The Ontario Family Law Act (FLA) determines the division of property between spouses on marriage breakdown. But what happens when a spouse is a beneficiary of a discretionary trust?
By way of background, the FLA requires each spouse on marriage breakdown to value his or her “net family property” (NFP). NFP is the value of all property owned on the date of marriage breakdown less “excluded property” and less the value of all property owned on the date of marriage. Debts and liabilities are also deducted. Excluded property includes gifts received during marriage and income earned on such gifts if expressly excluded by the donor. The spouse with the lower NFP is entitled to one-half of the difference between the two spouse’s NFP (known as an “equalization payment”).
If a spouse is a beneficiary of a discretionary trust, the threshold issue is whether the spouse’s interest is “property” under the FLA, which is defined as meaning “any interest, present or future, vested or contingent”. The trustees of a fully discretionary trust may decide whether or not to pay income or capital of the trust to any or all beneficiaries, as well as when and in what amounts. Under trust law, beneficiaries of a discretionary trust do not have an existing property interest or an entitlement to receive any trust property. Nevertheless, courts have held that an interest in a discretionary trust is property under the FLA. While this conclusion may be questionable, it aligns with the objectives of the FLA. In British Columbia, new legislation now expressly includes certain discretionary trust interests as property subject to division on marriage breakdown, while in other jurisdictions, such as some U.S. states, legislation expressly excludes discretionary trusts from division.
The more difficult issue spouses commonly face is determining how to value an interest in a discretionary trust. In making this determination, courts typically rely on the “fair value” or “value to owner” concept as a more equitable approach than relying on the “fair market value” concept. The value to owner focuses on what a spouse would pay to not lose his or her discretionary interest in the trust.
This approach is not easy to apply because there are many factors to consider, including the extent of control the spouse exercises over the trust, whether distributions to the spouse would be contrary to the purpose of the trust, and the past history of trust distributions to the spouse and other beneficiaries. In the U.K., courts consider whether capital distributions would be made to the spouse if requested, which tends to result in all or substantially all of the value of the trust being considered a financial resource subject to division. As each situation is dependent on its own facts, there are no clear guidelines that help in determining the value of an interest in a discretionary trust.
A further issue can arise should a significant value be assigned to a spouse’s interest in a discretionary trust, but the spouse is unable to make the equalization payment without receiving a distribution from the trust. If the spouse does not control the trust, hardship could ensue if the spouse has to use all of his or her other assets to make the equalization payment. Conversely, it may also lead to hardship for the other spouse as he or she may have a right without a remedy if the spouse does not have sufficient other assets to make the equalization payment.
These issues are emerging but not well developed in Canadian case-law creating sometimes unexpected and undesired results on marriage breakdown. To provide greater certainty, a prenuptial or marriage contract is often advisable to address trust interests. Under such contracts, the spouse’s interest in the discretionary trust could, for example, be defined to be excluded property. Not dealing with these issues in advance could make an already difficult situation even more difficult.
Please join us for our next blog post when we discuss new developments regarding the interjurisdictional recognition of substitute decision-making documents.
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.