A brief guide to trusts and trustees

TRUSTS AND TRUSTEES

1. WHAT IS A TRUST?

The concept of a trust is derived from a 12th century requirement in England to have a protective measure ensuring that wealth in the form of land passed down in a controlled manner from one generation to another. The trust mechanism had a secondary function of reducing the incidence of taxation. Despite the centuries during which trusts have existed, there is no comprehensive definition of “trust”. One of the best available is that contained in Pettit’s Equity, Fourth Edition, which defines it as follows:-

“A trust is an equitable obligation, binding on a person (who is called a trustee) to deal with the property over which he has control (which is called the trust property) either for the benefit of persons (who are called the beneficiaries or the cestius que trust) of whom he may himself be one, and any of whom may enforce the obligation, or for a charitable purpose, which may be enforced at the instance of the Attorney General or for some other purpose permitted by law though unenforceable”.

The Hague Convention on the Recognition of Trusts reflects this description in Article 2 which reads as follows:-

“For the purposes of this Convention the term “trust” refers to the legal relationship created inter vivos or on death – by a person, the settlor, when assets have been placed under the control of a trustee for the benefit of a beneficiary or a specified purpose”.

The modern position is that trustees’ obligations will be enforced by the English Courts, as well as the vast majority of other common law jurisdictions which developed their main system of law from the law of England. These jurisdictions are the other parts of the UK with separate legal systems (such as Scotland and Northern Ireland), and ex-British colonies and protectorates (such as the USA, Australia, Canada, Jersey, Guernsey and the Cayman Islands).

2. WHY CREATE A TRUST?

Trusts may be used for a great number of different purposes, and can be structured to suit the particular circumstances of the settlor and the beneficiaries. The more common uses of trusts

–         to hold the assets for minors or persons who are physically or mentally incapable;

–         to protect the assets against those beneficiaries with a tendency to spend;

–          to attend to the succession of the assets on the settlor’s death;

–          to provide a level of asset protection for beneficiaries who may become bankrupt or divorced;

–         to provide for charitable purposes or objects;

–         to provide for confidentiality;

–         to assist with tax planning;

–         to hold pension funds and insurance policies.

3. THE DIFFERENT TYPES OF TRUSTS

There are a number of different types of trust, but they broadly fall into one of the following categories. Each type is treated in its own way for tax purposes, and trustees should ensure that they understand the nature of the tax obligations, and consider appointing a professional adviser to assist in connection with the trust and its tax affairs. The principal trusts are:

–          A Bare Trust: The beneficiary of this type of trust is fully entitled to both the capital and income of the trust property. The trust property is held in the name of a trustee, but that trustee will have no discretion over what income to pay to the beneficiary. The trustee is in effect a nominee in whose name the property is held.

–          An Interest in Possession Trust: In this type of trust the beneficiary has the current legal right to the income from the trust, and the trustees will have no power to withhold income from the beneficiary other than to meet certain expenses. The beneficiary need not, and often does not, have any rights to the capital of such a trust. Normally the capital will be payable to a different beneficiary, or beneficiaries, at a specific time in the future, or after a specific future date — most usually after the income beneficiary (often called “the life tenant”) has died. The trust deed may give the trustees the power to pay capital to that income beneficiary if they see fit.

–          A Discretionary Trust: The trustees of this type of trust have the discretion how to use both the income and the capital of the trust. They may be required to use any income for the benefit of particular beneficiaries, but it is often for the trustees to decide how much is paid and how often the payments are made. The trustees may, or may not, be allowed to accumulate income within the trust for so long as the law permits rather than passing it on to the beneficiaries. No beneficiary may demand either income or capital. These trusts are probably now the most common.

–          An Accumulation and Maintenance Trust: This type of trust permits the trustees to use income for the maintenance of the beneficiary before the date on which that beneficiary becomes entitled to the property of the trust, or to an interest in possession in it, but the accumulation aspect permits the trustees to accumulate the income of the trust until a certain date at which time the beneficiary, or beneficiaries, will become entitled to the property of the trust, or to the income arising from it. In other words, the Trust is a hybrid and starts discretionary and ends up like an interest in possession

4. WHAT ARE THE DUTIES, OBLIGATIONS AND LIABILITIES OF A TRUSTEE?

Trust law has evolved over the centuries and is mainly based on case law clarifying trustees’ powers and duties. The courts judge the actions of a lay (ie non-professional) trustee as requiring the standard of behaviour that would be expected of an ordinary and sensible businessman. A professional trustee is expected to give a far higher standard of care and skill to the role.

–          On acceptance of a trusteeship, the trustee should ensure that he understands the trusts involved, and in particular who the beneficiaries are, so as to ensure that he does not distribute trust property to someone who is not entitled. Trust property should be placed in the names of the trustees, or a nominee (if the trust deed expressly permits this).

–          Trustees are under a duty to invest trust funds prudently, keeping an even balance between beneficiaries where they have differing interests in income and capital. They should invest prudently, avoiding speculative investments. Trustees may only invest trust funds in investments which they are authorised to invest in by law subject to modification in the trust deed. In most trusts the restrictive statutory investments permitted are expanded to allow the trustees to invest in whatever an absolute owner would be able to invest in subject to a duty to consider ‘diversification’ (ie, not all ones eggs in one basket). Trustees are also under a duty to keep the investments under review to the same extent as would a reasonably prudent businessman in respect of his own affairs. For example, with quoted shares, periodic reviews coupled with the input of a professional investment adviser should be sufficient.

–          Trustees are under a duty to maintain accounts and produce them for the beneficiaries on request. Whilst trustees are not obliged to provide beneficiaries with free copies of the accounts, this has become quite common.

–          Trustees are under a positive duty to distribute to the correct beneficiary. They can recover payments made to the wrong person where a mistake arose over fact rather than law. An aggrieved beneficiary, as well as having recourse against the trustees, can seek to trace property given to the wrong person by the beneficiaries. Where trustees have acted honestly and reasonably, they have protection against liability for breach of trust and distributing property incorrectly.

–          Trustees are under a duty not to profit from their trusteeship, and therefore there is no entitlement to fees or remuneration other than for professional trustees as provided for in the trust deed. Trustees are allowed to be reimbursed for expenses they incur. They should not place themselves in a position of conflict as regards their fiduciary duties, and cannot purchase trust property or derive any benefit from it unless expressly permitted by the trust deed.

–          Trustees can only exercise powers which are available to them either at law or as given by the trust deed itself. In exercising any power, the trustees must consider all the circumstances, including the legal consequences. Generally, if trustees exercise a power honestly, the Court will support their decision even if they would have reached a contrary view themselves. They must make their own decisions unless they are authorised to delegate them. Trustees can protect themselves by obtaining the informed and legally binding agreement of all persons adversely affected as a result.

–          Courts will enforce trust powers if trustees do not exercise them, and where they are required to exercise them, they must do so within a reasonable length of time.

–          Generally, trustees should be unanimous, but some trusts give trustees the power to act by majority via the trust deed (albeit that this is academic if there are only two trustees) and charitable trusts have this power automatically.

–          Dependent on the type of trust, trustees may have powers to apply income or capital in favour of beneficiaries. For example, trustees of a discretionary trust have the power to appoint income to any of the beneficiaries completely at their discretion. They also have the power to determine which of the beneficiaries takes capital, and whether by outright advance or loan. Trustees also have discretions over income in trusts for infant beneficiaries where the statutory rules apply, or as contained in the trust deed. Discretions must be exercised reasonably and not capriciously.

–          Again depending on the type of trust, it may give trustees certain powers over capital including a power of appointment in favour of a class of beneficiaries, a power to transfer capital between settlements, to allocate assets amongst various beneficiaries and to advance capital to them. The trustees may have powers to determine which beneficiaries take capital and whether it is by outright advance, loan or possibly on a fixed interest trust.

–          Beneficiaries have no automatic right to interfere with the administration of a trust whilst the trust affairs are being properly run. If the administration is not being carried out correctly, the beneficiary can take steps to ensure proper administration and preserve his interests under the trust. This almost invariably involves the assistance of the Court. A beneficiary has the right to see trust documents and records. Items recording the reasons for trustees exercising their discretion are generally private to the trustees. The Courts will not support attempts by the beneficiaries to limit, fetter or interfere with the exercise of a trustees’ discretion.

At Morgan Trusts & Tax Planning Limited we have a Trust team. We provide a comprehensive service to individuals in respect of Wills, the creation and administration of trusts, landed estates, probate, asset protection, inheritance and estate planning, attorneyship and the Court of Protection. We have also advised on cross-border issues of estate devolution and taxation in relation to individuals with assets outside the UK.

Tax advice provided includes Inheritance and Capital Gains tax planning, post-death planning, property taxation, Inland Revenue investigations and the taxation of UK trusts. We also do a limited amount of Income Tax advisory work but not generally VAT advice work.

This note is intended to give you an outline of the different types of trust and the duties placed on trustees. It is not intended to give and may not be relied upon for legal advice in isolation.