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Do You Need to Deduct Tax When Lending Money to Family?
11/03/2026
Understanding RWT on Family Loans
When Family Becomes the Bank: The Tax Rules You Need to KnowIt's a conversation that happens in farming families and business families across New Zealand every day. A brother helps a sister buy her first rental property. Parents lend their son money to purchase the neighbouring farm block. Siblings pool resources to help one of them expand their business.Family loans are common, practical, and often the difference between seizing an opportunity and missing out. But when interest changes hands between family members, an important question arises: do you need to deduct resident withholding tax (RWT)?The answer isn't always straightforward, and getting it wrong can create unnecessary complications with IRD. Let's break down the rules in plain English.What Is Resident Withholding Tax (RWT)?
RWT is tax that must be deducted from certain types of income before it's paid out. Think of it like PAYE for interest payments. When a bank pays you interest on your savings account, they automatically deduct RWT and send it to IRD on your behalf. You receive the net amount.The same principle can apply when you pay interest to another person – but not always.The Basic Rule: When Do You Need to Deduct RWT?
Under New Zealand tax law, you're required to deduct RWT from interest payments if either of these conditions applies:
That second point is where things get interesting – and where family loans often fall outside the RWT net.What Does "Taxable Activity" Actually Mean?
For RWT purposes, a taxable activity is broadly defined as any activity carried on continuously or regularly that involves supplying goods or services for money. This includes business activities, rental property activities, and even some activities you might not immediately think of as "business."Importantly, it doesn't matter whether you're making a profit or even intending to make a profit. If you're carrying on an activity with some regularity and there's an exchange of value, it could be a taxable activity.Private vs. Business: The Critical Distinction
Here's where the rubber meets the road for family loans. If you're borrowing money for a private, personal purpose – not connected to any business or income-earning activity – then the interest you pay is not being paid "in carrying on a taxable activity."And if the interest isn't being paid as part of a taxable activity, you don't need to deduct RWT.A Real-World Example: The Holiday Home
Let's look at a practical scenario that IRD recently addressed.Two brothers, Adam and Ben, sold a property they owned together in partnership. Each walked away with $500,000. Adam wanted to buy a $1 million holiday home for his family's private use. Ben agreed to lend Adam $500,000 at 3.5% interest.The question: Does Adam need to deduct RWT when he pays monthly interest to Ben?The answer: No.Why? Because Adam is borrowing the money for a purely private purpose – buying a holiday home for his own family's use. The holiday home won't be rented out, won't generate any income, and isn't connected to any business activity. Therefore, the interest payments Adam makes to Ben are not being made "in carrying on a taxable activity," and RWT doesn't apply.When RWT Would Apply to Family Loans
Now, let's flip the scenario. Imagine Adam was buying a rental property instead of a holiday home, and Ben was still lending him the $500,000. In this case, Adam would be using the borrowed funds to carry on a taxable activity (residential rental). The interest payments would be connected to that rental activity, and Adam would be required to deduct RWT from each interest payment to Ben.The same would apply if:
In all these cases, the borrowing is connected to an income-earning or business activity, so RWT applies.What About Rental Properties?
Here's an important technical point: even though residential rental income is exempt from GST, it's still considered a "taxable activity" for RWT purposes. The definition of taxable activity for RWT rules specifically excludes the GST exemption for residential rentals.This catches some people by surprise. If you're borrowing to buy a rental property – even though you won't charge GST on the rent – you still need to deduct RWT on interest payments to your family lender.Practical Implications for Rural Families
For farming families, this creates some interesting scenarios:Scenario 1: The Deposit for the Farm Your daughter and son-in-law want to buy their first dairy farm. You lend them $500,000 toward the deposit. When they pay you interest, they'll need to deduct RWT because they're using the money for a farming business (a taxable activity).Scenario 2: The Family Bach Your son wants to buy a bach at the beach for family holidays. You lend him $300,000. When he pays you interest, no RWT deduction is required because it's a private asset.Scenario 3: The Mixed-Use Property Your nephew buys a property that he'll use partly as his home and partly to run his agricultural contracting business. This is where things get complex. If the loan is specifically for the business portion, RWT would apply to that portion of the interest.What If You Get It Wrong?
If you should have deducted RWT but didn't, you become liable to pay that RWT to IRD yourself, plus potential penalties and interest. The IRD takes RWT obligations seriously.On the flip side, if you deduct RWT when you didn't need to, you've created unnecessary compliance work and possibly confusion for your family member at tax time.Key Takeaways
Private loans = No RWT If you're borrowing from family for a purely private purpose (your own home, a holiday home, personal items), you don't need to deduct RWT on interest payments.Business loans = RWT applies If you're borrowing for any business or income-earning purpose (rental property, farm, business equipment), you must deduct RWT from interest payments.Documentation matters Keep clear records of loan agreements, the purpose of borrowing, and all interest payments. If IRD ever asks, you'll need to show the private nature of the arrangement.The "taxable activity" test is broad Don't assume something isn't a taxable activity just because it's small-scale or not your main income source. Regular income-earning activities usually count.When in doubt, ask RWT mistakes can be costly. If you're unsure whether your family loan arrangement requires RWT, get advice before the first interest payment is due.A Final Word
Family loans can be a wonderful way to help those you love achieve their goals. Understanding the RWT rules ensures these arrangements stay simple and compliant. The key is to look at what the borrowed money is being used for. Private purpose? No RWT. Business or income-earning purpose? RWT applies.Need help navigating a family loan arrangement? We're here to help ensure you get it right from the start.
