Discretionary trusts are common estate planning tools used for a variety of reasons such as tax minimization and general wealth protection, including protection on matrimonial breakdown and from creditors. These trusts are often used in an estate freeze where shares in privately-held corporations are “frozen” to defer capital gains liability which might otherwise arise on a shareholder’s death in favour of the next generation where the “growth” shares are held by a trust. Margaret O’Sullivan’s recent paper “When Trust Law Meets Family Law” provides a review of discretionary trusts and their recent treatment by matrimonial courts in several jurisdictions. My post highlights some of the observations and concerns raised in Margaret’s paper.
Traditionally, trust law would say that a person who is named as the object of a trustee’s discretion–to whom the trustee can choose to pay income or capital but is under no mandatory obligation to do so–does not have an existing property interest. Instead, he/she would be viewed as having only an “expectancy” and a right to be considered as a potential beneficiary when the trustee chooses to exercise discretion to make a distribution from the trust. Because trust law does not consider an expectancy to be property, the traditional view has been the such interests have little or nominal value–an analogy is expecting to receive a birthday gift or a present at holiday time.
Matrimonial courts, on the other hand, which oversee the equitable division of property between spouses at a marriage’s end, have muddied the waters in certain jurisdictions by imputing value to these discretionary interests.
Whether a person’s interest in a discretionary trust is property and if it is, the value of that interest, become important questions when a beneficiary is going through a marital breakdown. If the interest is property that has a value, it may factor into division with the beneficiary’s spouse.
In Ontario, as well as other Canadian provinces, some courts in recent years have on occasion not only found that an interest in a discretionary trust is property for the purposes of dividing assets between divorcing spouses, but have also attached significant value to those interests for the beneficiary spouse.
Recently, British Columbia eliminated any ambiguity regarding the treatment of such interests through unprecedented (in Canada, at least) provisions in its new Family Law Act, which expressly include discretionary trust interests among the pool of assets available for marital property division.
Unfortunately, to date in Canada, no formal methodology has been developed in the case law or by statute for reliably calculating the value of a discretionary trust interest.
Similar shifts in the court’s treatment of discretionary interests have occurred in other common law countries such as the UK and Australia, while other jurisdictions (like many U.S. states and New Zealand) generally tend to continue to take a more conservative stance and exclude discretionary interests from matrimonial property division.
Given the complexity and uncertainty of the treatment of discretionary trust interests in the matrimonial setting, three considerations come to mind:
- During the planning stage, take a careful and focused approach, with proper trust law advice, to the use and drafting of these trusts in light of recent developments.
- The treatment of these interests during a marital breakdown should involve not only expert family law advice, but also expert trust advice and where required, professional valuations based on actuarial evidence to arrive at a sound methodology and set of guidelines in answering the valuation question.
- Beneficiaries of such trusts (for example, children) should consider domestic and marriage contracts to deal with their trust interests.
Discretionary trusts will continue to be valuable planning tools. In light of the change happening in our family law courts as judges attempt to make an equitable distribution of property between spouses when a relationship ends, it will be more necessary now than ever to get proper trust law advice at all stages.
Please watch for our next post on planning options for minimizing estate tax on U.S. real property.
The comments offered in this article are meant to be general in nature, are limited to the law of Ontario, Canada, and are not intended to provide legal or tax advice on any individual situation. Before taking any action involving your individual situation, you should seek legal advice to ensure it is appropriate to your personal circumstances.