Harmless Concession or Harmful Competition?

An Analysis of New Zealands Foreign Trust Regime

Nick Beresford1 To many people around the world, countries such as Switzerland, the Cayman Islands and the Bahamas are synonymous with the term tax haven. The term tax haven, in turn, is generally seen as being linked to nefarious activities such as tax evasion, money laundering, and extreme levels of secrecy. Whilst New Zealand is not a low tax jurisdiction and cannot be labelled a tax haven in a general sense, recent media and political commentary in New Zealand2 has raised controversy over the use of New Zealand trusts by offshore settlors. The key issue arising from this commentary is whether New Zealands foreign trust regime allows foreign settlors to facilitate tax evasion or avoidance in their home jurisdiction, and whether this risks harming New Zealands reputation. The increasing scrutiny on our foreign trust regime comes at a time of increasing global scrutiny of tax havens, harmful tax competition, and base erosion and profit shifting. In the aftermath of the 2008 global financial crisis and its on-going effects, Governments facing deficits and declining tax revenues are taking wide-ranging and unprecedented steps to try and stamp out tax evasion and avoidance. The implementation of FATCA,3 the Liechtenstein Disclosure Facility,4 the criminal prosecution of Swiss banks by US authorities5 and the large increase in Tax Information Exchange Agreements being signed 6 are just some of the more publicised measures being adopted to fight tax evasion and avoidance. This paper will examine the New Zealand foreign trust industry and the reasons for its strong growth. This paper will then examine whether New Zealands foreign trust regime is, or risks being seen as, an example of harmful tax competition. Particular reference will be had to the

1 2

Tax Consultant, Blackmore Virtue & Owens, Barrister and Solicitor of the High Court of New Zealand. See Matthew Backhouse Dunne Dismisses Tax Haven Suggestions The New Zealand Herald (online ed, New Zealand, 8 October 2012); Tim Hunter NZ Foreign Trusts Among Global Tax Havens Fairfax NZ News (online ed, New Zealand, 22 August 2012); Chris Barton Taxations Black Hole The New Zealand Herald (online ed, New Zealand, 2 November 2012); and Green Party New Zealand Foreign Trusts must be broken open (press release, 7 September 2012). 3 See generally Deloitte About FATCA (August 2013) <www.deloitte.com>. 4 HM Revenue and Customs Liechtenstein Disclosure Facility: Frequently Asked Questions (March 2013) <www.hmrc.gov.uk>. 5 See generally Katharina Bart U.S. Officials Arrest Swiss Banker: Sources Reuters (online ed, Switzerland, 29 April 2013). 6 Organisation for Economic Co-Operation and Development A Step Change in Tax Transparency: OECD Report for the G8 Summit (OECD Publications, Paris, 2013) at 12.

efforts of the OECD7 in reducing harmful tax competition, specifically its scrutiny of harmful preferential tax regimes.8 The paper ultimately concludes that New Zealands foreign trust regime is not an example of harmful tax competition and that much of its criticism is unwarranted and unfair. The writers overriding view is that the negative comments regarding New Zealands foreign trust regime stem from a lack of understanding of the profile of foreign settlors who establish trusts here and the regulation which governs our foreign trust industry. I Introduction

Since the inception of New Zealands settlor based trust taxation regime in 1988, New Zealand has seen a steady proliferation in the number of foreign trusts in New Zealand, with Inland Revenue statistics suggesting that their number may be approaching 10,000.9 Some of these will be trusts settled by New Zealanders living offshore. However, a substantial majority will have been settled by people with no prior ties to New Zealand. New Zealands settlor based approach to the taxation of trusts was introduced for two main reasons. Firstly, to combat tax avoidance by New Zealand based settlors who were establishing offshore trusts.10 Secondly, because it was considered that the circumstances of the settlor were more economically relevant than the trustee when imposing tax on trusts.11 The most widely believed reason for New Zealands popularity as an offshore trust jurisdiction is the tax advantages on offer. Under New Zealands settlor based trust taxation rules, a trust settled by a non-resident is exempt from New Zealand tax on its foreign-sourced income:12
Foreign-sourced amounts: resident trustees (1) A foreign-sourced amount that a New Zealand resident trustee derives in an income year is exempt income under section CW 54 (Foreign-sourced amounts derived by trustees) if (a) no settlor of the trust is at any time in the income year a New Zealand resident who is not a transitional resident.

Such a class of trust is deemed a foreign trust under the Income Tax Act 2007. 13

7 8

Organisation for Economic Co-Operation and Development. Organisation for Economic Co-Operation and Development Harmful Tax Competition: An Emerging Global Issue (OECD Publications, Paris, 1998). 9 Barton above n 1. 10 Joanne McCrae and Paul Singleton New Zealands Foreign Trust Rules Legitimate Tax Avoidance? (November 2012) Deloitte <www.deloitte.co.nz>. 11 John Prebble Income Taxation: The New Zealand Minor Beneficiary Regime (Working Paper Series, No. 5, Victoria University of Wellington) at 9. 12 Income Tax Act 2007, HC 26 13 Income Tax Act 2007, HC 11.

As a result of New Zealands favourable reputation as a trust jurisdiction, a thriving industry of foreign trust providers has developed. Estimates suggest annual fees earned by foreign trust providers total around $20m.14 New Zealands foreign trust industry has an excellent reputation amongst financial services professionals globally.15 New Zealand has not suffered reputational damage from rogue foreign trust providers like some traditional offshore centres. This can be ascribed to the professionalism of those working in the industry and the effectiveness of regulation which governs foreign trust providers.16 II New Zealand as an Offshore Trust Jurisdiction

Before discussing the indicators of a harmful preferential tax regime and their application to New Zealands foreign trust regime, it is essential for context to examine the reasons why foreign settlors establish trusts here. Predictably, many of the non-tax reasons for establishing a foreign trust have been completely ignored by the mainstream media in its reporting on the subject. Civil Law Jurisdictions The most obvious but overlooked reason why New Zealand and many other common law countries are attractive to establish a trust in is the fact that settlors from civil law countries have no real alternative in their country of residence. Civil law settlors must generally look offshore in order to take advantage of the many benefits of a trust that residents of common law countries like New Zealand take for granted. Civil law countries, as a general rule, do not have comprehensive domestic trust laws.17 This is because civil law is generally incompatible with the idea of divisibility of property. In other words, civil law does not allow the separation of legal ownership (i.e. the trustee) from beneficial ownership (i.e. the beneficiary). Some may have certain legal structures that on a rudimentary level can be seen as analogous to trusts,18 but there are generally fundamental differences between these structures and the common law trust.19
14 15

Hunter above n 1. See generally New Zealand Trust & Investment Corporation Limited Foreign Trusts <www.newzealandtrustcorp.com>. 16 Providers of New Zealand foreign trustee services have extensive disclosure and record-keeping requirements to government departments. An example is the Anti-Money Laundering and Countering Financing of Terrorism Act 2009, which requires reporting entities including trust companies to report suspicious transactions and conduct due diligence on clients. A second example is the Tax Administration Act 1994. Both of these statutes will be discussed later in this paper. 17 The only exceptions are Curacao and Liechtenstein: see generally Maria Hernandez The Curacao Trust Regime (March 2013) Society of Trust and Estate Practitioners <www.step.or g> and Envisage Wealth Management Services Liechtenstein Trusts <www.envisage.ch>. 18 An example is the Swiss fiducie: see generally A.E. von Overbeck National Report for Switzerland in Prof D.J. Hayton, Prof S.C.J.J. Kortman and Prof H.L.E. Verhagen (eds) Principles of European Trust Law (Kluwer Law International, The Hague, 1999). 19 Ibid at 110. This states that upon the bankruptcy of a trustee the fiducies assets form part of the trustees estate and must be realised in favour of creditors. This is a fundamental difference to the common law trust. See also generally Geoffrey Cone Common law trusts by persons based in civil law jurisdictions: does New Zealand offer a solution? (2010) 177 Trusts & Trustees Vol 16.

Not only do the majority of civil law jurisdictions have no domestic trust law, many do not even expressly recognise offshore trusts under domestic legislation or private international law. The Hague Trust Convention20 is a multilateral treaty designed to harmonise international trust law and provide for the recognition of trusts in countries with no domestic trust law21. It is currently only ratified by 12 countries,22 9 of which are civil law countries in Europe and Asia. No Latin American countries have ratified the Convention to date. However, case law from Latin America generally suggests that offshore trusts will be recognised if properly established.23 As stated above, few civil law countries have a legal creature similar to the common law trust, so civil law settlors look to offshore trusts in the knowledge that they will be recognised in their home jurisdiction if correctly structured. Estate Planning A key driver in the establishment of New Zealand foreign trusts is forced heirship laws.24 Testators enjoy freedom of testamentary disposition almost universally among common law jurisdictions. In contrast, most civil and sharia law jurisdictions impose extensive restrictions on testamentary dispositions. For example, in Argentina, 80% of a deceased persons estate must pass evenly to the deceaseds children (this is one of the largest forced portions in the world); if the deceased has no children, 66% must pass to the deceaseds parents; and if there are no children or parents as heirs, 50% must pass to the deceaseds spouse.25 There are similar forced heirship provisions in most Latin American countries. Sharia law also places restrictions on testamentary freedom. It is generally accepted that only a third of a deceased Muslims estate can be freely disposed of under sharia law. 26 Various other restrictions on testamentary dispositions also apply under sharia law, including the requirement that only blood relatives benefit from a deceaseds estate (thereby disenfranchising groups such as illegitimate and adopted children); and the inability of a nonMuslim to benefit from the estate (a non-Muslim can generally only benefit from the estates freely disposable share if they are a Christian or a Jew).

20

Hague Convention on the Law Applicable to Trusts and Their Recognition (opened for signature 1 July 1985, entered into force 1 January 1992). 21 Jonathan Harris The Hague Trusts Convention: Scope, Application and Preliminary Issues (Hart Publishing, Oxford, 2002) at 84. 22 Hague Conference on Private International Law Status Table <www.hcch.net>. 23 For example, see Vogelius, Angelina T et al v Vogelius, Federico et al (Buenos Aires City Civil Chamber of Appeals 2005, Argentina) and Moreno, Julio C v Tax Authorities (Buenos Aires City Contentious Administrative Chamber of Appeals 2007, Argentina). 24 Nicolas Malumian Forced Heirship (February 2011) <www.step.org>. 25 1868 National Civil Code (ARG) 26 Dr. Abid Hussain Islamic Laws of Inheritance (October 2013) <www.islam101.com>.

In order to circumvent forced heirship laws it is generally necessary to establish a trust with the trustee and trust assets located in a jurisdiction which does not have its own forced heirship laws, and will not recognise a foreign forced heirship court judgment.27 New Zealand, unlike typical offshore trust jurisdictions,28 does not have specific rules designed to limit the enforcement of a foreign creditors court judgment against a trust. To the best of the writers knowledge, no case law exists in New Zealand involving the enforcement of a foreign forced heirship (or any other) judgment against a New Zealand foreign trust. However, it is unlikely that a claim to enforce a foreign forced heirship judgment against a New Zealand trust would succeed providing the trust was properly established, the settlors disposition of assets was valid, and absent a finding of sham.29 Asset Protection Asset protection is one of the most popular reasons for establishing a trust. Trusts facilitate asset protection by separating the legal and beneficial ownership of assets, which means that the assets of a trust are generally beyond the reach of a bankrupt settlor or beneficiarys creditors. Figures have put the amount of wealth held in New Zealand foreign trusts in the tens of billions, based on an estimate of annual trustee fees of circa $20m to New Zealand foreign trustee providers.30 Whatever the exact figure, it is clear that New Zealand foreign trustee providers service many ultra-high net worth individuals. Many of these clients will be entrepreneurs or owners of large offshore companies and businesses. It is only natural that people of such wealth will want to take steps to protect their assets in the case of an uninsurable event placing their asset base at risk. Whilst New Zealand trusts provide asset protection under general trust law principles, New Zealand is not seen as a specific asset protection jurisdiction. Many traditional offshore trust centres have enhanced asset protection provisions in their domestic trust law and deliberately weak fraudulent conveyance laws. Such laws generally exist in an attempt to appeal to unscrupulous debtors looking to defeat existing or potential creditors. For example, the Cook Islands are a notorious asset protection jurisdiction often used by residents of the USA,31 and are promoted by trust providers as giving advanced levels of asset protection and a limited range of creditors remedies. Cook Islands trusts are usually structured so that any challenge to the trust has little chance of succeeding.32

27 28

Harris above n 18 at 368-369, see also Pouey v Hordern [1900] 1 Ch 492 (France). Contrast with the Trust Law (2011 Revision) (CYM) Part VII s87-94 and the Trusts (Choice of Governing Law) Act, 1989 (BHS) s8-10. 29 See Cone above n 16 at 180. 30 Hunter above n 1. 31 Cook Islands Trust Corporation Ltd Asset Protection Trusts (2013) <www.cookislandstrust.com>. 32 Ibid.

In contrast, New Zealand has standard creditors remedies in line with English common law and equity. These include the developing sham and alter ego doctrines33 and fraudulent conveyance laws under the Insolvency Act 2006 and Property Law Act 2007.34 Accordingly, foreign settlors receive no advanced or unusual asset protection advantages by choosing New Zealand as a trust jurisdiction. Anonymity and Security New Zealand consistently ranks among the most liveable countries in the world.35 Economic, political and social stability are taken for granted by New Zealanders. Unfortunately, this is not the case for billions of people around the world. Take residents of Latin American countries, which make up a significant proportion of foreign settlors establishing trusts here. Latin America is, incredibly, home to all of the worlds 20 most violent cities outside of countries engaged in civil war.36 Countries such as Mexico, Venezuela and Colombia have extraordinarily high rates of kidnapping for ransom, which is often carried out by drug cartels and other organised crime groups.37 The risk in some countries is so great that ransom insurance is now popular amongst the middle class, which covers, among other events, reimbursement for the costs of ransom payments and compensation for death or dismemberment.38 When the risks to personal security are coupled with high rates of identity theft,39 then it is logical to expect people to take steps to discretely protect their assets. Establishing a trust in a stable common law country is one way to do so. Some Latin American countries such as Venezuela have exchange controls in place in an attempt to prevent capital flight resulting from domestic instability.40 These often place severe restrictions on capital flows in and out of countries, and the ability to invest in offshore equities and foreign exchange. Given the economic, political and social turmoil in countries such as Venezuela, many foreign settlors are eager to transfer funds outside of their home country in case of economic collapse. From this perspective trusts can be used to plan around exchange controls.41

33

See generally Official Assignee in Bankruptcy (in the property of Reynolds) v Wilson & Ors [2008] NZCA 122. 34 See generally Eugene Collins Transferring Assets to Defeat Creditors (March 2012) <www.collinsmay.co.nz>. 35 United Nations Human Development Report (Palgrave McMillan, New York, 2011). 36 Joshua Berlinger The 50 Most Dangerous Cities in the World Business Insider Australia (online ed, Australia, 10 October 2012). 37 The Inkerman Group Kidnap & Ransom Monthly Review (July 2012) <www.inkerman.com>. 38 Clements Worldwide Kidnap & Ransom Insurance (January 2013) <www.clements.com>. 39 Michael Tatone Mexico 8th In World For Identity Theft Insight Crime (online ed, Colombia, 10 February 2013). 40 U.S. Department of State Venezuela Country Specific Information (August 2013) <www.travel.state.gov>. 41 Jersey Association of Trust Companies Jersey: A Quality Trust Location (February 2005) <www.jatco.org>.

Tax Avoidance and Evasion? Based on comments from the mainstream media and some political figures, one could be forgiven for thinking New Zealands foreign trust regime primarily exists to facilitate tax evasion and avoidance by shady criminals and underworld figures. Many serious allegations have been made over the last 12 months about the use of New Zealand foreign trusts:
[The writer] can't help wondering why New Zealand maintains a regime so obviously advantageous to tax dodgers and criminals. We're [not] part of the solution, we're a big part of the problem.42 New Zealands foreign trusts form part of a trillion dollar tax haven industry that should be transparent to help stop tax evasion.43 The number of foreign trusts based here for overseas billionaires to get away tax free has almost doubled since National came to power. There is a serious ethical issue here. These people, who are often rich families in poor countries, arent paying their fair share. Thats not something New Zealand should be supporting. Its not the Kiwi way.44

Some of the commenters went on to make other criticisms of New Zealands foreign trust regime that were prima facie concerning, such as a lack of transparency (these criticisms will be addressed later in this paper). However, the complete absence of any concrete evidence of the use of New Zealand foreign trusts for tax evasion was interesting. Whilst critics of the regime would contend that this is due to a lack of transparency (and thus the inability to identify tax evasion) another reason could simply be that the sensational headlines are not supported by reality. In order to ascertain whether New Zealand foreign trusts are being used to facilitate tax evasion or avoidance, then it is fundamentally important to understand how other countries tax foreign trusts. Sadly, such analysis was absent from the public debate. This is unfortunate as even a modest amount of inquiry suggests that the assumption of widespread tax evasion and avoidance is far from sound. Take settlors from Latin America for example, who (as previously mentioned) constitute a substantial proportion of clients for New Zealands foreign trust industry. Many Latin American countries have territorial tax regimes which do not impose taxation on foreign-sourced income.45 In relation to foreign trusts, this generally means that they are only taxed to the extent that funds are remitted to a beneficiary as a distribution. For example, Argentinean law only taxes foreign trusts to the extent that a distribution is made to an Argentinean-resident beneficiary, where the distribution is not from accumulated capital or trust corpus.46 Similarly, Brazil taxes the income of
42 43

Hunter, above n 1. Green Party New Zealand, above n 1. 44 New Zealand Labour Party Dunne Evades Tax Haven Questions (press release, 8 October 2012). 45 Myriam Bril Navigating the Grey Zone (September 2013) < www.step.org>. 46 Tax on Earnings Law, art 140 (ARG).

foreign trusts only to the extent the income is Brazilian sourced. Beneficiaries are taxed on a remittance basis, but foreign-sourced trustee income will generally not be taxed in Brazil on the basis the foreign trust is a non-tax resident.47 On the other hand, where trustee income is derived outside of the settlors home country, it is generally not taxed there on the basis it is foreign sourced. Generally the trustee income will be foreign sourced as the trust fund is likely to be invested under professional management in a recognised financial centre. Two important questions arise regarding the above points. Firstly, if other countries tax New Zealand foreign trusts under their domestic legislation on a beneficiary remittance basis only, then is it tenable to infer tax evasion or avoidance merely from evidence of foreign trusts being established here? There is clearly no tax evasion or avoidance being committed if a settlors home country does not tax the retained income or capital gains of a New Zealand foreign trust as a matter of policy. Secondly, if income is distributed to a beneficiary, and that beneficiary omits reporting that income to their domestic tax authorities, is that the fault or responsibility of the New Zealand trustee? The writer is unaware of any trust law principle by which a trustee must ensure a beneficiary who has received a trust distribution meets their personal tax obligations regarding that distribution. As New Zealand trustees generally do not have foreign tax reporting obligations themselves (if only beneficiary remittances are taxed) then there does not seem to be any obligation or responsibility incumbent on the New Zealand trustee to ensure a beneficiary meets their personal tax obligations in their home country. This is putting aside the practicality of even being able to monitor a beneficiarys tax obligations when the New Zealand trustee is unlikely to be well versed in the tax laws of the beneficiarys home country. A failure of a beneficiary to report income if required under their home countrys laws is of course likely to constitute tax evasion and attract civil or criminal penalty. Opponents of New Zealands foreign trust regime are by inference suggesting that we facilitate this behaviour. However, is this type of tax evasion any worse than if the beneficiary had, for example, suppressed income from their retail business in their home country? Most people would surely accept that both types of tax evasion are equally undesirable, and equally able to be identified by tax authorities (remembering that the beneficiary would generally need to have received a distribution in their home country for it to attract tax).

47

Alessandra Machado, Lavinia Junqueira and Luciana Nobrega Private Client Law in Brazil (1 February 2013) <www.uk.practicallaw.com>.

Is it fair then, in the absence of any evidence, to single out New Zealands foreign trust regime for opprobrium when any tax evasion committed by a beneficiary would be completely outside of the New Zealand trustees knowledge or control? III The Definition of Harmful Preferential Tax Regime

In May 1996, in response to a request from member states, the OECD launched a project on harmful tax competition. This project culminated in the OECDs 1998 Report on Harmful Tax Competition (the 1998 Report).48 The 1998 Report distinguishes between tax haven countries and countries which engage in harmful tax competition, the latter being the primary focus of the Report:49
While the concept of tax haven does not have a precise technical meaning, it is recognised that a useful distinction may be made between, on the one hand, countries that are able to finance their public services with no or nominal income taxes and that offer themselves as places to be used by non-residents to escape tax in their country of residence and, on the other hand, countries which raise significant revenues from their income tax but whose tax system has features constituting harmful tax competition. With respect to preferential tax regimes, key factors, other than no or low effective taxation on the relevant income, include: whether the regime is restricted to non-residents and whether it is otherwise isolated from the domestic economy (i.e., ring-fencing), nontransparency and a lack of access to information on taxpayers benefiting from a preferential tax regime.

When looking at New Zealands tax system overall, with its broad base and relatively high rates of tax, it is clear that we are not a tax haven in the general sense. To argue otherwise would be ludicrous when New Zealands tax revenue as a percentage of GDP is 31%.50 New Zealand does not and has never featured on any tax haven blacklists. Of course, this does not mean that our entire tax system is free from specific examples of harmful tax competition. It is with this in mind that this paper turns to the four primary indicators of a harmful preferential tax regime. No or nominal tax on the relevant income The first of the four indicators of a harmful preferential tax regime is a low or zero tax rate on the relevant income:51

48 49

Above n 8. Ibid at 20. 50 Heritage Foundation 2013 Index of Economic Freedom: New Zealand (2013) <www.heritage.org>. 51 Above n 8, at 26.

A low or zero effective tax rate on the relevant income is a necessary starting point for an examination of whether a preferential tax regime is harmful. A zero or low effective tax rate may arise because the schedule rate itself is very low or because of the way in which a country defines the tax base to which the rate is applied.

As previously mentioned, New Zealand foreign trusts are not taxed on foreign sourced income. This is not because the rate on their foreign sourced income is nil or nominal, but because their foreign-sourced income is exempt from tax altogether. This is a natural consequence of New Zealands settlor-based approach to the taxation of trusts. In other words, New Zealand tax policy explicitly recognises that a trust settled by a nonresident should not be taxed on its foreign sourced income here, because the non-resident settlor, being the trusts economic agent, is unlikely to have any ties to New Zealand. Even though the trustee is resident in New Zealand, tax policy considers an exemption from tax on foreign sourced income to be appropriate given the circumstances of the settlor rather than the trustee are considered more relevant when assessing a trusts tax liability. The rationale of the settlor-based approach was neatly summarised by John Prebble as follows:52
The basis of the New Zealand policy is this. We say that if a foreigner is sufficiently confident in the New Zealand trust industry that he will give his property and the income from it to the trustee to look after, why would New Zealand tax that income, assuming there is no other connection with New Zealand? There is no more reason to tax that income than if the foreigner decided to use a New Zealand bank, for instance, to collect interest that emanated from another jurisdiction.

The logic of the territorial tax treatment of foreign trusts is reinforced when one considers the settlor is likely to be a beneficiary (or at least associated to a beneficiary) and the definition of settlor includes someone who provides a trust with value or non-market financial assistance.53 Given trusts exist to hold assets for beneficiaries, who are the ultimate beneficial owners of the trust property, then the foreign trust regime does no more than confirm the established position that New Zealand does not tax the foreign sourced income of non-residents. This established position is reflected generally in the Income Tax Act 2007, which states that the foreign sourced income of a non-resident is non assessable income54 and so falls outside the tax charge altogether.

52

John Prebble Trusts and Tax Treaties (2008) VIII (2) Journal of International Tax Planning. Association 75 at 75. 53 Income Tax Act 2007, sHC 27-28. 54 This general rule is stated in the Income Tax Act 2007 at sBD 1(4). One of many specific examples apart from the foreign trust rules is sHM 55F, which zero-rates the taxation of certain PIE investments held by nonresidents.

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Ring Fencing Of Regimes The second of the four indicators of a harmful preferential tax regime is the ring fencing of that regime. In other words, is the regime inaccessible to residents of the country in question and only able to be utilised by a non-resident?55
Since the regimes ring fencing effectively protects the sponsoring country from the harmful effects of its own incentive regime, that regime will have an adverse impact only on foreign tax bases. Thus, the country offering the regime may bear little or none of the financial burden of its own preferential tax legislation.

Whilst the foreign trust tax rules are of course only available to a non-resident settlor, this is not due to any sinister tax policy concession with the aim of turning New Zealand into a tax haven. Rather, as explained above, the foreign trust tax rules were introduced to reflect the economic logic of taxing trusts based on the settlors circumstances and to reduce tax avoidance by New Zealand residents. A recent article by Craig Elliffe and Jeremy Beckham 56 has suggested that trustees of New Zealand foreign trusts may be improperly accessing New Zealands double tax treaty network. This paper draws a comparison between New Zealand foreign trusts and conduit companies, the latter having been regarded by the OECD as improperly asserting residency under double tax treaties for treaty shopping purposes. Whilst the concerns raised in the article are valid, they appear to indicate deficiencies and anomalies in the construction and / or interpretation of double tax treaties, rather than a deliberate policy attempt to create tax advantages for non-residents by the use of New Zealand resident trustees. In other words, they do not indicate a deliberate ring-fencing of the foreign trust regime from the trust tax laws which apply to New Zealand residents. Lack of transparency The third factor which may indicate a harmful preferential tax regime is a lack of transparency. Transparency in this context this refers to a lack of transparency in the tax administration of a particular jurisdiction:57
The lack of transparency in the operation of a regime will make it harder for the home country to take defensive measures. To be deemed transparent in terms of administrative practices, a tax regimes administration should normally satisfy both of the foll owing conditions: First, it must set forth clearly the conditions of applicability to taxpayers in such a manner that those conditions may be invoked against the authorities; second,

55 56

Above n 8, at 26. Craig Elliffe and Jeremy Beckham The Inconvenient Problem with New Zealands Foreign Trust Regime (2012) New Zealand Journal of Taxation Law and Policy, Vol. 18, No. 2, 2012. 57 Above n 8, at 29.

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details of the regime, including any applications thereof in the case of a particular taxpayer, must be available to the tax authorities of other countries concerned.

There has been no suggestion of any impropriety regarding the interface between New Zealands foreign trust regime and the tax system. There is no suggestion th at the Commissioner gives preferential or lenient treatment to New Zealands foreign trust industry. In contrast, many tax compliance requirements of a New Zealand foreign trustee are onerous and carry the risk of harsh civil and criminal penalties.58 The Commissioner also has statutory obligations under the care and management provisions of the Tax Administration Act 1994. These include an obligation on the Commissioner to protect the integrity of the tax system and to fairly and impartially administer the tax laws.59 Following the above, the Commissioner is bound to apply the tax laws to New Zealand foreign trusts in the same way as any other taxpayer. Lack of effective exchange of information The final indicator of a harmful preferential tax regime is the lack of effective exchange of information:60
The ability or willingness of a country to provide information to other countries is a key factor in deciding upon whether the effect of a regime operated by that country has the potential to cause harmful effects.

A country may lack be unwilling or unable to exchange information with other countries because of strict banking secrecy laws; because it is uncooperative and / or a tax haven; or because the information is simply not collected by domestic authorities in the first place. New Zealand does not have strict banking secrecy laws and neither is it deliberately uncooperative in exchanging information.61 This brings us to a key criticism of our foreign trust regime. Are our foreign trustee providers, aided and abetted by deficient tax policy, fostering a secretive offshore industry by simply not collecting sufficient information on their clients? The Tax Administration Act 1994 regulates the disclosure and information gathering requirements of New Zealand foreign trustees. A breach of these rules carries the risk of a fine of up to $50,000 and imprisonment of up to 5 years.62
58 59

Tax Administration Act 1994, s143A. Ibid, s6 and s6A. 60 Above n 8, at 29. 61 New Zealand has an extensive network of Double Tax Agreements, Tax Information Exchange Agreements, and reciprocal arrangements. See generally Inland Revenue Policy Advice Division Tax Treaties <www.taxpolicy.ird.govt.nz>.

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The tax compliance requirements of a trustee of a foreign trust include: A requirement to retain in New Zealand full legal and financial records, including the trust deed and other constitutional documents; the particulars of any settlements made on the trust; the assets and liabilities of the trust; and day to day entries of monies received and spent by the trust;63 The requirement, within 30 days of the trusts establishment, to furnish IRD with the name and identifying particulars of a foreign trust; and to confirm whether the settlor is an Australian resident;64 and The requirement to provide the name and contact details of the trustee, and if the trustee claims to be a qualifying resident foreign trustee,65 then the name of the approved organisation to which the trustee belongs.66

Critics contend that the lack of a requirement to provide IRD with the identities of the settlor and beneficiaries hinder our international tax information sharing obligations.67 However, if a foreign tax authority knows other particulars of a foreign trust, such as its name, and requests information from IRD then the Commissioner can use her powers under s17 of the Tax Administration Act to compel the New Zealand resident trustee to provide her with further information. The IRD has made clear however that it will not entertain fishing expeditions or requests for information by countries that do not have tax information sharing protocols with New Zealand.68 An obvious but important point which missing from the recent public debate is that New Zealand foreign trust providers must conduct due diligence on clients to ensure that the identity of all settlors and beneficiaries of a foreign trust are obtained. This is a requirement of the Anti-Money Laundering and Countering Financing of Terrorism Act 2009, which substantively came into effect from 30 June 2013. As reporting entities under the Act, foreign trust providers now have extensive compliance requirements, including the requirement to establish a compliance programme setting out initial and on-going customer due diligence requirements.69

62 63

Above n 56. Ibid ss22(7)(iii). 64 Ibid s59B(1). 65 A qualifying resident foreign trustee is a New Zealand resident trustee of a foreign trust who is a member of an approved organisation. A body corporate can also be a qualifying resident foreign trustee if a director or other person with significant influence over the trustee is both resident in New Zealand and personally a member of an approved organisation. Approved organisations recognised by IRD include the New Zealand Law Society, the New Zealand Institute of Chartered Accountants, and the Society of Trust and Estate Practitioners. 66 Above n 56, at s59B(1). 67 Hunter above n 1. 68 Henry Brandts-Giesen New Zealand Trusts for International Wealth Structuring (2010) 168 Trusts & Trustees Vol 16 at 174. 69 Anti-Money Laundering and Countering Financing of Terrorism Act 2009, Part 2.

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Under the Act there are extensive record-keeping requirements; requirements to refuse to enter into a customer relationship where customer due diligence cannot be completed satisfactorily; and requirements to not knowingly set up customer relationships with anonymous clients or clients using false names.70 Harsh civil and criminal penalties apply for breaches of the Act and include fines of up to $2m and imprisonment for up to 2 years.71 Apart from any obligations under statute, the requirement to be able to identify a trusts beneficiaries is a fundamental requirement of establishing a trust.72 If it is accepted that foreign trust providers do conduct due diligence on clients and identify the settlors and beneficiaries of a trust, then the logical next question is to ask is why these details are not required to be automatically provided to IRD to aid our information exchange obligations. In New Zealand, it is accepted that trusts are essentially private arrangements. The Government has traditionally rejected calls for a central trust database such as the public register which exists for companies in New Zealand. There have been recent calls for the introduction of such a register as part of the Law Commissions Review of the Law of Trusts.73 However, the introduction of a trust register was not recommended in the Final Report, with the Law Commission stating:74
[In an earlier report] we did not consider the benefits of registration to be sufficient to warrant the introduction of a registration requirement for trusts. Our main reasons were that a register would significantly alter the nature of trusts by giving them a publicly registered status. We considered that this would be a significant shift away from the current treatment of most trusts as essentially private arrangements between citizens. We also questioned whether some of the problems identified by some people should truly be viewed as problems. Some of those calling for registration identify the private nature and confidentiality of trusts as a significant problem. However, privacy and confidentiality have historically been recognised as among the essential virtues of the trust form.

In the writers view, the current regulations in place under the Tax Administration Act and the Anti-Money Laundering and Countering Financing of Terrorism Act are sufficiently adequate to allow the IRD to meet its information sharing obligations. If a foreign tax authority suspects that a New Zealand trust is being used for tax evasion or avoidance, then it can ask IRD to obtain information. If the foreign tax authority has the name of the trust then it should be easy enough for IRD to find further details as this information is disclosed upon the trusts establishment. If it only has the names of the settlors and beneficiaries then this
70 71

Ibid. Above n 70, Part 3. 72 In order for a trust to be formed, the three certainties must be present. This includes the certainty of intention to create a trust, the certainty of subject matter (i.e. the trust property) and the certainty of objects (i.e. the trust beneficiaries). Regarding the latter requirement, see generally McPhail v Doulton [1970] UKHL 1. 73 For the final report by the Law Commission, see Law Commission Review of the Law of Trusts: A Trusts Act for New Zealand (NZLC R130, 2013). 74 Ibid at 229.

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makes it harder to find the details of the trust they are connected with, but it could still conceivably be found if, for example, a section 17 request was made by the Commissioner to a trust company asking for details of any trusts associated to the person(s) in question. The lack of a requirement to disclose the names of settlors and beneficiaries to IRD could appear to make it difficult for a foreign tax authority to obtain details of trusts established here unless they provide IRD with a reasonably (critics may say onerously) specific request for information. However, requiring foreign tax authorities to provide specific, as opposed to general, requests for information prevents fishing expeditions. IRD will not assist with fishing expeditions, as previously stated.75 It is pertinent to note at this stage that many countries place obligations on a settlor and / or beneficiaries of a trust to report any beneficial interests in a trust to their domestic tax authorities.76 The information gathered from these regulations will conceivably make it easier for foreign tax authorities to request more specific information from IRD in the future in respect of New Zealand foreign trusts. As a closing comment, it is interesting to note that in terms of transparency, there is a double standard involved with respect to domestic versus foreign trusts in New Zealand. For example, as a matter of discretion the Commissioner allows non-compliance with the Tax Administration Act in the case of trusts which do not earn taxable income, by allowing such trusts to choose not to file a tax return or obtain a tax file number.77 Given the number of trusts that are established here to own only a family home and private assets, there are potentially hundreds of thousands of trusts in New Zealand with billions of dollars in wealth which are not registered with the IRD and therefore anonymous with respect to the Government. With the number of domestic trusts dwarfing the number of foreign trusts established here,78 then improving the regulation of domestic trusts may be a more pressing priority then meddling with the regulation of our functioning, ethical and reputable foreign trust industry. IV Conclusions

What is hopefully clear to the reader from this paper is that the media scrutiny of New Zealands foreign trust regime has superficially focused on the alleged harmful tax effects of New Zealands foreign trust regime.

75 76

Above n 69. RBC Wealth Management Trust and Tax Reporting: Update on Latin America (April 2013) <www.rbcwminternational.com>. 77 See Inland Revenue Estate or Trust Return Guide (2013) at 9, and Geordie Hooft Keeping Trusts in Step with the Times (October 2013) <www.stuff.co.nz>. 78 The number of domestic trusts in New Zealand has been estimated at up to 500,000 above n 69 at 6. In contrast, the number of foreign trusts has been estimated at less than 10,000 Barton above n 1.

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The use of New Zealand foreign trusts by offshore settlors is in large part driven by non-tax factors such as estate planning, asset protection, and anonymity. In many cases, the home jurisdictions of foreign settlors only tax foreign trusts on a remittance basis only. The retained income and capital gains of a trust often fall outside the settlors home jurisdictions tax net as a matter of policy. Accordingly, tax is usually not a pivotal consideration in choosing New Zealand as a trust jurisdiction and instead factors such as New Zealands economic and social stability, developed trust law, modern legal system and skilled professionals are driving the growth in our foreign trust industry. With this in mind, the writer is of the view that New Zealands foreign trust regime, which was not originally targeted at non-residents and does not on the evidence facilitate tax evasion and avoidance, is not an example of harmful tax competition. New Zealands foreign trust regime merely reinforces the established principle that New Zealand does not tax the foreign sourced-income of non-residents, and so there is no question of preferential treatment being given to foreign settlors. The regime is not ring-fenced in the sense that it is only available to foreigners - it simply carves out foreign-sourced income from the tax base. New Zealands foreign trust regime is transparent in the sense that the tax administration system does not unfairly favour it. The writer concedes that there are some valid concerns over the effectiveness of the foreign trust disclosure rules and their impact on New Zealands tax information exchange obligations. However, it is submitted that these still give adequate scope for the identification of tax evasion and avoidance given trustees obligations under the Tax Administration Act and the Anti-Money Laundering and Countering Financing of Terrorism Act, and the increasing amount of trust reporting obligations in many offshore jurisdictions. The closing comment of this paper is that New Zealands foreign trust industry is by and large ethical, reputable and staffed by skilled professionals. New Zealands foreign trust industry services many of the worlds ultra-high net worth individuals who are drawn to New Zealand by its good reputation and attractive trust laws. Characterising New Zealand as any kind of trust tax haven is totally misguided and based on a fundamental lack of understanding of the offshore wealth planning industry.

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