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Discretionary trusts: a wider perspective by TaxCounsel Pty Ltd Discretionary trusts (including testamentary trusts) are popular business, investment and tax planning vehicles and can be obtained “off-the-shelf”. Tax practitioners must be aware of the wider context of such trusts. Some recent decisions of interest are noted.

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Background

in Wollongong, NSW. Also, the original

Proper law of the trust

Establishing a discretionary trust is not a difficult task. Indeed, a deed may be obtained “off-the-shelf”. But care is always needed to ensure that the deed as drafted is satisfactory from a trust law perspective (for example, that there is an adequate power of amendment) and also has the requisite flexibility for taxation purposes (for example, that there is power to “stream” particular kinds of amounts and that the beneficiary class is wide enough). It also needs to be understood that, despite the wide terms of a discretionary trust deed, issues of fiduciary duty (for example, where the appointor/guardian (or whatever) is also a discretionary object) or undue influence may arise. These issues may well become live issues where there is contention between the potential objects of a discretionary trust (for example, family members).

trustee had been replaced with an

The first issue considered by Young AJ was what the proper law of the trust was. Young AJ said that the proper law of the trust was to be ascertained as at the time that the trust was established. There was no provision in the trust deed which provided for the proper law of the trust.3 In the absence of such a provision, the question fell to be determined in accordance with general law principles and the Hague Convention on the Law Applicable to Trusts and on their Recognition4 which in fact reflected the general principles.

This article considers several recent decisions which highlight different points.

Inadequate powers A recent decision of the New South Wales Supreme Court illustrates the difficulties that may arise if the powers conferred on the trustee by the trust deed are inadequate and the deed does not contain a power of amendment that would enable the difficulty to be solved.1 The case also raised issues as to the proper law of the trust. Re Dion Investments Pty Ltd concerned a discretionary trust that was established by a deed made on 10 August 1973 in Port Moresby, with a company incorporated in PNG as its initial trustee.2 Despite the trust being set up in Port Moresby, all of the possible beneficiaries had at all times resided in, and the administration of trust had taken place,

Australian corporation shortly after the creation of the trust. Incidentally, there was a revenue reason for the trust being established in Port Moresby. This was explained by Young AJ as follows: “Doubtless the Trust was set up in Port Moresby in 1973 because under the then death duty laws even if physical assets were situated in New South Wales no estate tax would be payable on the assets of the trust. This was because the beneficiaries only had a right of action against a trustee who was in Papua New Guinea, therefore the property of the beneficiaries would not be liable for New South Wales death duty. However things have now changed with State death duty being a thing of the past, Commonwealth estate duty having being either abolished or transmogrified into an aspect of capital gains tax. Fiscally, people are in a far different plight than they were in 1973. Indeed, with the nation of Papua New Guinea becoming independent there is little to be gained by having a trust situated there.” The financial advisers of the trustee and the beneficiaries had advised that the trust deed was inadequate in the current economic climate and should be amended and the trust varied. There was no clear power of amendment in the trust deed and an application was brought by the trustee in the New South Wales Supreme Court seeking a number of orders but, principally, that the court give judicial advice as to the power of the trustee or other relevant persons to amend the trust deed and vary them, and an order under s 81 of the

Young AJ concluded that the court with the prime responsibility for dealing with the present application was the National Court of Papua New Guinea. That did not, however, decide the matter because the New South Wales Supreme Court had two sources of jurisdiction to deal with the matter. These were: „„ if there was a statute which was wide enough to cover trusts which have a substantial connection with NSW, then that statutory power may be exercised notwithstanding that the proper law of the trust is not NSW. The classic example for the exercise of this jurisdiction is Re Webb; Webb v Rogers,5 where the South Australian Full Supreme Court held that it had jurisdiction to order accounts where trustees were administering trusts in South Australia, even though the proper law of the trust was the Northern Territory; and „„ where the trustee was within the jurisdiction so that the court had an in personam jurisdiction over the trustee.

Trustee Act 1925 (NSW) that the trustee be

Was there a power to vary?

empowered and authorised to amend the

Clause 15 of the trust deed conferred a power on certain persons to revoke all or

trust deed.

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tax tips  any of the trusts and declare other trusts. Young AJ held that this power did not enable an amendment to be made to the trust deed which varied it.

Statutory power In the absence of a power of variation or amendment of the trust, Young JA went on to consider whether the court could vary the trust under s 81 of the Trustee Act 1925. Subsection (1) of that section (which is in similar terms to s 47 of the Papua New Guinea Act) reads as follows: “Where in the management or administration of any property vested in trustees, any sale, lease, mortgage, surrender, release, or disposition, or any purchase, investment, acquisition, expenditure, or transaction, is in the opinion of the Court expedient, but the same can not be effected by reason of the absence of any power for that purpose vested in the trustees by the instrument, if any, creating the trust, or by law, the Court: (a) may by order confer upon the trustees, either generally or in any particular instance, the necessary power for the purpose, on such terms, and subject to such provisions and conditions, including adjustment of the respective rights of the beneficiaries, as the Court may think fit, and (b) may direct in what manner any money authorised to be expended, and the costs of any transaction, are to be paid or borne as between capital and income.” Young AJ said that the great weight of authority supported the proposition that, apart from the adjustment of the terms of the trust or rights of the beneficiaries which is incidental or consequential on the advantageous dealing, the court has no power to vary a trust. The basal understanding is that, once a person has given his or her property on trust, then that trust is unalterable save and except insofar as the trust deed itself makes it alterable. His Honour rejected the view, expressed in some judicial observations, that the word “transaction” in s 81(1) authorised the court to vary a trust. As a backstop to his primary case, counsel for the trustee put forward a more restricted proposal, namely, that three new subclauses be added dealing with the power of the trustee to raise or borrow money, to draw, endorse, accept, guarantee or indemnify or be a party to a commercial bill or other bill of exchange etc, and to guarantee, indemnify, secure by 358

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way of mortgage, charge or otherwise the payment or repayment of money or debts. Young AJ said that it seemed to him that each of the proposed additional powers were well within s 81 of the Trustee Act 1925 and did not raise any matter of radical alteration to the rights of beneficiaries. His Honour made an order that the trustee would not be justified in assuming that cl 15 of the trust deed authorised a variation of the trust deed and that, pursuant to s 81 of the Trustee Act 1925, the trust deed may be amended by inserting the new proposed subclauses.

Meaning of “beneficiary” One issue that arose in Brady Street Developments Pty Ltd v ME Asset Investments Pty Ltd6 was whether a discretionary object (a Mr El Sayed) under a discretionary trust deed had standing to bring an action for declaratory relief in relation to the appointment of another discretionary object as the appointor of the trust. The action by the discretionary object arose out of the fact that a Mr Hawach was a potential discretionary object under the trust (the Brady Street Developments Trust), was the solicitor advising the trustee, and had, on 28 September 2011, been appointed as the appointor for the purposes of the trust deed. Pembroke J said that the nature of Mr Hawach’s “interest” in the trust was relevant to the analysis of the suggested conflict between Mr Hawach’s duty as the solicitor for the trust, his role as appointor pursuant to the trust deed, and his interest as a member of a class of eligible objects of the trust. His Honour also said that the nature of a discretionary object’s interest was also relevant to the question of whether Mr El Sayed had standing to bring a claim to invalidate the appointment of Mr Hawach as appointor under the trust deed. Pembroke J said: “As is well known, the expression ‘beneficiary’ when used in the context of a discretionary trust is a misnomer. As Gummow and Hayne JJ explained in Kennon v Spry [2008] HCA 56; (2008) 238 CLR 366 at [125], the use of the word ‘beneficiary’ is inapt insofar as it suggests the existence of any beneficial interest. Such a person is ‘an eligible object’ of the trust. The Hon. Justice Paul Brereton AM RFD set out the following analysis, which I adopt, in an address to the National Family Law Conference on 19 October 2010 entitled ‘A

Trustee’s Lot is Not a Happy One - Discretionary Trusts and Self-Managed Superannuation Funds’: Thus, a discretionary trust does not have beneficiaries in the traditional sense, whose interests together aggregate the beneficial ownership of the trust property. Instead, there is a class of persons, usually described in wide terms, who are the objects of a power to appoint either income or corpus or both to selected members of the class. The members of the class are objects of a power, rather than beneficiaries in the strict sense. They do not have a proprietary legal or equitable interest in the trust fund. They have no beneficial interest in the trust property, and they are not persons for whose benefit the trust property is held by the trustee; at the highest they are members of a class of persons for the benefit of some one or more of whom the trustee may in due course hold property if it so determines. At best, they are potential beneficiaries, not beneficiaries. In terms accepted by French CJ in Spry, no object of such a trust has any fixed or vested entitlement, and the trustee is not obliged to distribute to anyone; the default distribution gives the default beneficiary no more than a contingent remainder.’” His Honour said that to the same effect was a statement, frequently made in this area of the law, that the object of a bare power of appointment has no proprietary interest in the trust but only a “mere expectancy or hope of consideration by the trustee”.7 That, his Honour said, was not to say that a person, such as Mr Hawach, who is an object of a power of appointment and a member of an eligible class of potential beneficiaries, does not have an “interest” sufficient for the invocation (against him) of the rule that obliges fiduciaries to avoid any realistic possible conflict between their duty and their interest. That was a different question. Mr Hawach’s “interest” as a member of one of the classes of eligible objects under the trust entitled him, at a practical level, to endeavour to maximise the pecuniary value to him or his family of any decision taken or transaction effected relating to the trust. His “interest” may not be vested and may be contingent on the exercise by the trustee of a discretionary power, but it is sufficient to give him an incentive to bring about a result that he perceives will advance his personal interest. That was sufficient to trigger a possible conflict and give rise, in a given situation, to a breach of fiduciary duty. From 28 September 2011, Mr Hawach became subject to fiduciary duties in two



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separate capacities — as solicitor for the trustee and as appointor under the trust. The potential for conflict with his personal interest arose because many of the powers of an appointor (like those of a solicitor) are fiduciary in character and are not to be exercised solely for the appointor’s own benefit.

Who was the appointor/ protector?

provided that the trustee of his estate was to be the protector under the second trust.

In George Christopher Harris v Sophia Rothery (as co-executor of the Estate of the Late Christopher George Harris),10 the basic issue was whether a company had been duly appointed as the trustee of each of two discretionary trusts.

It was, in his Honour’s view, quite apparent that Mr Hawach’s interest and his duties were not congruent. In any given situation, his powers as appointor under the trust deed, his duties as solicitor for the trustee and his personal interest as a member of one of the classes of eligible objects may be a source of conflict. His personal interest might cause or contribute to him exercising his powers as appointor under the trust deed, or his duties as solicitor for the trustee, in a manner designed to advantage him or his family. On the particular facts of the case, the possibility of any such conflict was not remote or fanciful. By making himself appointor, Mr Hawach heightened the risk and breached one of the primary obligations of a fiduciary. Pembroke J went on:

The first trust, called the Christopher Harris Family Trust, was established by deed dated 26 September 1981 (“the first trust”). The second trust, called the Christopher George Family Trust, was created by deed dated 24 November 1987 (“the second trust”).

By notices and deeds made on various dates in August 2010, George purportedly (as appointor and protector) removed the trustee of each trust and appointed a company that he controlled (GC Harris Nominees Pty Ltd) as the trustee of each trust.

“For those reasons, I do not think, as a matter of principle, that Mr Hawach should have allowed himself to become appointor under the trust. However, notwithstanding that view, there is an anterior question as to whether, by reason of his limited ‘interest’ in the trust, Mr El Sayed has standing to bring a claim to invalidate the appointment of Mr Hawach as appointor. I have concluded that he does.”

“Beneficiary” and tax law The meaning of “beneficiary” in the context of taxation legislation was raised most recently in Yazbek v FCT8 where Bennett J held, in the context of the provisions governing the time limits on the Commissioner’s power to amend an income tax assessment, that “beneficiary” included a discretionary object under a discretionary trust deed. It is not clear that the decision is necessarily correct, particularly given the practical consequences that may flow from it. Also, the decision seems to be somewhat at odds with the approach taken by the High Court in FCT v Bamford9 where the High Court held that the expression “the income of the trust estate” in Div 6 of the Income Tax Assessment Act 1936 (Cth) was to be interpreted according to trust law concepts.

The trustee of each trust (at the time of its establishment) was GP Harris Nominees Pty Ltd of which Christopher Harris (“Mr Harris”) and his two brothers were the directors. Mr Harris was the appointor under the first trust and was the protector under the second trust. In those capacities, he had the power in relation to each trust to (inter alia) change the trustee. In the week or so before 8 December 1992, the plaintiff George Harris (who was a son of Mr Harris and was a solicitor) met with his father. George presented his father with two notices, one in relation to the first trust and the other in relation to the second trust (“the notices”). The first notice purported to appoint George as appointor under the first trust. The second notice purported to appoint George as the protector under the second trust. Mr Harris, who at the time was preoccupied with impending heart surgery, signed the notices without reading them or having them read to him and they remained undated. Mr Harris trusted and was reliant on George, at whose request he signed the notices. George took the documents with him. Mr Harris later asked for copies but these were not given to him. The original notices had been lost and all that survived were copies.11 By deeds made on 3 December 1993 and 6 June 1995, George (purportedly as appointor under the first trust and as protector under the second Trust) removed the trustee of the first trust and of the second trust and appointed Christopher Harris Pty Ltd as the new trustee, a company that had been incorporated on 29 November 1993 with George as its sole director. Mr Harris died on 17 May 2010. In his will (made on 10 December 2000), Mr Harris

Issues in relation to the first trust The deed which established the first trust provided (in cl 13.1) that the appointor “shall within 14 days of the date hereof nominate in writing to the trustee the person or persons to act as the successor to the office of Appointor”. Among the issues raised by the defendants in relation to the first trust notice and the answers given by Kunc J were: (1) Was the first trust notice ineffective because: (a) it misstated the date of the relevant trust deed? No; (b) it was undated? No; (c) it was a copy? No; (d) the appointment was not made within the 14 days specified in cl 13.1 and could not be ratified? Yes; or (e) it was never delivered to be recorded in the minute books and kept with the records of the first trust? Yes. On the proper construction of cl 13.1, receipt of the written nomination was essential for a valid nomination as a consequence of the words “nominate in writing to the Trustee”. On the ordinary meaning of the words, something cannot be nominated to someone without it being received by that person. (2) If the first trust notice was otherwise effective, when did the appointment as appointor under the first trust notice take effect? As a matter of ordinary English, when someone nominates a successor (someone to succeed or follow after them in a position or office), they are not thereby understood, without more, as resigning or vacating their present office or position. Further, cl 13.1(c) clearly assumed (although it did not require) a temporal difference between nominating a successor and the nominee succeeding to the office. TAXATION IN AUSTRALIA | VOL 48(7)

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tax tips  Issues in relation to the second trust Similar issues to those that arose in relation to the first trust also arose in relation to the second trust. However, for this trust, the appointment of a protector clause raised some other questions. Clause 11 of the second trust deed provided: “11.1 Subject to Clause 11.4, the power of appointing a new Protector shall be vested in the Protector for the time being hereof who shall be entitled to appoint in writing by will or otherwise any person or corporation to be Protector in his place. 11.2 A person holding the office of Protector shall be entitled to retire upon giving written notice to the Trustee, and forthwith upon receipt of such notice such person shall cease to hold office PROVIDED HOWEVER that such notice shall be accompanied by written consent by another person to hold the office of Protector upon and as from the retirement, AND that other person shall be the Protector as from receipt of such notice. 11.3 Upon receipt of any notice of change in the person for the time being holding the office of the Protector as aforesaid the Trustee shall endorse or permanently annex to this Deed a memorandum to that effect and any person who is for the time being a Trustee himself shall be entitled to rely on such memorandum (or the latest of such memoranda if more than one) as sufficient evidence that the person named therein is for the time being the Protector or has ceased to be the Protector, as the case may be. 11.4 If the Protector, being an individual, dies without having nominated a successor or is declared bankrupt or of unsound mind, or being a corporation, enters into liquidation or receivership, then the personal representative, trustee, liquidator or receiver, as the case may be, shall perform the functions of the Protector until such time as a new Protector is appointed. In such a case, the Settlor shall appoint a new Protector as soon as possible after such death, declaration, liquidation or receivership (as the case may be).” Kunc J said that it was clear from the scheme in cl 11 that, in the absence of earlier legal incapacity, the appointment of a successor protector under cl 11.1 would take effect upon the death of the protector for the time being. This was apparent from cl 11.1 specifying the primary means of appointment as being “by will” and the reference in cl 11.4 to the possibility that the protector “dies without having nominated a successor”. Therefore, while the second trust notice was valid as a notice under cl 11.1, the appointment of 360

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George as protector would not take effect until Mr Harris’ death. But Mr Harris by his will revoked any appointment.

Appointor/protector as a fiduciary Kunc J said that there was a live academic and judicial debate about the extent to which the powers of an appointor/protector are fiduciary.12 Since the appointor/ protector does not hold the trust property, he or she is not a trustee. Nevertheless, the generally accepted view appeared to be that the powers of an appointor/ protector will generally be fiduciary, but need not necessarily be so. For example, a protector with the power to remove or appoint trustees will be a fiduciary, just like any other person with such a power. Other powers may be personal, depending on the proper construction of the trust instrument. His Honour went on: “The significance of the distinction is that while all power holders must act within the scope of their powers, only those whose powers are for the benefit of others (such as fiduciaries) are subject to the ‘fraud on a power’ rule. That rule requires the power holder to act in good faith and for a proper purpose. Insofar as a power is fiduciary, then it is a straightforward conclusion that, if the power has been exercised subject to undue influence, equity will not regard it as having been exercised in good faith or for a proper purpose. If the appointor’s/ protector’s power to appoint a nominate [sic] a new appointor or protector is a fiduciary one, then this line of reasoning supports the conclusion that the power purported to be exercised by the Notices is amenable to the doctrine of undue influence. On the other hand, if, on the proper construction of the trust deed, the power to appoint a new appointor/protector is a purely personal (nonfiduciary) power, it might be argued that a different result would follow … To the extent it may be necessary, my view is that the power to appoint a new appointor/protector under the First and Second Trusts is a personal one. However, that does not put the exercise of the power beyond the reach of the doctrine of undue influence. Unless it is clear from the instrument conferring the power, where a personal power is conferred on someone it is axiomatic that for the exercise of that power to be within its scope and intention, it must be the free and voluntary act of the holder of the power. For these reasons, whether or not the power to appoint a new appointor/protector is fiduciary or personal, the exercise of such a power is susceptible to the application of the doctrine of undue influence.” Kunc J said that the facts give a rise to the presumption of undue influence in relation

to the execution of the notices. George had been unable to rebut that presumption. If the notices were otherwise effective, Kunc J said that he would have declared them to be void.

Tax Counsel Pty Ltd References 1

Re Dion Investments Pty Ltd [2013] NSWSC 1941. A similar question also arose recently in Robert Thomas Grant as trustee of the Grant Family Testamentary Trust [2013] NSWSC 1603.

2

PNG was then an external territory but became an independent nation in 1975.

3

Such a provision would ordinarily govern the position (Ballard v AG (Vic) [2010] VSC 525). Where a trust deed stipulates the governing law, this may be amended if there is a sufficiently wide power of amendment conferred by the trust deed (Oakley v Osiric Trustees Ltd [2008] UKPC 2).

4

[1992] ATS 2.

5

(1992) 57 SASR 193.

6

[2013] NSWSC 1755.

7

Gartside v Inland Revenue Commissioners [1967] UKHL 6.

8

[2013] FCA 39.

9

[2010] HCA 10.

10 [2013] NSWSC 1275. 11 Mr Harris in May 1993 wrote an open letter purporting to disavow two notices. Ultimately, this letter had no substantive effect on the judgment. 12 See also the views expressed by Pembroke J in Bradley Sheet Developments noted earlier in the text.