Discretionary trusts are commonly used by families to arrange their financial affairs. They offer many attractions including that they allow families to maximise their wealth, to distribute capital and income to various beneficiaries in a tax effective way and offer some protection from creditors (and, in certain circumstances, spouses).
Ordinarily, until such time as the trustee of the discretionary trust exercises the discretion to distribute an amount to a particular beneficiary, the beneficiary’s interest in the income and capital of a discretionary trust is a “mere expectancy” and the only right that a beneficiary of a discretionary trust usually possesses is the equitable right to demand that the trustee properly administer the discretionary trust. However, the treatment of discretionary trusts in family law property settlements is distinct to the treatment of trusts in other areas of law.
The first step in a family law property settlement is to identify the net value of the property, liabilities and financial resources of the parties, including superannuation at the date of the agreement or Hearing (commonly referred to as “the asset pool”). In determining the asset pool the interests of the parties in a discretionary trust may be treated in the following ways:
1. The assets of the trust (or part of them) are treated as property of the parties (or either of them) and included in the asset pool available for division, as the person in control is treating the assets as their own.
2. The assets of the trust are not included in the asset pool but treated as a financial resource of the parties (or either of them).
3. The assets of the trust are ignored, if neither party to the marriage has legal or de facto control over the trustee’s discretion and they are not a financial resource.
How the assets of a discretionary trust are considered will depend upon the facts of the case including the terms of the Trust deed. To make an assessment as to how the trust is to be treated a careful review of the trust deed, financial statements, tax returns, trustee resolutions, management accounts, general ledgers and other trust documents is usually required. The assessment is more complex if the discretionary trust is wholly or substantially funded by the parents of a party, trusts in which neither party to the marriage had actual or effective sole control, or in which a third party has a genuine interest.
Consideration needs to be given from the outset of a family law property settlement as to how the interest in a discretionary trust is to be treated. If the interest in the discretionary trust is property or a financial resource, then a valuation may be required.