Beneficiary Current Account Balances – The Practical Implications

Sep27

One thing we see a great deal with trusts that have been around for a while is high beneficiary current account balances where the trustees owe beneficiaries quite significant amounts of money.  This has come about through trust income being distributed to beneficiaries who have a lower marginal tax rate as the trustee, i..e income splitting.  Even though the trust income has been distributed the beneficiary never received the funds and they were recorded as a loan to the beneficiary in the beneficiary current account.  Sometimes these balances can be large – over $500,000 in a few circumstances.

These amounts the trustees owe the beneficiaries can cause some serious practical implications as follows:

  1. The amounts are repayable on demand.  This means if a beneficiary asks the trustees to repay it they must.
  2. The amount is an asset in the hands of the beneficiary and should be taken into account when the beneficiary fills in any statement of assets and liabilities, for example when applying for bank loans.  The difficulty here is the beneficiary has no idea they are actually owed the money!

The options to deal with this are limited.  We have heard of some accountants wanting to ‘gift’ off the balances through journal entries which is not advisable as the only person who can actually gift the balances are the beneficiaries.  Also, there is an added complication that if the beneficiaries gift the balances they will also be considered a settlor of the trust under trust law principles.

The best course of action is to be open with the beneficiaries.  With the proposed changes to New Zealand’s trust they are going to be able to obtain this information in any event, assuming there are no further changes before it is finally passed by Parliament.  Sit them down and tell them they are owed money but the trust cannot pay it back but it will be paid back in the future.

TRUST POWERS

Apr17

The Clayton v Clayton decision regarding trustee powers, and other powers, equating to property continues to be very relevant in the trust law area both in New Zealand and overseas.  Effectively the courts are looking at the substance of the relationships between the parties of a trust, but the provisions of the deed of trust are still extremely important in the end result of any court decision.  This can be demonstrated by the following two cases.

Goldie v Campbell: in the New Zealand High Court case the settlor was also the trustee and had the power of appointment and removal of trustees.  Based on Clayton principles on first glance, this would make the trust structure open to attack by third parties based on the power that individual wielded and this was argued in the hearing.  However, the High Court after reviewing the deed of trust ultimately found the trust assets were not relationship property as there were restrictions on those powers and the trust was formed for specific purposes.  The most important thing was that the person holding these powers could not apply the trust assets for his sole benefit which was different to Clayton.

Mezhprom v Pugachev: this was a UK High Court case but it involved a number of New Zealand governing law trusts.  The settlor and discretionary beneficiary in question was also the Protector of the trust and had to give his consent to a number of trustee decisions, including distributions, investment, removal of beneficiaries etc.  The judge in question ruled that the powers held by that person were not restricted and could be exercised solely for his benefit.  As a result, the judge viewed that the beneficial ownership of the trust assets had never been transferred to the trustees as control over those assets had never been given up.

Based on current case law these decisions are hardly surprising.  Neither trusts were considered shams but the trustee, and other, powers are very important, especially if the holder of those powers can exercise them solely for his or her benefit.  We suspect there is a large number of trusts in New Zealand that is attacked in court would fail and the trust assets would be available to settle third-party creditor claims.

Marcus Diprose

As always, the Covisory team is happy to talk to you about your needs, now and going forward. If there is anything we can do to help, please call or email me.

Please note that the information in this article is for informative purposes only and should not be relied on as legal advice.

TRUST FORMATION TIME FRAMES

Mar29

A lot of clients we deal with come from an environment that setting up a trust structure is easy, and can happen pretty much overnight.  That may have been the case in the past but it is the exception rather than the norm in today’s professional environment.

Too often we are seeing requests come in on a Tuesday or Wednesday to put together a trust structure for a property transaction that settles on a Friday.  You can imagine the disappointment when we say that this is not possible.

The main issues causing formation time frames to be greater than in the past are:

  1. Anti-money laundering rules: trusts are considered to be high risk for money laundering which means enhanced due diligence must be carried out on the parties involved in the structure before any document drafting can start.  To complete these checks all know your client documentation needs to be collated which can take a few weeks depending on the geographical spread of the parties.
  2. The Inland Revenue Department no longer issues IRD numbers on a same day or overnight basis.  So, for those trust structures that need an IRD number to get GST registered to complete the land transaction a suitable time frame to obtain an IRD number must be budgeted for.
  3. A great deal of the work we do is restructuring of current trusts as the trust deed does not reflect what the settlors originally intended as the formation was rushed.  Some measured consideration during the trust formation process would have meant a lot of these issues would not have arisen.

 

Our advice is simple: when forming a trust budget on sufficient time to get everything in place.

Clayton v Clayton – A Reinstatement of the Trust?

Jan10

A trust should be a simple concept.  A person, the Settlor, provides property to another person, the Trustee, to manage on behalf of the beneficiaries.  However, over the last twenty to thirty years, and in particular post the repeal of estate duty, there has been a definite trend for the Settlor to retain a certain amount of control over the trust property.  The recent New Zealand Supreme Court decisions in Clayton v Clayton look at these types of arrangements and it is clear a number of New Zealand trusts will now need to review powers that vest with parties that are not the trustee.

The Clayton litigation involved a husband and wife with substantial assets held in two trusts.  Although the parties ultimately settled out of court in late 2015 the Supreme Court still issued two separate judgements due to the precedents raised in the cases.

Background

Mr and Mrs Clayton entered into a relationship in 1986 and were married in 1989.  They separated in 2006 and the marriage was formally dissolved in 2009.  Before they were married they entered into a section 21 contracting out agreement.  Under the terms of the agreement Mrs Clayton was to receive a maximum of $10,000 for each year of marriage up to a maximum of $30,000.

Vaughan Road Property Trust (VRPT)

The VRPT was settled in 1989.  A summary of the trust was:

  • Mr Clayton was the settlor and sole trustee.
  • The discretionary beneficiaries include Mr Clayton, Mrs Clayton and their two daughters.
  • The daughters were the final beneficiaries.
  • Mr Clayton held other powers under the deed of trust, including the power to add and remove beneficiaries, bring forward the vesting day and resettlement the trust.

Mrs Clayton argued that the VRPT was a sham or an illusory trust.  The claim of sham failed and the Supreme Court said that the term illusory trust was unhelpful.  There is either a trust or not and this will be driven by the actions of the parties involved.

Mrs Clayton also argued that the powers held by Mr Clayton should be considered as relationship property under the Property Relationships Act 1976 as they were rights or interests in property.  The Property Relationships Act 1976 applies for a de-facto relationship and as the VRPT was settled before Mr and Mars Clayton were married it applied here.  The Court of Appeal had previously found the power to add and remove beneficiaries held by Mr Clayton was relationship property and attributed fifty percent of the assets of the VRPT to Mrs Clayton.  This decision was challenged by Mr Clayton in the Supreme Court.

The Supreme Court ruled in favour of Mrs Clayton but did decide that Court of Appeal was incorrect in their approach.  Instead, the Supreme Court took a holistic view of the trust and the powers held by Mr Clayton.  The court ruled that Mr Clayton’s powers collectively under the VRPT were classified as rights and, therefore, gave Mt Clayton an interest in the VRPT for the purposes of relationship property.  As these powers were provided to Mr Clayton after the relationship with Mrs Clayton began the Court valued the powers as equal to the net assets of the VRPT.

It was important to note as the Court took an overall view it considered both fiduciary and personal powers held by Mr Clayton and bundled them up together.  This is an important point – it was clear the court was looking at the substance on how the trust operated as opposed to the strict legal form which is equity in a nutshell.

Claymark Trust

The legal principles that affected the Claymark Trust were different.  The Court had to decide whether the Claymark Trust was a nuptial settlement under section 182 of the Family Proceedings Act 1980.  This section allows the Court to order varying a trust to be made for the benefit of the children or a spouse or civil union partner.  However, for such an order to be given the trust must be considered a nuptial settlement and unlike for the VRPT Mr and Mrs Clayton were married when the Claymark Trust was settled.

The Supreme Court said that a two-stage approach to section 182 claims should be taken:

  • Step 1 – determine whether the settlement is a nuptial settlement. The Supreme Court said that to be considered a nuptial settlement the trust must have a connection with the marriage.  It is important to note that the make-up of the assets is not important and a nuptial settlement can be made for business reasons.  In this case, the Claymark Trust was settled during the marriage with assets acquired during the marriage for the benefit of the Clayton family.
  • Step 2 – decide whether the court’s discretion under section 182 should be exercised, and if so, how the discretion would be exercised. This simply means each case will be considered individually and practically this requires a comparison of how the parties will benefit from the trust post-separation compared to what would have hypothetically occurred had they not separated.

For the Claymark Trust, the Supreme Court found there was a nuptial settlement and the discretion under section 182 should be exercised.  This was because there were clear benefits to Mrs Clayton from the trust if the marriage had of survived.  As the parties have settled no formal order was given by the Supreme Court but if no settlement has existed an order would have been given to split the Claymark Trust equally into two separate trusts.

The result here is that section 182 is potentially a very powerful tool that can be used by the courts to benefit a spouse in the event a relationship breaks down and there are substantial assets tied up in trusts.  As long as a spouse can prove the trust was a nuptial settlement he or she should be able to obtain a court order that provides them with benefit from the trust.

Practical Implications

What does this mean for current New Zealand trusts?  There are now a number of specific issues that should be considered by Settlors and Trustees:

  1. Trusts which have a number of powers that vest in a singular Settlor or Principal Family Member should be reviewed and if necessary amended to ensure those powers are not held by the Settlor. This is especially so if that person is also a trustee and beneficiary.
  2. Consideration needs to be given that when a relationship starts a section 21 contracting out agreement is entered into, that covers all interests in trusts as well, i.e. they remain a person’s separate property.
  3. If parties are in a relationship and want to keep property separate, including the formation of a new trust during the relationship; then a section 21 contracting out agreement should be put in place.
  4. As always in the event of a relationship breakdown, it is far easier to negotiate a settlement between the parties as opposed to entering into prolonged and expensive litigation.

It is clear the courts are looking at trusts from a perspective of how they have been run and how the parties have acted.  The Supreme Court simply confirms that approach and this case simply reinstates general trust principles.

If you would like to discuss how these changes will impact your Trusts or have any questions relating to Trusts please contact Marcus Diprose.

RETENTION OF TRUST RECORDS

Oct14

We have seen a few cases recently where trust records such as trustee resolutions, financial statements etc have been disposed of. It appears these records have been destroyed along with the tax records for the trust after the 7 year retention period under the Tax Administration Act has finished. We want to remind everyone that apart from tax records all trust documents need to be retained for the trust, including all financial statements for the trust.

This is necessary especially if there are any queries about decisions taken by trustees in the past. Under the new anti-money laundering rules we are also seeing banks and other financial institutions request information about the original source of wealth transferred into the trust and this is hard to supply if all of the trust records have been destroyed.

Please contact Marcus Diprose if you need to discuss this further.

Key Law Commission Recommendations | Keeping New Zealand Trusts in step with the times.

Mar16

The New Zealand Courts are making it very clear that they expect certain standards to be observed in the investment and administration of Trust assets and (where applicable) trust liabilities or potential liabilities. If the standards are not maintained, then the trustees can be held liable.

In 2009 the Law Commission was asked to review the Trustee Act 1956 and trust law generally. In September 2013 they tabled a report in Parliament, Review of the Law of Trusts: A Trusts Act for New Zealand (R130), which was preceded by six issue papers. At the heart of the report is the recommendation for the introduction of a modern and comprehensive Trusts Act to replace the outdated Trustee Act 1956 – keeping New Zealand Trusts in step with the times.

The main points addressed are:

  • setting out the characteristics of a trust and how a trust is created;
  • setting out the duties of trustees;
  • modernised trustee powers provisions;
  • a modernised, flexible approach to investment;
  • improved procedures for the appointment and removal of trustees;
  • more comprehensive and useful provisions on the variation and revocation of trusts;
  • a refined approach to the power of the courts to review the actions of trustees; and
  • the replacement of the rule against perpetuities and Perpetuities Act with a new rule limiting the maximum duration of a trust.

 

Essentially the 59 year old Trustee Act is not in step with how trusts are now being used. Over the past 20 years the use of trusts has grown steeply and the current estimate is that New Zealand has now somewhere between 300,000 and 500,000 trusts operating. Although the New Zealand Government agrees that there is need for a new Trusts Act it has called for further research on the implications of the new Act on existing Trusts and work still is needed on many of the Law Commissions recommendations.