Writing off a family-trust loan: who gets taxed — and the simpler fix

Loans run in both directions around a family trust — money the trust owes, and money beneficiaries owe the trust. The most common is a beneficiary who owes the trust, often from years of help with a house, a business or living costs. When it’s time to tidy up, the instinct is to “just write the loan off.” But if you do that, the write-off is taxed — and the real surprise is who gets the bill. Here’s how it works, and the one extra step that reaches the same result tax-free.

Key points

•    Writing off a debt creates taxable “remission income” — and it lands on the debtor, not the creditor.

•    If your trust writes off a loan a beneficiary owes, the beneficiary is taxed.

•    Trustees can’t use the “natural love and affection” exemption — in law, they aren’t natural persons.

•    A capital distribution that clears the loan does the same job, tax-free.

•    Get legal and tax advice before you write anything off.

What the law actually does

‍A loan is, in tax terms, a “financial arrangement.” New Zealand’s financial arrangements rules (subpart EW of the Income Tax Act 2007) govern how a loan is taxed over its life. (Inland Revenue — financial arrangements rules.) When a loan is repaid or runs its course, each party does a wash-up calculation — a base price adjustment under section EW 31. Normally it nets to nil.

Writing off a debt breaks that. When a debt is written off, the borrower is deemed to have received a financial benefit equal to the amount forgiven — they have been released from the obligation to pay. The financial arrangements rules capture that benefit by adding the forgiven sum back into the borrower’s base price adjustment as an “amount remitted.” The result is a positive base price adjustment, which is income to the borrower.

The keyword is borrower. Remission income lands on the debtor — the person who owed the money — not on the creditor who let them off. That one fact decides who pays, and that is where most people get caught out.

The common case: your trust forgives a beneficiary’s loan

This is the situation most families face. Over the years, the trust has lent a beneficiary money to get into a first home, finance a business, or cover living costs. or to purchase a retirement village apartment. It is recorded as a loan; the beneficiary owes the trust (a “debit” loan account). If the trust is being wound up, the obvious move is to write off the loan.‍ ‍

Take the Rata Family Trust — the names are made up; the situation is not. The trustees lent Hannah, their daughter, $250,000 as a deposit for her first home. The Trustees of the Trust wrote off the loan. Here is the catch. Hannah was the debtor — she is the one the law treats as receiving the benefit, because she no longer had to repay the $250,000. Hannah was deemed by Inland Revenue to have received that $250,000 as a financial benefit and had to bring it into her base price adjustment as an “amount remitted.” The full $250,000 was treated as income in her hands, taxed at her marginal rate. A gesture the family thought was simply generous resulted in a large tax bill for Hannah.

The “natural love and affection” exemption only works when the person forgiving the debt is a natural person. Trustees, acting in their trustee capacity, are not natural persons, so a trust cannot forgive a loan tax-free, however much love sits behind it.

Does any of this create a tax liability for the trust itself? No — and that is the part people miss. The trust is the creditor; it simply loses the money it lent (a loss it usually cannot even deduct). The tax falls on the beneficiary who owes it.‍ ‍

The simpler fix: distribute capital instead

‍There was a clean way to get Hannah the same result with no tax: instead of forgiving the loan, the trustees could have made a capital distribution to her and applied it to repay the loan.

A distribution of capital from a complying trust is exempt income in the beneficiary’s hands under section CW 53. Hannah would have received a $250,000 capital distribution tax-free, and that money would have cleared her loan account. Because in that case the loan is repaid — not forgiven — nothing is “remitted,” there is no remission income, and the base price adjustment nets to nil.

Same family, same $250,000, the same end position — Hannah owes nothing and keeps the home. The only difference is the route: distribute and repay, rather than write off. The form is what the tax system reacts to. (This assumes a complying trust and properly documented trustee resolutions; if the beneficiary lives overseas, other rules can apply — see the note below. ‍

It cuts the other way too: when the trust owes the money

The same principle explains the reverse case. If a family company lends the trust $420,000 and then writes off that loan. Now the trust is the debtor, so the remission income accrues to the trust and is taxed at the 39% trustee rate. Because a company cannot have natural love and affection, no exemption applies, and a $420,000 write-off becomes roughly $163,800 of tax. Once again, the answer is to repay or restructure the loan rather than to forgive it.

One rule applies in both directions: remission income follows the debtor, and forgiveness escapes tax only when a natural person forgives out of love and affection.‍ ‍

The one thing most people get wrong

The belief that sinks people is: “It’s all family, so writing the loan off costs nothing.” It can cost a great deal — and the bill often lands on the very person you were trying to help.

There is a genuine exemption: a debt forgiven by a natural person for natural love and affection is not counted as remission income (section EW 44). It is why parents can safely forgive loans owed by their family trust for decades — there, a natural person is forgiving out of love for the family. Inland Revenue accepts that close family and friends usually have that affection (QB 20/02). But it turns entirely on who is doing the forgiving:

•     A trust forgiving a beneficiary’s loan — trustees are not natural persons, so there is no exemption; the beneficiary is taxed.

•     A company forgiving a loan — a company cannot have natural love and affection, so there is no exemption; the debtor is taxed.

•     A parent forgiving the trust’s debt — a natural person, for love and affection: so there is no tax.

Returning capital, by contrast, never depends on proving anyone’s affection. That is why it is the reliable route.‍ ‍

What you can do — and where we can help

Before you forgive anything, work out what is owed, to whom, and which way it runs.

•     Map the loans first. List every loan and current account in and out of the trust, and note who the debtor is in each loan— that is, who any tax follows.

•     Clear a beneficiary’s loan with a capital distribution, not a write-off. Distribute, then repay; the result is the same, and the distribution from a complying trust is tax-free.

•     Don’t rely on “natural love and affection” when a trust or company is doing the forgiving. It will not apply.

•     Document everything. Trustee resolutions, current financial statements and an up-to-date deed turn a clean plan into a defensible one.

•     Get the lawyer and the accountant working together. Trust law and tax have to line up; advice that ignores one will cost you the other.

RHL reviews family trusts, drafts the resolutions and deeds, and manages wind-ups so the legal steps and the tax position fit together — alongside your accountant.

Where to get information and support

•     Inland Revenue — financial arrangements rules

•     Income Tax Act 2007 (sections EW 31, EW 44, CW 53, HC 4)

•     Inland Revenue — QB 20/02, the natural love and affection exemption

•     RHL — estate planning  ·  your own accountant or tax adviser, for figures specific to your trust.

One change to watch

The Government is consulting on new rules for loans made by companies — including loans that are not repaid. An officials’ issues paper proposes treating some unrepaid company loans as taxable income, aimed at new loans from late 2025 and with a $50,000 threshold per company, plus separate rules where a company is struck off the register with loans still outstanding. None of this is settled law yet, but the direction is clear: related-party loans are under closer scrutiny, and “we’ll deal with the loan later” is getting riskier. We will keep an eye on the final rules

Tidying up or winding down a family trust with loans on the books? RHL can map the loans, draft the distributions and resolutions, and structure it so a write-off doesn’t become someone’s tax bill — in step with your accountant. Get in touch.

This article is general information only and is not legal, tax or financial advice. It describes the law as of June 2026, which may change. The tax-free treatment of a capital distribution assumes a complying trust, and beneficiaries who live overseas can face additional rules here and abroad. Your situation is unique; please obtain specific legal and tax advice before acting.