at 33% on behalf of the beneficiary. The trustee is required to include the tax withheld on this income in his or her provisional tax payments.

If a trustee fails to deduct at 33% from beneficiary income that is subject to the rule, the trustee will be liable for this tax, and penalties will potentially lie with the trustee. If the minor is mistakenly taxed at 33% when he or she should have been taxed at 19.5%, the minor can claim a refund for this additional tax in his or her return.