THE NZ TRUSTEE COMPANIES ASSOCIATION LIMITED

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1 THE NZ TRUSTEE COMPANIES ASSOCIATION LIMITED 9 September 2016 Clerk of the Committee Finance and Expenditure Select Committee Parliament Buildings WELLINGTON Dear Sir / Madam FINANCE AND EXPENDITURE SELECT COMMITTEE - SUBMISSION ON THE TAXATION (BUSINESS TAX, EXCHANGE OF INFORMATION, AND REMEDIAL MATTERS) BILL This submission is made by the NZ Trustee Companies Association Limited on the Taxation (Business Tax, Exchange of Information, and Remedial Matters) Bill. The Association consists of a number of entities involved with the management and servicing of New Zealand foreign trusts. We wish to have the opportunity to make an oral submission to the Committee on this submission. Our submission is restricted to Part 1 of the Bill dealing with the implementation of Automatic Exchange of Information ( AEOI ) and the Common Reporting Standard ( CRS ) associated with that, and the proposed disclosure requirements for foreign trusts following the recommendations of the Government Inquiry into Foreign Trust Disclosure Rules the Shewan Inquiry. Our submission is that officials be directed to consult with those with a detailed technical knowledge of how foreign trusts work to amend the bill to make it more workable in practice while meeting the stated objective of ensuring that our foreign trust disclosure rules meet the highest international standards for transparency. As an opening comment we note that whereas AEOI/CRS has been subject to consultation between officials and the private sector, by its nature the proposed foreign trust disclosure rules have been subject to a different process that has in effect meant no consultation on the technical aspects of the proposals. In other words, there has been no Generic Tax Policy Process on the foreign trust disclosure rules. Instead the process involved the establishment in April 2016 of an Inquiry under section 69(3) of the Inquiries Act 2013 constituting one person, Mr John Shewan. The Shewan Inquiry sought and received submissions on its terms of reference which were broad and policy in nature. The Inquiry reported in June 2016 with detailed recommendations which, the Bill (as the Bill Commentary and Explanatory Note state) largely follows. There has been no opportunity in this process for detailed technical consultation so that workable law results. We agree with the Shewan Inquiry s conclusion that New Zealand should retain its existing tax laws relating to foreign trusts but ensure adequate information disclosure. We also agree that such disclosure should be limited to Inland Revenue and appropriate law

2 enforcement authorities (with the ability to for them to exchange information to their overseas counterparts) in accordance with international best practice. Our concern is that the Bill provisions do not seem practical or workable. We focus on four areas: The requirement to provide trust deeds on registration and update them. The apparent lack of consistency between, and duplication of, foreign trust information requirements and CRS requirements. Excessive Requirements Technical Issues With respect to technical issues we conclude that it seems that the bill does not work to achieve its stated policy objective. We note that the various information disclosure requirements are intended to apply in some cases to family trusts. This is evident from the proposed grace period for disclosing information for such trusts in the proposed section 59C(3) clause 10. This is explained in the Commentary pages 117 to 118. This stresses the importance of having legislation that is workable and clear and as easy to comply with as possible. Trust Deeds The Bill (clause 10- section 59B(3)(e)) proposes that the trust deed be required to be filed on registration with amendments filed within 30 days of amendment and that any changes to this be included in an annual return to IRD. This appears to follow the Shewan Report that recommended foreign trusts be required to mirror the information requirements of ordinary New Zealand trusts that apply for an IRD number (at paragraph 12.9). In fact when applying for an IRD number for a domestic trust Inland Revenue requires only excerpts from the trust documentation so as to identify the trust being: Date page, Name page, and Execution pages. This has been translated into legislation as a requirement to register and update a copy of the trust deed. Clearly a process for identifying and registering foreign trusts requires the lodgement of some form of identity verification. Trust deeds are not the most appropriate documentation to use. They can be bulky documents containing much information extraneous to any interest to IRD or other relevant agencies (such as family matters and investment powers). The terms and parties to trust deeds also change frequently. It is for that reason that the Law Commission (as the Shewan Inquiry itself notes at paragraph 13.5) concluded that the compliance costs of establishing a register of all trust documents would be excessive for little benefit. The issue of what identity documentation for trusts in general is appropriate in the modern environment is something that should be considered as part of IRD s Business Transformation, but, in the interim, for foreign trusts our submission is that the same 2

3 requirement that applies to domestic trusts should apply as it seems the Shewan Inquiry intended. That is on registration the trustee should provide excerpts from the trust documentation so as to identify the trust. Obviously the trust deed should be available for IRD inspection should that be required. In that case section 22 (7)(d)(i) of the Tax Administration Act ( TAA ) - which requires trustees to retain documents that evidence the creation and constitution of trusts should not be repealed as proposed by clause 9(4) of the Bill. Annual Return Reporting Requirements Consistency with CRS The Bill (clause 10 section 59D) proposes that foreign trusts be required to file with IRD an annual return with information on Any change to the registration information identification detail, settlements, settlor, trustee and controller, and beneficiary. Annual financial statements Distributions made. Our concern is that most foreign trusts will also have parallel reporting requirements under Anti Money Laundering (AML), Foreign Account Tax Compliance Act (FATCA), and the Automatic Exchange of Information (AEOI) and Common Reporting Standard (CRS) requirements. AEOI/CRS requirements are also being legislated for in this bill. All these have the common objective of detecting illicit activity through multilateral international cooperation. As a basic principle, to the extent possible, an entity should not have to meet multiple disclosure requirements all of which have the same objective. Inconsistencies between disclosure requirements should be avoided. Thus with respect to AEOI/CRS the bill does appear to try to avoid duplication and inconsistency with FATCA. Our submission is that trusts that are subject to AEOI/CRS under this bill be considered to meet foreign trust information disclosure requirements unless additional information is justified in which case that information should be specifically required as an addition to AEOI/CRS rules. Where a trust is not subject to AEOI/CRS rules, disclosure requirements should be as consistent as possible with AEOI/CRS rules. This principle is not it seems reflected in the bill. We support the objective of greater transparency but it is not clear what format is envisaged for this and the extent to which any such information requirements would be consistent with other existing disclosure rules AML, FATCA, AEOI/CRS. At the extreme there seems to be the possibility of four different reporting requirements for essentially the same information for essentially the same purpose. Not only would such a duplication of rules impose an unreasonable compliance burden and unnecessary high administrative costs it would create a significant risk of confusion among recipients of information. Especially with respect to information intended to be provided to overseas agencies that information should be provided in a standard and consistent manner and format in a way that is within their expectations as to what the information is and what it means. 3

4 We provide below examples we have noted of apparent or possible inconsistencies with AEOI/CRS that seem likely to create confusion with overseas revenue authorities, uncertainty and high compliance costs. Reporting Period. The proposed section 185N of the bills states that 31 March is the end of the CRS reporting period. Although the CRS rules permit each jurisdiction to adopt a reporting period not based on the calendar year, this could potentially create a data mismatch where the majority of overseas revenue authorities adopt a calendar year reporting period but NZ Reporting Financial Institutions reports are based on a different reporting period. Address and details of settlors, trustees and beneficiaries. The bill requires that foreign trusts provide addresses of settlors, trustees and beneficiaries. This is not required by CRS. Some people do not have an address but no provision is made for this in the bill. Similarly, while CRS and the foreign trust rules propose the provision of a Tax Identification Number ( TIN ), CRS (and the proposed section 185N of the bill) recognise that a person may be resident of a jurisdiction that has no TIN. No provision is made for this in the proposed foreign tax rules. More generally CRS provides that a reporting entity can take reasonable means to determine country of birth and country of tax residence. The country of tax residence of a person may be determined not only by where they live but what the centre of their vital interests is. This may be unknown to a trustee. CRS allows for this, the foreign trust rules do not. Given these sort of issues, we submit that it would seem more sensible to adopt the AEOI/CRS for trust disclosure rules. This has been developed after considerable international effort as the best practice providing the key information to be exchanged internationally that will identify potential tax evasion/avoidance and illicit activity. By adopting some other standard for trusts New Zealand would impose unnecessary administrative and compliance costs, and risks confusing overseas agencies by providing them with information in an unfamiliar form. There even seems to be a risk that by not adopting the internationally agreed standard of key information New Zealand might create international suspicion that we are deliberately not following international best practice undermining our international reputation. The conclusion reached by the Shewan Inquiry that New Zealand needed specific trust disclosure rules seem to have been on the basis that a significant number of foreign trusts might fall outside AEOI/CRS disclosure requirements. That seems at best an exaggeration. It would indeed seem to be a surprising result if the considerable international efforts to develop a framework for the international exchange of information to combat tax evasion and illicit activity concluded by producing a mechanism that did not include information handled by trusts when these have internationally been identified by commentators as a significant area of risk for the very activity that these international efforts are directed at. We agree that AEOI/CRS reporting will not necessarily cover all trusts with foreign settlors. The ambit of AEOI/CRS seems designed to exclude small estate and family trusts and nominee entities. It thus excludes trusts where the trustee is an individual, trusts over mainly real estate assets and/or that derive less than 50% of their income from Financial Assets 4

5 and bare trusts. Sections YB21(1) and (2) of the Income Tax Act define such bare trust (nominee entity) as a nominee relationship, and not a trust. Bare trusts include those where the trustee or those managing the trust do not have discretionary authority to manage [the trust s] assets (in whole or in part). It seems to be the policy objective that such bare trusts outside AEOI/CRS should still be subject to disclosure. This needs to be provided for. For trusts subject to CRS/AEOI compliance with those rules should be sufficient. It would seem that there is a view that many of the trusts that are commonly referred to as New Zealand foreign trusts might fall within the exemption from AEOI/CRS for lack of discretionary authority on the basis that only purely administrative services are provided in New Zealand and there is no discretionary authority to manage the trust s assets here (paragraph 25 of Annex 5 of the Shewan Report). That would be a misunderstanding of the nature of the industry. The majority of trusts that are the focus of this reform are always professionally managed and are discretionary trusts not bare trusts. They are a Financial Institution being an Investment Entity or professionally managed by another entity that is a Financial Institution (i.e. a NZ corporate trustee and/or professional investment manager). An Investment Entity is one that conducts a business and otherwise invests, administers or manages funds or money on behalf of other persons. Put simply, a trust that is professionally managed will be subject to CRS/AEOI and this includes at least most of the trusts that are the object of this reform. These trusts are already complying with FATCA. The UK Revenue has determined that this is the case in the UK. The view that a significant number of what are generally thought of as foreign trusts are outside AEOI/CRS requirements is misplaced. The Inquiry Report noted a problem with extending CRS/AEOI in that it could, for example, cause confusion as to what is the reporting entity under CRS/AEOI (paragraph ). That could be dealt with by imposing the CRS/AEOI requirements on all foreign trusts without extending/changing the definition of Reporting Financial Institution under those rules. Alternatively, new foreign trust disclosure rules could be limited to those not subject to CRS/AEOI. As noted, if any disclosure, in addition, to AEOI/CRS was seen as being justified that could specifically be provided for. Excessive Requirements In a number of areas the proposed requirements in the bill seem to involve excessive compliance costs or be more burdensome than seems justified. We provide some examples. Strict liability for failure to comply. The main sanction for failure to comply with disclosure requirements seems to be loss of the tax exemption on offshore income (sections HC 26 and CW 54). That could be a very significant penalty. As this submission indicates, the proposed information requirements are complex and likely to be open to some differences in interpretation. A trustee may in some cases have difficulty in complying fully or may inadvertently provide information that turns out to be incorrect. AEOI/CRS rules provide for this by setting out various due diligence approaches which can allow the reporting entity to rely upon some information 5

6 provided to it. Furthermore the proposed provisions in this bill on penalties provides exceptions for failure to comply when such failure is beyond the control of the information provider or the information provider makes reasonable efforts to meet the requirement. No similar provision seems to be proposed for trustees that do not meet even the most immaterial detail of the information requirements set out in the proposed sections 59B and 59D. This could be as minor as being provided by a settlor with a street address that transcribes the wrong street number. To impose tax on otherwise untaxable income for issues beyond the control of the trustee where a trustee has taken reasonable efforts to comply with the legislated requirements seems unreasonable. It is submitted that exemptions along the lines of those in the proposed section 142I (with respect to AEOI/CRS) should be included. Updating registration information. Section 59C(2) requires changes in information provided on registration to be provided within 30 days of the trustee becoming aware of the alteration. This is in addition to the requirement in section 59D to provide this each year in the annual return. This seems excessive. Inland Revenue (and other relevant authorities) will be notified of changes in this information at least once a year in the annual return. If there are suspicious transactions, these should be reported under AML legislation. The requirement in section 59C(2) seems to impose compliance costs for no obvious benefit. Registration prior to deriving income. The proposed section HC 26(1)(b) requires a trust to be registered before it derives any income. This seems excessive and unnecessary. A trust cannot register until it receives a settlement. From the point it receives a settlement it is likely to derive income making it necessary, it seems to settle and register simultaneously. That is not likely to be practical. It is submitted that the requirement for registration should be within a reasonable time. The current requirement under IR607 is 30 days. Technical Issues In addition to the above the bill raises some technical issues that seem to make its workability in practice questionable. One example of this is section 59B (4) clause 10. This would require a trustee to provide on registration a signed declaration that the settlors, controllers and trustees have been informed of and agree to provide information necessary to comply with foreign trust disclosure and AML rules.. This raises some very practical problems when the settlor, for example, has died is mentally incapacitated or cannot be traced. This will be the case in some circumstances - a testamentary trust or when an established trust is re-located to New Zealand. It is submitted that there needs to be an exception for when this is not practical or reasonable. The trustee could be required to explain in the registration papers why that is the case. A significant technical issue is the legislative scheme of the proposed trust disclosure rules. For the purpose of imposing information disclosure requirements and for the purpose of 6

7 taxing foreign income if those requirements are not met, the bill focuses on foreign trusts imposing disclosure requirements on trustees of such trusts and taxing such trusts on foreign income. The Commentary (at page 114) states that a foreign trust is a trust with a foreign settlor. However, that is not the Income Tax definition of a foreign trust. A trust with a foreign settlor includes all the world s trusts not settled by a New Zealander e.g. a UK trust with UK trustees, settled by a UK resident and with UK beneficiaries deriving UK income. Presumably New Zealand has no intention of imposing its disclosure laws on such trusts that have no jurisdictional connection with New Zealand. For New Zealand income tax purposes a foreign trust is defined merely for the purposes of determining the New Zealand tax status of distributions. The issues are complex and set out in the Annex but in short it would seem unlikely that any of the foreign trusts referred to in the media over the past few months would be foreign trusts with the result that none of the information disclosure rules in the bill would apply to them. This is obviously not intended. It is not obvious how the rules can be redrafted in a more satisfactory way. For example, information disclosure rules could apply to any trust the foreign income of which is tax exempt under sections HC 26 and CW 54, but that would apply on a year basis and it would only be apparent if a trust fell within the ambit of the rules at the end of the income year. A third example is the definition of settlor for the purposes of these rules. Under the Income Tax the term settlor is specifically defined (sections HC 27(2) and HC 27(4)). This is a very wide definition (for example, it includes the provision of subsidised services) because it is designed to bring into the New Zealand tax base any trust that could be used to avoid New Zealand tax (see Annex for details). It would seem inappropriate for these purposes. For example, the references to a settlement by a CFC seem entirely inappropriate. This definition applies only for the purposes of the trust rules that is defined by section YA 1 as including section 59 and 93D of the TAA but not the proposed sections 59B or 59D. It is unclear what is intended by the term settlor in these sections. Should it be necessary we can be contacted robin@olivershaw.co.nz. Yours faithfully Robin Oliver on behalf of NZ Trustee Companies Association Limited 7

8 Annex The Basic Rules The basic New Zealand tax rules for trusts are that prima facie all NZ resident trustees are taxable on trust income. Any trust that has a New Zealand resident trustee is prima facie taxable in New Zealand on its worldwide income as per normal income tax rules for an individual. A trust, even with New Zealand resident beneficiaries, is not taxable on its income if no New Zealand residents are trustees. Income of the trust allocated to beneficiaries within 6 months of the tax year is income of the beneficiary (and not the trust) and taxable as such. Earnings held by the trust and later distributed to beneficiaries might under general principles be taxable income of the beneficiary. These basic rules are amended by various provisions of the Income Tax Act. Rules Taxing Distributions from a Trust First the tax on distributions depends on whether the trust is: A complying trust (section HC10) the trustee has no foreign income exempt from tax and all trustee tax obligations are met for that and former tax years. Distributions are exempt income under section HC 20. A foreign trust (section HC 11) if no settlor is or has been New Zealand tax resident from December 1987 until date of distribution. Distributions (other than capital or capital gains) are taxable to a New Zealand resident beneficiary as normal income. (Section HC 15 and HC 18) A non-complying trust (section HC 12) a trust that is neither a complying nor a foreign trust. It may for instance have a New Zealand resident settlor but no New Zealand resident trustee and thus not been taxed on foreign income. Distributions (including capital gains) are taxed at the penal tax rate of 45%. (Section HC 15 and BF 1(B)). A trust can elect to be a complying trust. These terms, including the term foreign trust, are relevant only with respect to how distributions are taxed under New Zealand law. A trust is classified as one of the above only at the time it makes a distribution (section HC 9) - implicitly arguable only to a New Zealand resident beneficiary - and each of the terms apply only in relation to a distribution. If there is no distribution, and outside consideration of the tax status of that distribution, the trust is not a complying, non-complying or foreign trust. A trust that has a non-resident trustee and only foreign sourced income can be subject to income tax under section HC 25 if a settlor of the trust (at time) is resident in New Zealand in that year. 8

9 Rules Taxing the Trust As noted above, the general rule is that a trust is taxable on its income if it has a New Zealand resident trustee (section HC 7). There is an exemption (HC 26 and also CW 54) where there is a NZ trustee but no person who was a settlor is resident in New Zealand in that year. In that case, foreign sourced income of the trust is tax exempt. The exemption can apply even if the trust is not a foreign trust as above. This applies where a trust has a New Zealand resident settlor post December 1987 (thus not being a foreign trust) but a settlor is not resident in New Zealand in that year. Note the exemption in sections HC 26 and CW 54 do not refer to foreign trusts because that term only applies to the tax status of any distribution. Settlor The definition of settlor is important because, for example, if a trust with a New Zealand resident trustee has a New Zealand settlor that year, the exemption for foreign income under sections HC 26 and CW 54 does not apply. More importantly, as noted above the existence of a New Zealand settlor can make a trust with non-resident trustees subject to New Zealand tax. This is to prevent New Zealanders being able to hold funds on trust tax-free so a very wide definition was adopted in sections HC 27(2) and HC 27(4) means any person that directly or indirectly transfers value or provides financial assistance to a trust. Bill Proposal The Bill (clause 5) provides that the exemption provided in section HC 26 not apply for a foreign trust that is not registered before the income is derived and the trustee complies with information disclosure requirements. This compares with the current legislation that provides that there must be a qualifying resident foreign trustee (member of the law Society etc.) resident here who can thus by required to provide Inland Revenue with necessary information. Given that a foreign trust is defined only with respect to a distribution and a trust is a foreign trust only at the time of distribution, the exclusion from the exemption seems much narrower than presumably intended. Examples: If a trust exempt under section HC 26 makes no distribution it is by definition not a foreign trust. If a trust has a New Zealand resident settlor but that settlor is not currently resident in New Zealand the trust is not a foreign trust but is still exempt under section HC 26. 9