In our hunt to find the best way to minimise our tax payments, my husband and I recently spent a lot of time researching trusts only to discover a trust wasn’t right for us at all.
We had hoped to find a trust structure, somewhere in the world (and not in some dodgy, unheard-of country), that would allow us to distribute income when we wanted and would reduce the tax we pay on our investment earnings. We also wanted to be able to manage the trust ourselves for little or no cost.
So, we spoke with lawyers in Australia and New Zealand, and buried ourselves deep in complex tax treaties and trust law, including for Hong Kong, Singapore and the Netherlands.
Yet instead of finding the perfect solution, we actually realized that setting up a trust wasn’t the right thing for us at all at this point in time.
Because trusts are recognized differently in every country, and in some countries not recognized at all, we found that a trust would not always reduce our tax in whatever future countries we might choose to live in. Yet, we’d still have the hassle and cost of maintaining the trust.
No thank you!
Despite our disappointment, I’m sharing our findings here, in the hope that it could be useful to other ‘citizens of the world’ pondering a similar approach.
Note, we’re not tax lawyers or accountants so don’t take what we say as bona-fide financial advice!
What is a trust?
Put simply, a trust is a relationship whereby property is held by one party for the benefit of another. A trust is created by a settlor, who transfers property to a trustee, who holds property for the trust’s beneficiaries.
Often, trusts are created in wills to provide a vehicle to distribute money and property to children or other beneficiaries. But trusts are also attractive as a way to minimise tax.
For us, we were hoping to use a trust as the vehicle through which all our shares, cash and bonds would be held and invested. This would then allow us to distribute the returns between ourselves and our child, as we saw fit each year, to minimise tax payments.
Let me show you how by using an example.
If I earned AUD 100,000 in a financial year, I would end up paying around AUD 25,000 in tax. Meanwhile, my husband, who stayed at home with our baby, did not pay any tax because he didn’t earn an income.
In that instance, we would use the trust to distribute the income from our investments to my husband, in the lowest tax bracket, and not myself, in the highest tax bracket.
If, in the following year, my husband earned significantly more than I did, then we would distribute the income from our shares to myself, because I would be in the lower tax bracket.
Sounds great right? You bet.
But trusts are much more complicated than that, and even more so for us, because we’re currently living overseas and are non-residents for tax purposes. So, let’s dig a little deeper.
Setting up an Australian trust as a non-resident
Besides the ability to distribute income every tax year, setting up and maintaining an Australian discretionary trust is quite easy and low cost for Australian residents.
To set one up costs AUD 500 in stamp duty fees and then a lawyer’s fee (our lawyer quoted us AUD 500). It can be done in a day. You may also want or need to establish a company, of which you are the director/s, to be the trustee. Ongoing, there are no legal fees, and you could choose to do the accounting yourself, thereby saving on accountant fees.
A notable downside of a trust is that it is not a good vehicle for owning property. While individuals have a threshold of AUD 480,000 before they must start paying land tax, which is 1.6% of the land’s value, a trust has to pay land tax from the first dollar of the valuation from the valuer general’s office.
For us, the greatest downside was that an Australian trust would be classed as an Australian ‘resident’ for tax purposes and be required to pay tax on capital gains even if it was distributing to a non-resident.
As non-residents for tax purposes, the growth of our non ‘real property’ assets (shares/funds) are not subject to capital gains tax. But if our assets are held in an Australian trust, which is almost always treated an Australian resident, the trust would still have to withhold capital gains tax, regardless of the tax residency of the beneficiaries.
So, on learning that, we decided to look over the ditch to New Zealand, which seemed to have a more advantageous trust structure.
Setting up a New Zealand trust as a non-resident
Compared to Australia – where a trust must distribute its income every year otherwise it is taxed at the highest rate of 48.5% – New Zealand trusts with a non-resident settlor are not taxed on non-New Zealand sourced income.
This provides a huge advantage. The investment income could simply be reinvested over and over again, with tax only payable when the income is finally distributed to beneficiaries, which could be delayed until you live in a no/low tax jurisdiction.
The other huge plus is that New Zealand does not have capital gains tax.
We thought we’d hit the jackpot.
But, we soon discovered that all New Zealand trusts require a resident trustee. It is possible to create a New Zealand based company to be a resident trustee, but companies in New Zealand require at least one resident director.
This meant we would have had to pay a lawyer or accountant around AUD 2,000 every year to be a joint trustee or co director of a company. Sure, they would do some admin, but you are essentially paying a fee to have a trust, and not getting all that much for it.
And despite trusts being a legitimate legal vehicle for wealth management, some countries in Europe don’t recognize them for tax purposes. Instead, they are simply ‘looked through’.
In Italy for instance, if a trust has named and identified beneficiaries, then the trust’s income is considered the beneficiaries’ income, regardless of whether it was distributed or not. In that instance, we would be paying high fees to maintain a trust that wasn’t providing us any benefit.
The jackpot, it turned out, may be more jack and less pot.
An alternative structure would be to create an investment holding company in a low tax jurisdiction such as Singapore or Hong Kong. This is something we are looking into and will post on soon.
Adopting a simple approach to minimise our tax
We came to realise that in our current situation – as ‘citizens of the world’ that frequently move countries – it will be difficult to find a trust structure that is suitable for all possibilities. How trusts are treated and taxed really depends on your country of residence and what works well for one place may not be that advantageous in another.
It also seems difficult to establish or manage a trust yourself. A domestic trust created by a resident is fairly straight forward, but foreign trusts with non-resident trustees and beneficiaries are complex and not well explained online.
In the future, if and when our situation changes, we’ll have another think about if a trust is right for us.
Instead, for the time being, we’re choosing to adopt a simple approach to minimising our tax:
- If we continue living abroad, when choosing which country to live in we will give preference to countries that have low tax rates or don’t tax foreign income (territorial tax systems).
- If living in Australia, the simplest way to reduce tax is to earn under the tax-free threshold. In fact, individuals pay no tax if they earn less than AUD 18,200. So, that’s the perfect reason to live as cheap as possible – to minimise the income you need for living expenses.
- In line with Warren Buffet’s approach, we will buy and hold shares and bonds for the long-term. This means we get the 50% discount on capital gains in Australia. By not buying and selling regularly you can effectively delay paying tax, which means you have more to invest, and grow, initially.
By continuing to make smart financial decisions and keep our living costs low, we can maximise our investment returns enabling us to be work-optional and financially free.