To gift or not to gift. And if so, then how much?

What is gift duty?

Most gifting occurs when a person sells an asset (usually their home) into a trust, and the trust owes a debt back to the person for that purchase. The loan is then gifted off at a rate of $27,000 per annum per person (meaning a husband and wife could gift off a combined value of $54,000 p.a.) and not pay any gift duty. Done over a period of time, the person could transfer assets out of their name and into a trust to protect the asset from any personal creditors, future partners, or to gain access to various Government assistance type benefits.

What is happening to gift duty on 1 October 2011?

Before 1 October 2011, any person who made a gift of more than $27,000 in a year was liable to pay gift duty. Any person making a gift or gifts with a combined total value of over $12,000 in any 12-month period had to complete a gift statement and forward it to IRD within three months of the gift.

From 1 October 2011, gift duty will no longer be charged on liable gifts. You will no longer be required to file a Gift statement (IR196) for these gifts.

The requirement to lodge a gift statement and accompanying documentation to IRD was a cost to both the taxpayer (in terms of preparation and lodgement), and IRD (in terms of administration). It turns out it cost the IRD more to deal with the necessary paperwork than it actually collected in gift duty. And that is the reason for the change.

What does the change to gift duty mean to you?

With gift duty being abolished from 1 October 2011, taxpayers will be able to gift off the remaining balance of their loans owed to them by the trust(s) they administer without worrying about any gift duty. It also means taxpayers will save money where they used to pay their accountants and/or lawyers to administer a gifting programme.

Taxpayers who may not have used trusts because of the likely gift duty implications, or because the debt back would not be gifted off in time to avoid any potential claim by creditors (people you owe money to) or (ex)partners, or to receive subsidies, will now be able to gift entire assets into a trust, without the cost of gift duty.

I already have a gifting program. Should I gift off my entire loan now?

You could gift off the entire balance of any debt back right now, but there are some issues to consider before making that decision.

By forgiving any debt owing, you give up one method of ‘control’ of the trust. As a creditor of the trust you have the right to demand payment for that loan. The right to demand payment is an indirect method of control over the trustees because they must consider your rights as a creditor and the need to repay you. Forgiving the loan means that obligation on trustees is no longer there.

Forgiving any debt owing may result in problems with any personal guarantees you may have given to anyone you owe money. Creditors may not be overly impressed if they call on any personal guarantee you provided, only to find out you have no assets to honour payment of the obligation. They will be even less impressed if they find out you gifted off a loan you were owed from a trust just prior to you dishonouring a loan repayment, which results in the personal guarantee being called upon. Care should be taken to ensure any personal guarantees you have provided can still be fulfilled if called upon (assuming there is a possibility the original loan obligation owing to the creditor may not be met).

The same can happen with any legacies you may offer under your will and last testament. If there is no debt back or no assets available then the legacy may be worthless … and potentially open to challenge due to the confusion created by the difference between what you bequeathed and what is actually there. It would be a good idea to update your will where the giftng will result in a major change to your personal situation.

I do not have a gifting program. But I do have assets I would like to put into a trust. Should I gift them into a trust now?

You could sell your assets into a trust and gift the entire loan balance off, but … you will need to consider any relevant tax issues, the necessary documentation required for any changes in title and ownership, whether you need a valuation, and whether there are any potential claims on the asset being transferred, before selling any asset into a trust. Otherwise, you may well find that while there is no gift duty, the IRD or a potential creditor could be knocking on your door looking for their share of any assets gifted off.

Creditor protection
Is there another reason you would like to transfer an asset into a trust and gift off the loan balance? For example: Are you likely to become bankrupt? Are you about to knowingly default on repaying a debt? Are you likely to be facing a relationship property dispute? Are you thinking of transferring personal assets to someone else (or a trust) to avoid those assets being available to ex-partners or someone you owe money?

There are certain legal rights available to potential creditors to protect them in circumstances where you decide to transfer assets to another person or entity. Those rights include the checking of any transfer of assets and subsequent gifting completed up to five years before a claim arises with gifts within six months automatically reversed. Where your transfer negatively impacts a creditor or (ex)partner, then you should expect that transaction to be scrutinised and potentially undone by the courts.

With the removal of gift duty, and the ability for people to completely gift assets into a trust, we also expect the rights of creditors and (ex)partners to be expanded.

Therefore, the timing of any transfer of assets into a trust, and the gifting off of the resulting debt back, will be important. To ensure any transfer of asset(s) and then gifting of the resulting debt back can withstand investigation, the transfer must happen at a time when you are able to pay your debts (without the asset concerned), and you are either not in a relationship or the asset concerned is not part of a relationship claim. You will also need to ensure any assets transferred are not undervalued (which may mean you will need to get a valuation done).

Tax issues
The transfer of any asset into a trust gives rise to a sale of that asset by you personally and a purchase of that same asset by the trust. The sale of an asset may result in a gain, and income tax, depending on the asset being transferred. Care should be taken to ensure any resulting income tax on any gain on sale can be met. Whereas the sale of an asset to a third party will result in cash so any tax liability could be met, the transfer of an asset from you to a trust may not involve any cash, but merely a debt back.

You may think you can transfer the asset at a lesser value than what it may really be worth to reduce any possible gain on sale (and resulting income tax). We caution you to think again. There are very specific sections with the Income Tax Act that deal with the sale of assets between associated parties which will treat the transfer at market value regardless of whatever value you specifically state. Having a valuation done will help you to defend yourself if the IRD or a creditor believes you have transferred that asset at less than what it was worth.

Goods and services tax could apply on the sale of the asset depending on your GST status. As is the case with income tax, there would normally be cash to pay any resulting GST if the asset is being sold to a third party, but when sold to a trust, there may well not be any cash to pay the GST liability, if any.

The transfer of shares in a company to a trust can give rise to continuity issues for losses and imputation credits. Where thresholds are broken, a company may lose the benefit of any losses to carry forward, or imputation credits available for dividend payments. The IRD has expressly stated they will be looking at companies with changes of shareholdings in the 2011/12 year as part of their compliance programme because they have found the continuity rules have not been followed in more cases than not.

When it comes to gifting, care should be taken to ensure the gift is between you and someone for whom you have "natural love and affection". Where this is not the case then income tax may well still result – not under the gifting rules, but under the financial arrangements rules (or otherwise known as the accruals rules). You cannot have "natural love and affection" for a company, but you can have "natural love and affection" for a trust where the beneficiaries include say, your children or spouse – which means you will need to make sure any trust you use to transfer assets into and then gift off the resulting debt back, must have beneficiaries including your immediate family.

Documentation of any changes in title and ownership
For an asset to be formally transferred, ownership must pass. There are some assets (for example land and shares) where the ownership records are public domain, and where any changes in ownership must be recorded … otherwise ownership remains with the original owner and not the new owner.

Where land is involved, your lawyer will need to record the sale and purchase of that land using a standard sale and purchase agreement, and then convey the property with Land Information New Zealand so title passes.

Where shares in a company are involved (remembering the tax issues noted above around losses and imputation credits continuity), resolutions and share transfer forms must be executed and then updated at the Companies Office.

Motor vehicle ownership details are maintained by the NZ Transport Agency. Where the ownership of a vehicle changes, the seller must complete and lodge the relevant documentation with the Agency.

Whether or not the transfer of assets involves land, shares or motor vehicles, we would also recommend preparing and signing off on a deed of transfer to formalise the transfer of the relevant asset. A deed of transfer will formally document a transfer of ownership of an asset and provides documentary evidence of ownership passing should a creditor challenge the transfer.

Considering the issues floating around solvency, and the potential risks of the transaction being unwound if a creditor is able to prove you were insolvent at the time of selling the asset for gifting, we would recommend a solvency certificate be done at the time of transferring the asset. A solvency certificate is a declaration that you are able to pay your debts as they fall due and the reasons why you believe that to be the case. A solvency certificate is a compulsory requirement where a company purchases or sells more than 50% of its net assets, but we believe there is a significant benefit in doing the same for you as an individual or for a trust, for very little or minimal cost - the benefit being a document ‘proving’ solvency at the time of transfer.

The removal of gift duty could see every man and his dog gift everything away to a trust. Surely there must be some ‘hooks’ I need to be careful of?

There certainly are some 'hooks' which could catch some people out:

• We expect a greater level of scrutiny of transfers of assets and/or gifting by creditors and other potential claimants (including the Government). To avoid transactions being unwound, you should ensure proper trust documentation is maintained, along with proper documentation of any assets transferred and gifted.
• Government departments are looking more at any gifting or assets controlled but not necessarily owned by people applying for a benefit. They are also looking back over longer periods of time for asset transfers and/or gifting. In 2011, the IRD rules around what constitutes family income for Working for Families Tax Credits was changed to include income earned by trusts or companies controlled or owned by a taxpayer. We expect those rules to be extended and used by other Government departments.
• When the annual gifting certificates were prepared, a certain level of documentation was required and trustees would have done a review of the trusts affairs (even if it may have been minor). With the removal of the need for any formal documentation for gifting, there is no longer a specific reason to remind trustees to review the trusts affairs, nor to prepare financial statements to record up to date loan balances. Therefore, it is possible some trusts may not survive being challenged due to trustees no longer meeting periodically, or for not keeping up to date trust documentation.
• Trusts are currently being reviewed by the Law Commission. The Commission has been asked to review the Trustee Act 1956 and trust law generally. The likely outcome is that trusts could end up registering much like companies and having to meet annual requirements. Trusts that do not meet the necessary requirements could find they are no longer trusts and the assets they thought they owned may well revert back to whoever created the trust in the first place.

Generally speaking, if you do not protect what is gifted, you may well find it will be ‘unwound’.

That is all useful information, but should I gift or not gift?

While the change to gift duty is a simple one, the answer to this question is not so simple. As discussed above, there may well be numerous issues to consider and/or resolve before completing a transfer of an asset and gifting off of the debt back, so we would recommend proceeding with caution. If you would like help finding the best solution for you (whether it is for your existing trust and gifting programme, or for transferring new assets into a trust for gifting off), you can complete and send us an automated email by clicking on the following email address or you can contact us another way. Our full contact details can be found here. We promise someone will call you back within 24 hours.

Brydon Davidson
September 2011