Discretionary trust deeds — aren't they all the same?

Not all family trust deeds are identical. It is imperative to have a deed that trustees (and their advisors) can easily understand and that promotes clarity of their rights and obligations.

In this article, we discuss some important features of the Cleardocs Discretionary (Family) Trust and Discretionary Trust — excluded beneficiaries document packages, which:

• advisors can easily review and understand when making distributions, reducing the confusion that often contributes to invalid distributions.
• are up to date with current laws and regularly reviewed for compliance. The Cleardocs deeds are specifically drafted to:
  • reflect and take advantage of current applicable tax laws, including the Bamford^[1] decision;
  • use plain English and clear language, the importance of which was recently highlighted in the decision of Mercanti^[2] ; and
  • assist trustees to avoid foreign duty surcharge rules introduced in 2016, if relevant.

1. What can go wrong with your deed — invalid distributions

It is imperative that when making trust distributions to beneficiaries, advisors and trustees ensure that they understand the provisions of their deed to avoid costly mistakes.

This is highlighted by both a recent ATO publication on trust income distribution arrangements^[3] and the recent decision in BRK (Bris) Pty Ltd v FC of T^[4] (BRK).

An invalid distribution from a trust can have a number of negative consequences, including that the income could be taxed at the highest marginal rate in the hands of the trustee, or in the hands of one or more beneficiaries who receive the distribution under a default distribution clause.

In the decision of BRK the trustee nominated two companies as general beneficiaries under provisions of the trust deed and made several trust distributions to those companies. The ATO argued that the distributions were invalid on the basis that the trustee did not have the power under the deed to make such a nomination.

The court agreed with the ATO, comparing the terms of the trustee's written resolutions with the terms of the deed. The court concluded that the trustee's resolutions, and the written nominations that preceded them, were not prepared by reference to the deed.

It then fell to the court to consider the consequences that would flow from the failure. The trustee argued that on the proper construction of the trust deed, the failure to correctly apply the income meant that the income for those years fell to be considered by the terms of the default distribution clause (clause 5) of the deed. Clause 5 stated:

if the trustee shall not exercise any discretion as aforesaid, then the fund in relation to any income year shall be distributed equally between the beneficiaries.

However, when considering this provision, the court held that it had to first consider the preceding accumulation provision (clause 4), which gave the trustee the absolute and uncontrolled discretion to accumulate any income and to hold it as an accretion to the capital of the fund. The court held that clause 4 did not require that the duty to accumulate be discharged within the relevant income year. Clause 5 was then subject to clause 4, and only dealt with income that the trustee had determined would not be accumulated.

The court considered that the circumstances required to trigger the operation of clause 5 had not arisen, and as a result, there were no beneficiaries presently entitled to the income of the trust. As a result, the court ruled that all undistributed income would therefore be assessed against the trustee at the highest marginal rate.

The issue in BRK is addressed in the Cleardocs deed (purchased as part of the standard Discretionary (Family) Trust or Discretionary Trust — excluded beneficiaries document packages). These deeds state that if the trustee fails to exercise its discretion to accumulate income by 30 June, then the income will be held in trust for the persons and subject to the rules in the default distribution clause. The Cleardocs default distribution clause then sets out the default position for 30 June income distributions.

2. Taking advantage of applicable tax laws and the Bamford decision

The Bamford decision allows a trustee to adopt a different definition of income in the trust's deed, either by stating that definition in the deed, or by the deed granting the trustee an express power to adopt a different definition in respect of different periods.

Deeds which confer power on the trustee to adopt a different definition should also heed the decision of Forrest v Commissioner of Taxation^[5] (Forrest), which read down the trustee's powers in a clause designed to utilise the Bamford reasoning. In Forrest, the court held that such a power was a power to make an administrative determination only, and that it was not an unconfined discretion to determine whether a receipt represents realised or unrealised capital gains.

Several clauses in the Cleardocs deed have been redrafted with Bamford and Forrest in mind, granting the trustee the flexibility to determine whether receipts are to be treated as capital or income. The Cleardocs deed grants the trustee the power to determine whether to adopt an alternative definition in respect of a particular income year, which is unconfined and not merely an administrative power.

3. Plain language and Mercanti's case

The recent decision of the Western Australia Court of Appeal in Mercanti v Mercanti 2016 WASCA 206 (Mercanti) confirms the importance of having a trust deed which uses plain language.

In Mercanti the court was required to consider the validity of the variation of the schedule to the trust deed (which changed the trust's appointor) and whether the trustee was allowed to make such a variation in the first place. Ultimately the decision turned on the wording of the trust deed and the court's interpretation of the word "hereinbefore". The wording of clause 28, the clause in dispute, allowed the trustee to revoke, add to or vary 'all or any of the trusts terms and conditions hereinbefore contained'.

The argument was whether "hereinbefore" meant:

• the trustee could only vary terms and conditions appearing before that clause (meaning the trustee could not vary the schedule); or
• whether "hereinbefore" was not intended to operate as a word of limitation.

It was argued that because the schedule appeared after this clause, it was not a term or condition "hereinbefore" contained.

The trial judge concluded that the variation of the appointor in the schedule was valid and the change was within the trustee's power.

On appeal, the court held that the wording of the empowering clause did not restrict the trustee's ability to vary the appointor in the deed. In particular:

• The majority of judges pointed out that the appointor was defined in the beginning of the deed as including the person named in the schedule. This clause precedes the empowering clause and is therefore "hereinbefore" contained.
• The President of the Court of Appeal made a similar finding, but found that the word "hereinbefore" was in fact a word of limitation and did mean that the trustee could not amend those clauses appearing after clause 28. However, because the definition of the appointor included the person in the schedule — the trustee could still vary the appointor.

The use of plain language is designed to avoid matters of interpretation needing to be determined by successive judicial decisions at great cost to the parties. The Cleardocs deeds are constructed using plain English and clear language therefore avoiding issues such as those raised by Mercanti.

4. Addressing the risks regarding foreign trusts and surcharge duty and land tax

The Cleardocs Discretionary Trust — excluded beneficiaries document package allows you to choose whether you wish to limit distributions of income and capital, by excluding foreign persons as beneficiaries.

You can read about the additional duty and land tax surcharges for foreign purchasers of land in Australia in our earlier ClearLaw article.

More information from Maddocks

For more information please contact Maddocks in Melbourne (03 9288 0555) and ask for a member of the Tax & Revenue Team.

More Cleardocs information on related topics

You can read earlier ClearLaw articles on a range of trust topics.

Order Cleardocs discretionary trust packages

• Discretionary (Family) Trust set up
• Discretionary Trust — excluded beneficiaries (which provides options to exclude foreign and/or non blood beneficiaries from the trust set up)
• Change of Trustee Discretionary Trust
• Discretionary (Family) Trust Minutes & Resolutions