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Trusts: Get it right or forget it

An increasing amount of litigation aimed at unwinding trusts is likely as their numbers and size balloon, Guardian Trust's Mark Cassidy

Sunday, November 1st 1998, 12:00AM

by Philip Macalister

By Mark Cassidy
New Zealand Guardian Trust, business development manager


- In researching my previous article on gifting a very interesting statistic emerged - the Inland Revenue Department (IRD) receive approximately 75,000 gift statements annually. Clearly many New Zealanders are actively seeking to rearrange ownership of their assets, perhaps not a world shattering revelation in itself, but if you look at the implications of this more closely some quite staggering figures emerge.

A gift statement does not have to be filed if all the gifts made by an individual in any 12 month period do not exceed $12,000. In the context of a trust, many gifts will be for the maximum amount permissible of $27,000 before incurring Gift Duty.

It would seem logical to conclude that the minimum amount of all reported gifts would be a multiple of the two figures producing a total of $900 million annually reported gifts each year. If all the gifts were part of a formal gifting programme where $27,000 was being gifted, then this figure increases dramatically to over $2 billion annually.

There will of course be cases where no gift statements have been filed even though more than $27,000 may have been gifted. Although there is no hard evidence readily available to the public to confirm the actual figures, it would not be unreasonable to assume that most of the gifting will be under a formal programme associated with the transfer of assets to family trusts.

If the above amounts are in any way indicative of the assets going into trusts in New Zealand each year then this figure added to the assets already held in trust ‘debt free’ would produce a pool of assets of quite astronomic proportions.

Apocalypse now?

It is little wonder that the IRD and other government departments are beginning to look closely at trusts and how they are run, as quite clearly they now represent a sizeable proportion of the country’s personal asset base. This may well be a trend followed by other interested parties such as disgruntled creditors. In times of economic uncertainty and increased risk of personal bankruptcy and company liquidations a debtor's personal family trust is more likely to come under closer scrutiny.

As reported in the Evening Post (Bankruptcy numbers rise sharply, Oct 24) it was reported that company liquidations rose 20 per cent to 1038 in the year to September and that 64 per cent of bankruptcies were initiated by the bankrupt.

The stigma formally associated with bankruptcy has perhaps diminished with the ability through careful pre-planning to retain the family fortune notwithstanding a business failure.

Disenfranchised family members and beneficiaries may also prove to be a thorn in the side of settlors and trustees.

They may seek to unravel arrangements that have been put in place that rightly or wrongly, they may feel unjustly discriminate against them. As the numbers of trusts increase so will the likelihood of litigation initiated by those interested groups.

Whereas in the past case law has been rather thin on the ground and many practices advocated and implemented untested this may not prove to be the case for the future. A floodgate of litigation may open, paving the way for serious challenges to trust arrangements thought to be impregnable in earlier times.

As there invariably will be losers in the process, past experience has suggested that they will look to their advisers and the advice they were given. There never seems to be a shortage of legal advisers in such circumstances ready and willing to take up the case on behalf of those clients seeking redress.

So what can be done? The starting point is to consider what part of the trust arrangement is most likely to come under challenge. To appreciate this, it is important to understand two essential elements of a trust.

Firstly the establishment of the relationship between the settlor, trustees and the beneficiaries as evidenced by the trust deed and secondly, the transfer of assets (i.e: the change of ownership of both the legal and beneficial interests in the asset being settled in trust).

In other words, can the trust itself and/or, the transfer of all or some of the assets to the trust be set aside? The answer is yes on both counts.

Quite mistakenly and misleading a trust is often thought of (and referred to by some commentators) as a separate legal entity, rather like a limited liability company. It is not.

Although capable of being assessed for tax by the IRD, rather like a charitable trust, simply being treated as such for tax purposes doesn’t make it legally such and the consequences of mixing up the tax test and the legal test can give rise to unforseen consequences.

For the trust to legally exist, three characteristics must exist, namely the three certainties of intention, subject matter and objects.

Although the subject of litigation over the years (due more often than not too bad drafting), it is generally not difficult to establish what assets have been transferred to the trustees and for whom they are being held.

The certainty of intention, however, is quite different. Put simply the settlor must at the time the trust was established (and when additional assets are transferred to the trustees) have intended to transfer the control of those assets to the trustees for the benefit of the beneficiaries (albeit that the benefit may be suspended until such time as the trustees have exercised a discretion in their favour - as is the case with a discretionary family trust).

The case of Rahman vs Chase Bank (CJ) Trust Company Limited clearly demonstrates not only that failure to have such intent undermines the very existence of the trust, but also that the way in which the trust is conducted (in this case retention of significant control over the investment of the trust assets by the settlor, rather than the vesting of such control in the trustees) can clearly be brought in as evidence of the settlor’s intention.

To use an analogy from criminal law the settlor must have the mens rea (the mental intent) as well as the actus reus (the commission of the act). Although the facts of the Rahman case are unique, as Denham Martin points out in his paper Advanced Trusts II, delivered to members of the Institute of Chartered Accountants, the similarities between the Rahman trust and the typical New Zealand family trust are such that alarm bells should be ringing loud and clear.

The creation is about far more than simply getting the documents right. It is a matter of substance over form.

Substance over form

The importance of substance over form in maintaining the integrity of the trust is also important in the administration of the trust. A trustee must understand his role and in particular, the duties placed upon him by the trust deed and the law. One of the key duties is to maintain proper records. Simply keeping records is not sufficient.

In the discretionary family trust the trustees have various discretions, amongst other things, to the allocation of income and capital throughout the life of the trust. In doing so the trustee must make a considered decision.

The recording of that decision, perhaps through an entry in a minute book or a trustees' resolution, is merely evidence of that, and not a substitute for it. It presupposes that the trustees are aware of their duties and the nature of them, as without that how can the trustees properly exercise the discretions entrusted to them under the trust deed?

Similarly, all the trustees must be involved in the exercise of the discretion, even where the trust deed allows for majority rather than unanimous decisions. How many lay trustees can faithfully say that they truly understand the real nature of their role as trustees or indeed actually exercise a considered discretion?

In the more extreme cases some trustees are not even brought into the process at all except to sign a resolution, the rationale of which they have not considered.

The transfer of assets to the trust is an area which will surely receive greater attention from government departments, creditors and would be litigants.

In certain cases there is statutory protection afforded to these groups to safeguard their interests as provided for in anti-avoidance provisions and specific pieces of legislation such as the Property Law Act.

This may be widened in the future as the balance between the interests of the parties sitting on either side of the fence has to be constantly reassessed as the use of trusts become more popular.

Recently there appeared a report on television referring to the possibility of obtaining insurance cover to meet the costs of creditors pursuing debtors on the collapse of companies. This could have quite far-reaching effects and would certainly appeal to the banks seeking to further safeguard their position.

It might also provide the funding for liquidators to pursue the directors of companies far more vigorously than perhaps in the past. Trust arrangements and the transfer of assets will inevitably come more and more under scrutiny.

In summary, for those who already have trusts or are thinking of setting one up, expert professional advice is essential to ensure that not only is the trust correctly established, but that its integrity is maintained through proper administration. This is an on-going process throughout the life of the trust and failure to recognise this could make the whole exercise an expensive waste of time.

Mark Cassidy is a New Zealand Guardian Trust business development manager. He can be contacted by e-mail at

Feel free to check out the New Zealand Guardian Trust Company Ltd website at

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