It is common for people to understand the importance of reviewing their Will as part of their estate planning. Unfortunately, less common is the need for people to review Trust Deeds – if they can even be found! It is often the case that after a Trust is settled, the Deed remains in the bottom drawer at an accountant’s office, or even worse, disappears with no record of the terms of the Trust.
It is important as part of the Estate Plan that Trust Deeds are reviewed and updated. Failing to update these critical documents can cause significant problems.
Our Lachlan Einsiedel, Senior Associate, Accredited Specialist in Wills and Estates Law, and Chartered Tax Advisor considers some of the issues with Trust Deeds that are missing or are not updated.
Net Income Definition
Many old Deeds (especially those settled before 2010) do not define “Income” within the Trust instrument, nor does the instrument include any power for the Trustee to determine whether a receipt is “Income” in nature or “Capital” in nature.
For those unfamiliar with accounting concepts, the distinction between capital and nature is most often described by an analogy from the US Supreme Court in Eisner v Macomber 252 US 189 (1919)where the Court stated:
…the fundamental relation of ‘capital’ or ‘income’ has been much discussed by accountants, the former being likened to the tree or the land, the latter to the fruit or the crops: the former depicted as a reservoir supplied from springs, the latter as the outlet stream to be measured by its flow during a period of time.
There can be tax consequences resulting from “Income” not being properly dealt with. The gravity of this is significant, particularly where a Trust comprises of large unrealised capital gains, and/or there is a restriction on capital distributions.
For Trust Law purposes, if not defined in a Trust Deed (and assuming there is no characterisation power), or defined in accordance with general accounting principles, Income for Trust purposes generally follow the Eisner formulation of income. At Trust Law, a capital gain arising on the sale of an asset will not be considered “Income”.[1]
However, for Income Tax purposes, a beneficiary who is made presently entitled to income for Trust Law purposes a reliable to pay tax on the same proportionate share of the net income (for tax purposes) of the Trust. Net Income for tax purposes includes a capital gain by virtue of s95(1) of the Income Tax Assessment Act 1936.
This means if not properly defined, a beneficiary who distributes the income of the Trust Estate as at 30 June of that particular year, notwithstanding that they may only be entitled to accounting income(excluding capital gains), will be assessed on the proportionate share of the Net Income for tax purposes (which will include any capital gain).
The result can lead to a mismatch between how a beneficiary is assessed pursuant to tax law compared to what a beneficiary can receive from the Trust (referred to as the actual distributable income). At the simplest, the beneficiary may be assessed for tax purposes as having received a capital gain, which they have not, and may not be able to receive under the Trust Deed.
This is further aggravated where the Trust is unable to distribute capital – perhaps by reason of the death of a Trust Guardian with no successor guardian. It may be that a Trust is unable to release sufficient funds to deal with the unexpected tax bill of the beneficiary.
There can be corollary problems, where an accountant does not review the Trust Deed or prepares annual distribution minutes that are not within the scope of the power of the Trustee under the Trust Deed. This can cause a number of issues, particularly if the income distributions/resolutions are invalid. It might be that beneficiaries assumed they were entitled to Trust Income, but that at Trust Law, the income of that particular year ought to have been treated as an accumulation or accretion to the capital of the Trust, or alternatively, enliven a default distribution clause. If tax returns have been prepared on the basis of an invalid resolution, and significant time has passed, it may cause complications in filing amended returns.
The problems that can arise sound scary – and to be frank – they are. Every Trustee or advisor should review the Trust Deed annually, and at the time of making any resolution, to ensure that the Trust Deed is fit for purpose and deals with these complicated issues.
If a Deed has never been reviewed or updated, it is essential that it be reviewed at the earliest opportunity.
Variation of Trusts
Some Trusts have a variation power, which ought to be strictly adhered to. Others do not contain a variation power.
Where a Trust does not contain a variation power either:
(a) if all beneficiaries of the Trust are sui juris and there are no persons with a disability (and there are no potential persons who are not yet beneficiaries but may come into existence within the class of beneficiaries), all beneficiaries can agree to the variation; otherwise
(b) an application can be made to the Supreme Court of Victoria to approve a variation to the Trust, to in effect, provide consent on behalf of beneficiaries who are otherwise unable to consent (e.g. underage and unborn beneficiaries)
For the latter application, the Court must be satisfied that the arrangement is for the benefit of the person of whom consent is sought on behalf of; and the arrangement is a proper and fair one.
These are very complex applications. Our office has first hand experience in these applications, having been recently involved in the important Supreme Court decision of The Pickering Family Trusts [2024]VSC 5, in which a variation to expand the class of beneficiaries was approved.
Missing Trust Deeds
If a Trust Deed goes missing, an application can be made to the Court, in its supervisory jurisdiction. These are complicated applications, and a substantial amount of evidence is required. The Court needs to be satisfied that, on the balance of probabilities, it can be satisfied as to the intention of the creation of the Trust (certainty of intention), the certainty of Trust Property (being certainty of subject matter)and the certainty of those who may benefit (certainty of object). Once the three certainties are established, the Court, in its inherent jurisdiction has remedial avenues available to “fill the gaps” in the Trust terms.
You may consider ignoring the issue, however, doing so is ill advised and fraught with danger, as you run the risk of causing cascading problems. The wisest approach is seeking assistance from the Court to give certainty around arrangements.
Suzanne Lyttleton Lawyers are experts in trusts and can advise you on any matters relating to trusts.
If you are a Trustee or a beneficiary of a Trust, contact our office for a trust review and we can advise you as to your rights under the Trust Deed.
[1] For example, see Lester v Lester [2018]VSC 611, [40].
