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New Zealand, foreign trusts and the Panama papers

08 September 2016 - By Edward Power

A shocking financial conspiracy of silence emerged on 3 April 2016 when an anonymous whistleblower known only as “John Doe” leaked over 11,500,000 documents from the Panamanian law firm, Mossack Fonseca to a German newspaper, Suddeutsche Zeitung.

These leaked documents exposed secret asset shifting and tax avoidance which affected almost every country in the world, including New Zealand. Caught up in it were some rich and famous individuals who were involved in a range of financial transactions, seemingly for the sole purpose of concealment of assets and income.

After receiving the leaked documents, Suddeutsche Zeitung utilised the investigative skills of a group of journalists known as the International Consortium of Investigative Journalists (ICIJ) to analyse the documents’ contents. The ICIJ posted copies of the documents on its website, inviting each of the affected countries to instigate their own action in response.

The leaked documents revealed a wall of secrecy created by the legal firm Mossack Fonseca to ensure that the assets and income of their clients were hidden from tax authorities, spouses and creditors alike.

A worldwide search for assets by lawyers acting for disgruntled spouses quickly emerged. The fallout from the exposure of the names of the high profile, high net worth individuals involved in hiding their assets has been significant and will not be fully realised for some time to come.

Also of concern to revenue authorities in Australia and New Zealand are the revelations in a recent Australian Broadcasting Commission story “The worst tax crime in history”.

George Rosvany, a 32-year veteran of the Australian tax industry and highly regarded author on transfer pricing law has blown the whistle on the four largest accounting firms and their involvement in tax avoidance which he has placed as high as $50 billion per annum in Australia. Mr Rosvany further stated that “any large client of Mossack Fonseca is more than likely to be audited by one of the big four accounting firms and have its tax practices signed off”. If Mr Rosvany’s claims are correct then this has huge implications on how the revenue authorities will now treat the audit results of the big four accounting firms.

Implications for NZ

At present it is unclear as to the real number of affected entities having a New Zealand origin. While some reports suggest that details of 12,000 foreign trusts have been published, this figure does not include the number of foreign trusts that have likely been created overseas by legal firms using a New Zealand trustee to create hundreds (or even thousands) of separate trusts.

The number of New Zealand registered companies being used as trustees of foreign trusts is unlikely to be within the present knowledge of the New Zealand Inland Revenue Department (IRD) as there is no present requirement for registration of foreign trusts in New Zealand.

These reports are of great concern to both the New Zealand Government and the IRD. There is little consolation for the IRD in the statements made by Prime Minister John Key and Revenue Minister Michael Woodhouse, that the OECD had looked at the New Zealand foreign trust rules in the past and had found no concerns.

Interestingly, in a radio interview, Gerard Ryle, a director of ICIJ reportedly stated that he had been looking at the issue of tax havens for years and New Zealand was known to be a “really soft touch”. When asked about his thought on the New Zealand Government ministers’ statements that the country was not a tax haven, Mr Ryle stated that that this was “rubbish”.

The New Zealand Government moved quickly in response and immediately appointed John Shewan to head a Government Inquiry into the adequacy of the present Foreign Trust Disclosure Rules and to make appropriate recommendations. The Shewan Report has been tabled in Parliament and I will incorporate some of its relevant findings, but a full analysis of the report is for a later time.

Is NZ really ‘a soft touch’?

A simple example illustrates how a typical New Zealand foreign trust might be used by Mossack Fonseca.

A Botswana businessman (Mr X) creates a New Zealand foreign trust to effectively hide wealth from his spouse, creditors and Botswana tax authorities through advice received from a Panamanian law firm.

The Panamanian firm advises Mr X that with the use of a New Zealand foreign trust his assets and any income derived thereon would be exempt from both New Zealand and Panamanian tax. Mr X would be assured that the creation of a New Zealand foreign trust would give him complete confidentiality in relation to the ownership of his assets and that he will be free to access his wealth in the trust without fear of exposure (except perhaps from a whistleblower).

Next, the Panamanian law firm purchases an NZ company, ABC Ltd, for use as trustee for the Mr X’s Discretionary Family Trust. The trustee may or may not later remain a resident in New Zealand for tax purposes. Mr X becomes the non-resident settlor of the trust, and he opens a bank account in a neutral country in the name of the trust with a cash settlement of as little as $20. Mr X also becomes the Appointor, Protector or Guardian of the trust and a listed beneficiary in the trust along with other members of his family. None of the family members are aware of the existence of the trust or even that they are beneficiaries.

The foreign trust sets the stage for the settlement of Mr X’s assets on the trust and his assets are now hidden from scrutiny. Apart from paying for the purchase of an NZ company to act as trustee, Mr X has had no connection with New Zealand at all.

Relevant NZ trust legislation

An examination of Subpart HC of the Income Tax Act 2007 (the Tax Act) indicates that tax “is assessed on trusts by reference to the tax residency of the settlor of the trust and income derived by a non-resident trustee from outside of New Zealand is deemed to be income of the trustee if any settlor of the trust is resident in New Zealand at any time during the income year”. Mr X is the non-resident settlor of the foreign trust.

The residency of the settlor is critical to the trust’s administration. The introductory provisions set out in Section HC1 of the Tax Act state, among other things, that Subpart HC determines who is a settlor and sets out their income tax liability; provides for the taxation of distributions from trusts and defines beneficiary income and a taxable distribution; and provides for the taxation of trustee income (if relevant).

Section HC 25 is headed: Foreign-sourced amounts: non-resident trustees and Subsection (1) states that “This section applies when a non-resident trustee derives, as trustee income, in an income year a foreign sourced amount that would be assessable income if derived by a person resident in New Zealand.” Subsection (3) states that the amount is not assessable income of the trustee “if the trustee is resident outside New Zealand at all times in the income year …”

Further, Section HC 26 states that “if the settlor is a non-resident at all times in the income year, the foreign sourced income derived by a New Zealand resident trustee is exempt income”. As Mr X is clearly non-resident at all times in the income year, the foreign sourced income derived by the New Zealand resident trustee is exempt income. ▪

Thus, if the trust’s settlor (Mr X) is a non-resident, or alternatively, if the trustee of the Mr X Family Discretionary Trust (ABC Ltd) is classified as a non-resident at all times in the income year, then the foreign sourced income derived by the Mr X Family Discretionary Trust is non-taxable in New Zealand.

Disclosure

In the example given, neither Mossack Fonseca nor Mr X is required to make any disclosure to the IRD of their dealings with the assets of the Mr X Family Discretionary Trust. Indeed, the creation of the New Zealand foreign trust is settled on the basis of achieving complete confidentiality of the assets and income of Mr X. Further, a non-resident trust in Panama is not subject to tax or to any reporting requirements.

While s 59 of the Tax Administration Act does require disclosure of information by the resident trustee of a foreign trust on its creation, the Shewan Report found that the present reporting requirements are inadequate, as:

  • the information presently required to be provided to the IRD when an offshore trust is established is minimal;
  • there is no obligation to report distributions;
  • no annual returns of any kind are required;
  • there is low likelihood of IRD requesting records and exchanging any information with offshore authorities;
  • no information of customer due diligence is likely to be disclosed to any government agency;
  • information on the source of funds in offshore trusts is in most cases not mandatory; and
  • the definition of beneficial ownership is complex and not well understood.

The Shewan Report made recommendations to the Government (and the Government has foreshadowed the introduction of legislation adopting all of those recommendations as soon as possible) that the disclosure requirements on registration be expanded from the present IR 607 disclosure requirements to, among other things, seek more information about the trust structure.

The question is whether overseas law firms would still contravene New Zealand trust tax laws by not disclosing information on the creation of a foreign trust after the introduction of the more stringent reporting requirements, and whether IRD could prosecute such non-disclosure.

In this regard it must be remembered that a New Zealand company purchased by a Panamanian law firm is only appointed as a trustee of a discretionary trust once offshore. While the foreshadowed amendments to the disclosure requirements are aimed to apply at the time of creation of a new foreign trust, the wording will be critical if it is to “disclose” the incorporation of a New Zealand company which is later appointed as trustee of a foreign trust in Panama and where the New Zealand disclosure requirements may not apply.

A trustee can certainly be prosecuted for non-disclosure of information required. Section 143A of the Tax Administration Act imposes a penalty on all, including settlors and trustees, who knowingly do not provide information about a foreign trust under s 59A of the Act. The penalties for evasion range from imprisonment for a term not exceeding five years, or a fine not exceeding $50,000, or both. These provisions do not appear to have been used to specifically prosecute a trustee for failing to make a proper disclosure under the present disclosure reporting requirement for a foreign trust.

Mr X or Mossack Fonseca in the example may be able to be prosecuted in New Zealand but the difficulty will be in enforcing any judgment obtained.

Conclusion

While an examination of the foreign trust legislation indicates that New Zealand is not a “soft touch” regarding foreign trusts, it is alarming that the Shewan Report has found the present disclosure requirements for foreign trusts are indeed inadequate in the present circumstances and require amendment.

However, once the new foreign trust disclosure law amendments are enacted, Panamanian legal firms will, in my opinion, be more likely to seek fresh fields to maintain the much sought after confidentiality desired by their clients, particularly now that Panama has decided to sign the OECD Multilateral Convention on Mutual Administrative Assistance in Tax Matters and join the fight against worldwide tax avoidance.

Edward Power is a barrister who specialises in tax law. He practises in both New Zealand, from Barristers.Comm, and in Australia.

Last updated on the 8th September 2016