When parties are happily married or in a marriage-like (de facto) relationship often the trusted family accountant recommends establishing trust structures to hold assets for a variety of reasons, such as to protect assets from creditors, to meet a family’s succession-planning aims to accumulate wealth for future generations or to create a vehicle to distribute income and/or capital and minimise a family group’s taxation obligations. This is quite sensible in the context of a subsisting family group, but what happens to the trust in the event of a divorce or separation? Trust issues regularly arise in property settlement cases in the Family Court, particularly because many Australian family businesses are conducted through a discretionary trust structure. In this article I touch upon some of the salient matters to be aware of in relation to discretionary trusts. There are other types of trusts, such as unit trusts, testamentary trusts, charitable trusts and trusts recognised in equity (for example, constructive or resulting trusts), that will not be covered in this article.
How does a trust work?
In a discretionary trust, a trustee or trustees hold the property of the trust for the beneficiaries, and an appointor can remove or replace the trustee. Therefore, the appointor has ultimate control over the wealth accumulated in the trust.
A trustee can be an individual or several individuals who act jointly. It can also be a company, which is controlled by its director or a number of directors.
A trustee can decide to distribute income or capital among the beneficiaries of a trust as they see fit. They are not held to predetermined arrangements or agreements. The trustee or trustees of the trust could use their discretion to change the allocation of funds to certain beneficiaries without having to make any major changes. This can cause problems in a separation context.
Who is a beneficiary?
The beneficiaries of discretionary trusts are usually immediate and extended family members, other family companies and charities. They do not all have to be included at the establishment of the trust; they can be added later as needed. In a discretionary trust, beneficiaries have no interest in the trust property unless the trustee exercises its discretion to distribute to them.
It all starts with the deed
The trust deed details the names of the settlor, appointor, guardian (if applicable), trustee and beneficiaries and when the trust was established and will cease to operate (vest). It also details the powers of the appointor and the trustee which they must adhere to in managing the trust.
The way in which trust issues in the Family Court will be decided will vary based on matters such as the terms of the trust deed, the positions held by the separating parties in the trust, the powers given to those parties by the trust deed, the interests of third parties in the trust, the way the assets of the trust have been accumulated and the history of the distribution of income and capital by the trustee to the beneficiaries.
Your family lawyer will need to consult the deed of settlement or establishment of the trust and any deeds of variation or amendment which may have been prepared and executed after the creation of the trust to verify those important details.
They will also likely need to consult financial statements and taxation returns for the length of the relationship (if available), trustee resolutions, documents evidencing the purchase and sale of assets by the trust and any loan agreements (for example division 7A loan agreements).
You can assist with the timely provision of advice by collating these documents and providing them to your lawyer in a chronological or orderly fashion.
Signing documents
An issue that often arises in a Family Court property settlement relates to execution of documents. Prior to separation, one party may have assumed the role of liaising with the family accountant in relation to the preparation of tax returns and financial statements and giving instructions about income distribution by the trust amongst the family group who are named beneficiaries. The other party may have taken a more passive role, had little to do with the accountant, signed documents when asked to without close or any scrutiny and received income distributions from the trust because they are eligible for a lower individual tax rate, which in turn reduces the family’s liability for income tax.
This practice if it has developed, should not continue after separation. If both separating parties are a trustee or a director of a trustee company, they must both give instructions to the family accountant for the preparation of accounts and about the distribution of the income or capital of the trust and both sign records as may be required.
If you are asked to sign any accounting documents after separation, such as tax returns or trustee resolutions, make sure you take them to your family lawyer before signing anything. Your family lawyer may refer you to take independent accounting advice to make sure you are acting in your best interests.
It may still be appropriate to accept an income distribution from a trust after separation because reducing income tax is mutually beneficial for both separating parties, but if there is a tax liability to be met, arrangements should be in place for it to be paid when it falls due and consideration should also be given to the impact the income may have on any income-tested pension or child support being received by a party. These are issues your family lawyer can advise about.
Active Participation
In the same way that a practice for signing documents during a relationship may have arisen, so too may have a practice for only one party participating in any trustee meetings. If you have separated and you are a trustee or a director of a trustee company and you receive notification of a meeting being called, you need to notify your family lawyer in advance to get advice about what you need to do. You should not ignore the notice. It is best to participate in the meeting personally, with or without representation or by way of a proxy (if this is permitted). You may also wish to call a meeting yourself to become appraised of the affairs of the trust and discuss issues pertaining to the management of any assets of the trust, such as a family business. Whilst meetings may have been one party’s domain pre-separation, post-separation it can be an effective way to become informed and have a say in the management of the trust and the distribution of its wealth.
Impact of Divorce Order
A trust deed often specifies that a spouse of a named individual is a beneficiary of a trust. If a divorce order is made by the Family Court, once it takes effect a separated party who was previously a beneficiary of a trust may find because of no longer being a spouse of the other party, they are no longer. This will potentially remove eligibility to receive distributions of income or capital from a trust. This may have been inadvertently overlooked or not considered when the divorce application was made and may put a spanner in the works of a well-made tax plan. Another good reason to have your family lawyer check the deed.
Access to records
Sometimes it happens that because the family accountant has established a relationship with one separating party and has had little to do with the other, the accountant is reluctant or uncooperative with the other party in relation to making records (such as those detailed above which your family lawyer will need to advise you) available.
This can be problematic because each party to a family law matter has a duty to disclose documents in their possession or control in relation to their financial circumstances.
A separated party who is a trustee, or even a beneficiary of a trust usually has the right under a trust deed or if not, otherwise at law to call upon the trustee to inspect the books and records of a trust. Their duty to give disclosure in their family law case will require them to disclose documents about their interest in the trust to the other party.
If you have an interest in a trust, your family lawyer may need to communicate to the family accountant that your request for documents needs to be complied with if there is any difficulty with cooperation.
If you are the party who has historically given instructions to the family accountant, make sure that you promote cooperation with the provision of records to the other party as, without them, a prompt settlement may be prevented and subpoenas or court orders to compel disclosure may be required. These processes can be time consuming and expensive.
Will the trust assets be treated as the property of the parties?
I have often encountered the misconception, sometimes promoted by someone who is not experienced in family law or a friend, neighbour or person on the street who has been divorced and therefore ‘highly informed’ on all things Family Court-related, that a trust and its assets are beyond the reach of the Family Court and will not be included as a divisible asset in a property settlement.
This is a misconception and the Family Court, in certain circumstances, in fact can.
The Family Court must identify the existing property interests of the parties to a marriage or de facto relationship when determining a ‘just and equitable’ (i.e. fair) property settlement.
So what is ‘property’?
Property is defined in the legislation which applies for de facto couples in WA and also for married couples in a similar way as “…in relation to [the separated parties, or either of them], means property to which those parties are, or that party is, as the case may be, entitled whether in possession or reversion.”
What does that mean in the context of a trust?
The nature of a party’s interest in a trust is a question of fact to be determined by the Court which requires a consideration of the facts and circumstances of a particular case, including the terms of any relevant trust deeds.
If:
- the legal title to trust property is held in the name of one of the parties to a marriage or de facto relationship in their capacity as trustee of the trust;
- a trust is controlled by one (or more) of the parties to a marriage or de facto relationship (i.e. they are a trustee) and they have the power to consider how the trustee’s powers should be exercised;
- a trust is a ‘creature’ of one of the parties to a marriage or de facto relationship which was established prior to the parties’ relationship;
- a trust is used to accumulate assets for the family;
- the assets of the trust have been acquired by or through the efforts of the parties to the marriage or de facto relationship or either of them, either prior to or during the relationship;
- the trustee, who is a party, has the power to appoint the trust fund (assets) to him or herself and/or the other party;
- one of the parties is a beneficiary who has the right in the due administration of the trust; and
- there is an absence of a legal or equitable interest in the property of the trust in any other party,
or a combination of the above, there is a strong prospect that the party’s interest in the trust will be ‘property’ for the purpose of a family law property settlement.
If the Court finds that a party’s interest in a trust is ‘property’:
- Then that interest is capable of alteration by the Court so as to affect a fair settlement between the separated parties.
- It does not follow that the Court can deal with that property as it sees fit. The Court cannot ignore the rights of third parties in the trust, nor, unless in certain circumstances, can it ignore any limits which may exist on the party’s right to that property.
What else could it be?
If a party’s interest in a trust is not ‘property’, it may be treated as a ‘financial resource’ which the Court has regard to in exercising its discretion to decide a fair settlement.
A ‘financial resource’ has been described as a source of financial support which a party can reasonably expect will be available to him or her to supply a financial need or deficiency and upon which the party is capable of drawing.
It has been long recognised by the Court that a nominated beneficiary of a discretionary trust, who has no control over the trustee but who has a reasonable expectation that the trustee’s discretion will be exercised in his or her favour, has a ‘financial resource’ to the extent of that expectation.
Whether a potential source of financial support amounts to a financial resource of a party turns in most cases on a factual enquiry as to whether or not support from that source could reasonably be expected to be forthcoming with a party to call on it.[1]
If a party’s interest in a trust is a financial resource, it is not directly susceptible for alteration by the Court, nor is it available for division as between separated parties.
If you suspect that you have trust issues in the context of a separation, the lawyers at Carr & Co can help. We specialise in complicated financial cases involving trust structures. Contact us to arrange an appointment.
[1] Hall v Hall (2016) 257 CLR 490