The Inland Revenue Department (IRD) has specific rules governing related-party lending, and understanding these is crucial for both lenders and borrowers. Getting this wrong can result in unexpected tax bills or compliance issues.

Resident Withholding Tax (RWT) on interest

If you're charging interest on a family loan, you need to understand your RWT obligations. When you receive interest from a loan, that interest is considered income and is subject to tax.

For loans between family members where interest is charged, the person receiving the interest income (typically the parents) must either declare this interest in their annual tax return or arrange for RWT to be deducted at source. The current RWT rates are 10.5%, 17.5%, 30%, or 33%, depending on the recipient's total taxable income.

Most family lenders simply include interest income in their annual tax return rather than deducting RWT at source. However, if you're receiving substantial interest income from multiple sources, you may need to pay provisional tax throughout the year rather than waiting until year-end.

Zero-interest and low-interest loans

Here's where many families get caught out. The IRD has rules about loans between associated persons (which includes family members) that charge nil or below-market interest rates.

Under section GB 45 of the Income Tax Act 2007, if you provide a loan to a family member at below-market rates and that loan is used to generate income (such as buying a rental property or funding a business), the IRD may treat the arrangement as tax avoidance and impute a market rate of interest anyway.

However, this rule generally doesn't apply to loans used for personal purposes, such as buying a family home to live in. If your child is borrowing money for their own residence, a zero-interest or low-interest loan typically won't trigger these anti-avoidance provisions.

The key distinction is what the borrowed money is being used for. Personal use (own home, car, wedding, etc.) is typically fine for zero-interest loans. Income-earning use (rental property, business investment, share portfolio) may trigger IRD scrutiny if you're charging below-market rates.

Loan forgiveness and debt write-offs

If you decide to forgive a family loan, either partially or completely, there are tax implications to consider.

For the borrower, loan forgiveness can potentially be considered taxable income under certain circumstances. If the original loan was used for business purposes or to acquire income-earning assets, forgiving that debt could result in a tax liability for the borrower. This is because they're receiving a financial benefit (no longer having to repay the debt) that's connected to their income-earning activities.

However, if the loan was used for personal purposes (such as buying a family home), loan forgiveness typically doesn't create a tax liability for the borrower.

For the lender, writing off a family loan usually doesn't create a tax deduction. You can't claim a bad debt deduction for loans to family members in most circumstances, as these loans are considered to be on capital account rather than revenue account.

Gift duty abolition

New Zealand abolished gift duty in 2011, which simplified family lending considerably. Prior to 2011, gifts over $27,000 per year were subject to gift duty of up to 25%, which meant many families structured transactions as loans even when they intended them as gifts, purely to avoid the duty.

Now, you can gift any amount to family members without triggering gift duty. However, this doesn't mean gifts are without consequences. Large gifts can still affect Work and Income means testing, relationship property calculations, and estate planning.

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