Discretionary Family Trusts & Wills by Paul Anderson | August 2006
These days it is common practice for people to set up discretionary family trusts, in some instances holding very significant and valuable assets. There is a tendency for the instigator of the discretionary family trust to regard his or her own property and the property held by the discretionary family trust as being one and the same. Legally however, this is not the case. Not infrequently, the affairs of the two can become muddled. For example, the instigator may draw a cheque for a personal debt on the bank account of the discretionary family trust on the assumption that “it is all my money”. This can create problems with the Australian Taxation Office. A good example of the potential confusion relates to Wills. The instigator of the discretionary family trust may, for example, make a Will leaving all his property to his wife, mistakenly assuming that the Will applies to the property held by the discretionary family trust as well. This is not the case. The property held by the discretionary family trust will continue to be held on the terms set out in the discretionary family trust deed and the Will is irrelevant. The Will applies only to property held by the deceased in his personal name and the discretionary family trust deed will continue to govern the operation of the discretionary family trust. The solution is to execute a Memorandum or Statement of Wishes addressed to the trustee of the discretionary family trust in addition to the execution of a Will.
What is a discretionary family trust? A discretionary family trust is a trust for a wide class of beneficiaries, usually all members of the one extended family, under which the Trustee has a broad discretion as to how income is to be split each year between the beneficiaries. There is also a broad discretion in the Trustee as to how the capital is to be split between the beneficiaries on termination of the trust which can last up to 80 years. The Trustee also has a discretionary power to terminate the trust early. Flexibility is the key to a discretionary family trust. The split in income can be varied from year to year. One beneficiary can receive all of the income in one year and none the next or any combination. The allocation of income is largely driven by the income tax positions of the various beneficiaries in an attempt to minimise the amount of income tax paid. In addition to beneficiaries, there are usually three other parties to a discretionary family trust deed: 1
The Settlor contributes a small amount, e.g. $10, and then has no further involvement. The sum of $10 is selected to limit the stamp duty payable on the deed to the minimum amount payable of $200. Additional cash is then usually gifted to the discretionary family trust without a liability for stamp duty. With the passage of time, very significant and valuable assets can be built up.
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The Trustee has the discretionary powers as to income and capital referred to above. Frequently the Trustee is a company. The instigator of the trust may be a director of the company (with or without other family members) and a shareholder (with or without other family members).
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The Appointor is usually the instigator of the discretionary family trust. Under the deed, the Appointor usually has the power to change the Trustee at any time in their life time or by his or her Will. This ensures that the instigator of the discretionary family trust has ultimate control.
EXAMPLE Marvin has been married twice. By his first wife (now deceased), he has two children, John and Marsha, who are now adults. John and Marsha do “not get along” with his second wife, Rebecca. Marvin has assets worth $1,000,000 in his own name and his discretionary family trust owns assets worth $500,000. His wish is that Rebecca should receive half of the total pool of assets, i.e. $750,000 and John and Marsha should each receive one quarter, i.e. $375,000 each. He makes a Will leaving half of his estate to Rebecca and one quarter each to John and Marsha, but omits to make any special arrangements in relation to the discretionary family trust. In particular, he forgets that Rebecca is the only other shareholder and director of Marvin Pty Limited, the Trustee of the discretionary family trust. The Will has no application to the assets held in the discretionary family trust. Following Marvin’s death, Rebecca assumes control of Marvin Pty Limited and then exercises the Trustee’s discretion as to capital in favour of herself. The full amount of the assets owned by the discretionary family trust are realised and paid to Rebecca. The result is that Rebecca receives one half of the estate assets ($500,000) and all of the Trust’s assets ($500,000) —a total of $1,000,000. John and Marsha each receive one quarter of the personal assets only ($250,000). The final result was not intended by Marvin! What should Marvin have done? There are three steps Marvin should have taken: �1
In his Will he should have gifted his shares in the Trustee company to a reliable person. However, this may not be sufficient to give that person control of the Trustee company if there are other shareholders involved.
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In his Will, he should have nominated the same reliable person as Appointor of the discretionary family trust. The Appointor has the ability to change the Trustee and this will give the reliable person total and ultimate control.
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He should have executed a Memorandum of Wishes and leave it with his Will.
What is a Memorandum of Wishes? A Memorandum of Wishes is a simple written statement addressed to the Trustee setting out the wishes of the instigator of the discretionary family trust in relation to its future operation. Although there are no limitations on the subject matter of a Memorandum of Wishes, it is customary to deal with issues such as termination date, ultimate division of capital on termination and division of income pending termination.
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Legal status of a Memorandum of Wishes In Hartigan Nominees Pty Limited v Rydge (1992) 29 NSW LR 405 the Court of Appeal dealt with a discretionary family trust established before his death by a wealthy business man, Sir Norman Rydge, whose interests included a well known hotel chain. The beneficiaries of the discretionary family trust were widely drawn but included Sir Norman’s grandchildren. The plaintiff was a grandson. Under the deed, the Trustees held the trust fund and the income thereof in trust for “all or such one or more exclusively of the others or other of the Eligible Beneficiaries and in such shares or proportions as the Trustee shall revocably or irrevocably appoint from time to time…” Clause 17 of the trust deed conferred upon the Trustees an “absolute and uncontrolled” discretion in the exercise of their powers. The assets of the discretionary family trust were of significant value. Before his death, Sir Norman executed a Memorandum of Wishes that effectively excluded the plaintiff from any share of the income or the capital of the Trust. The Court identified and decided two issues in the case: 1
Whether, in exercising discretion, a Trustee is entitled to take into account a Memorandum of Wishes executed by the instigator of the Trust; and
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Whether a discretionary beneficiary having only a contingent or potential interest in the trust fund is entitled to see a copy of the Memorandum of Wishes.
In relation to the first question, the Court held that there must be an exercise of discretion by the Trustee: he or she must not abdicate his or her discretion to another. The Trustee must consider the instant exercise of the power and make his or her own decision, which must be made honestly and bona fide. However, there was in principle no reason why the Trustee should not have regard to the Memorandum of Wishes. In relation to the second question, the Court held that there was no entitlement in a beneficiary to see the Memorandum of Wishes. The obligation of a Trustee to provide information to a beneficiary is limited to a general obligation “to provide documents and information to the beneficiary, at his cost, in relation to the trust property and to provide an accounting in respect or the administration of it.” In summary, the position is that, although not bound by a Memorandum of Wishes, a Trustee is entitled to take its contents into account in exercising a discretion under a trust deed along with any other relevant factors.
Conclusion The message is clear. An instigator of a discretionary family trust should at least consider the operation of the trust after his or her death. Certainly, they should appreciate that their Will has no application to any assets held by the discretionary family trust. However, it may be the case that he or she is content to leave the existing arrangements unchanged and let events take their course.
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On the other hand, it may be more appropriate to execute a Memorandum of Wishes and to take action through his or her Will to ensure that control of the discretionary family trust is vested in a reliable person. These considerations are only heightened in the modern world with a greater frequency of blended and disjointed families.
For More Information Please Contact: Paul Anderson Partner T: 02 8257 5742 paul.anderson@turkslegal.com.au
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