Discretionary Trust

WHAT IS A TRUST?

A trust is a relationship where a person (the Trustee) is under an obligation to hold property for the benefit of other persons (the Beneficiaries). This obligation is defined by the terms of the Trust Deed entered into between the Trustee and the Settlor.

The Trustee is the legal owner of the trust property and the beneficiaries hold the beneficial interest in the trust property.

WHAT IS A DISCRETIONARY TRUST?

A discretionary trust, also known as a family trust, is established when a “Settlor” provides a settled sum as a gift to the “Trustee” of the trust for the purpose of establishing a trust fund for the benefit of the “Beneficiaries” named in the trust deed.

In a discretionary trust the trustee has the discretion to determine which of the beneficiaries are to receive the capital and income of the trust and how much each beneficiary is to receive, but can only distribute to beneficiaries who are specifically named or belong to a nominated class as set out in the terms of the trust deed. The beneficiaries do not have a fixed entitlement or interest in the trust assets.

A trust is recorded in writing by a trust deed. The trust deed specifies the beneficiaries, the powers and duties of the trustee and the other terms of the trust.

HOW IT WORKS

The settlor makes payment of a sum by way of a gift to the trustee. The sum paid is usually a small amount such as $50. The settlor cannot in any way benefit from this transaction, for example by way of receiving a distribution of income or capital from the trust. If the the settlor is reimbursed in any way for the payment made, the trust will not have been validly established.

The settled sum constitutes the initial asset of the trust. The trustee is then allowed to increase the assets of the trust by way of loans, gifting or acquisition of assets.

Once payment of the settled sum has been made, and the settlor has executed the trust deed, no other legal obligations arise for the settlor, who is not responsible in any way for any subsequent acts of the trust or the trustee.

THE PLAYERS

1. The Settlor

   The settlor is the person who creates the trust by gifting a sum of money or item of property on trust for the beneficiaries. Once the trust has been established, the settlor plays no further part in the trust.

2. The Trustee

   The trustee is the legal owner of the trust property although not the beneficial owner. The trustee can be one or more individuals, or a company. If the trustee is a company, its actions are controlled by the directors, and ultimately by the shareholders in the company by virtue of their power to remove or appoint directors. The trustee carries out all transactions of the trust in its own name and must sign all documents for and on behalf of the trust. The trustee’s overriding duty is to obey the terms of the trust deed and to act in the best interests of the beneficiaries.
   If a trustee incurs a liability, in acting honestly as trustee, the trustee is entitled to indemnity from the trust assets for the liability. However, if there are insufficient assets of the trust to meet that liability, the trustee is liable for any shortfall. Therefore, if the trustee is an individual, the trustee’s personal assets are exposed to meet any shortfall.

3. The Appointor

   The Appointor is the person named in the Trust Deed who has the power to remove and appoint trustees. This would commonly occur when:.
   • the trustee dies, becomes bankrupt or is incapacitated;.
   • in the case of a company, the company is wound up..
   The Appointor has ultimate control of the trust assets and is usually the person for whose benefit the trust was initially established. Particular care should be given to choice of the appointor.

4. The Beneficiaries

   The beneficiaries are the people (including entities) for whose benefit the trustee holds the trust property. A discretionary trust usually has a wide range of beneficiaries, including companies and other trusts. There are often two categories of beneficiaries: primary beneficiaries and general beneficiaries. The primary beneficiaries are usually family members being principally involved in the business or investments owned by the trust. The general beneficiaries will include a wider range of beneficiaries, such as charitable institutions, any company in which a beneficiary holds an interest or any other trust of which a beneficiary is also a beneficiary.

THE BENEFITS OF A TRUST

Tax Benefits

The main advantage of a discretionary trust is the ability to distribute income or capital of the trust between the beneficiaries in the most tax effective manner. The trustee is required to distribute the income between the beneficiaries or to accumulate it. It can elect to distribute that income to any one of the primary or general beneficiaries, none of whom have any enforceable interest to require that a percentage of the income or any fixed sum is required to be paid to them in any year.

Asset Protection

No beneficiary has any claim to the assets of the trust, and therefore a trust is the most effective way of owning assets for the purposes of asset protection. For example, assume a trust owns a business and the business premises from which that business is conducted. As a result of a bad investment, a beneficiary encounters financial difficulty. Because that beneficiary does not have any claim to or ownership of the assets of the trust, (unless there is any money unpaid and owing to him by the trust) the creditor of the beneficiary cannot attempt to seize the assets of the trust to satisfy the debt.

Asset Protection and the Family Court

If the beneficiary is involved in Family Court proceedings, the Family Court cannot direct that the assets of a properly structured trust be used to satisfy the claim of the spouse in the Family Court property proceedings.

However- these benefits of a trust are subject to the role of an appointor of a trust.

THE ROLE OF APPOINTORS

Appointers have the most control over the assets of a trust. It is therefore important that the appointers be independent and the parties establishing the trust have absolute faith and confidence that such persons will act in their best interests.

It is also important to have a provision in the trust deed which disentitles a person from continuing to act as an appointor upon bankruptcy in order to further secure the trust assets from seizure by creditors. For example, if the trustee is a company, in which the bankrupt appointors hold the shares, the trustee in bankruptcy could take those shares and using the voting rights attaching to the shares appoint himself and his nominee to be directors. Those directors could then exercise their powers to realise the trust assets, and distribute the proceeds to the bankrupt beneficiaries who would be required to provide them to the trustee in bankruptcy for distribution amongst creditors.

This situation would be prevented if there was an independent appointor (not related to the trust in anyway) and if there was such a disentitlement provision as mentioned above.

Appointors and The Family Court

In the case where the appointors are involved in a Family Court property dispute it would again be necessary to have an independent appointor. This issue is also relevant if there is only one appointor. If two parties are appointors and involved in Family Court proceedings, the Family Court could direct that the appointors act in a certain way, for example to appoint one of them as trustee. That trustee would then be able to realise the assets of the trust, and distribute the proceeds to the parties or in accordance with the Family Court’s orders. In this way, the Family Court would have access to trust assets which it would not otherwise have. Any person who is not a party to the marriage cannot be subject to Family Court directions, and therefore, if there is an independent appointor, the appointors could not be directed by the Family Court to act in this way, given the requirement that the appointors must act jointly.

The terms of a trust deed and the powers of the trustee under the deed will be factors taken into account by the Family Court in formulating any order which may affect the assets held by the trustee upon the breakdown of the marriage of a person who is both a beneficiary of and has some involvement in the administration and/or control of the trust.

ESTATE PLANNING

As the trust assets are not owned by any beneficiary they cannot be passed by will. However, the trust deed can provide that following the death of the original appointors of the trust, their children become the appointors. In that way, the children obtain control of the trust following their parents’ death, just as they would if the assets were passed by will directly upon their parents’ death.

The benefit of the assets being held in a trust is that if following the death of the original beneficiaries, their children are involved in a matrimonial dispute, or encounter financial difficulties leading to bankruptcy, the assets retained in the trust would not be exposed in the first instance to distribution by the Family Court, and in the second instance to sale and distribution amongst creditors, as neither would have title to the trust assets. If funds are required by the children for any specific purpose, the asset can either be acquired by the trust, or alternatively a loan can be made by the trust to them, or a distribution of part of the capital can be made from the trust.

CONCLUSION

This article represents a basic introduction to the establishment, structure and benefits of a discretionary trust. Consideration should be given to a wide range of factors which are specific to your circumstances before you embark on this process. Our solicitors provide expert advice and assistance in this regard and are available on appointment.