discretionary trust
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A discretionary trust, in the trust law of England,
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, Canada and other common law jurisdictions, is a
trust Trust often refers to: * Trust (social science), confidence in or dependence on a person or quality It may also refer to: Business and law * Trust law, a body of law under which one person holds property for the benefit of another * Trust (bus ...
where the
beneficiaries A beneficiary (also, in trust law, '' cestui que use'') in the broadest sense is a natural person or other legal entity who receives money or other benefits from a benefactor. For example, the beneficiary of a life insurance policy is the perso ...
and/or their entitlements to the trust fund are not fixed, but are determined by the criteria set out in the
trust instrument A trust instrument (also sometimes called a deed of trust, where executed by way of deed) is an instrument in writing executed by a settlor used to constitute a trust. Trust instruments are generally only used in relation to an ''inter vivos'' tr ...
by the
settlor In law a settlor is a person who settles property on trust law for the benefit of beneficiaries. In some legal systems, a settlor is also referred to as a trustor, or occasionally, a grantor or donor. Where the trust is a testamentary trust, the se ...
. It is sometimes referred to as a family trust in
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or
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. Where the discretionary trust is a
testamentary trust A testamentary trust (sometimes referred to as a will trust or trust under will) is a trust which arises upon the death of the testator, and which is specified in their will. A will may contain more than one testamentary trust, and may address a ...
, it is common for the settlor (or
testator A testator () is a person who has written and executed a Will (law), last will and testament that is in effect at the time of their death. It is any "person who makes a will."Gordon Brown, ''Administration of Wills, Trusts, and Estates'', 3d ed. (2 ...
) to leave a
letter of wishes A letter of wishes is a tool used by someone setting up a trust, to pass along information to the trustee Trustee (or the holding of a trusteeship) is a legal term which, in its broadest sense, is a synonym for anyone in a position of trust and ...
for the
trustee Trustee (or the holding of a trusteeship) is a legal term which, in its broadest sense, is a synonym for anyone in a position of trust and so can refer to any individual who holds property, authority, or a position of trust or responsibility to t ...
s to guide them as to the settlor's wishes in the exercise of their discretion. Letters of wishes are not legally binding documents. Discretionary trusts can only arise as
express trust An express trust is a trust created "in express terms, and usually in writing, as distinguished from one inferred by the law from the conduct or dealings of the parties." Property is transferred by a person (called a trustor, settlor, or grantor) ...
s. It is not possible for a constructive trust or a resulting trust to arise as a discretionary trust.


Forms

Discretionary trusts can be discretionary in two respects. First, the trustees usually have the power to determine which beneficiaries (from within the class) will receive payments from the trust. Second, trustees can select the amount of trust property that the beneficiary receives. Although most discretionary trusts allow both types of discretion, either can be allowed on its own. It is permissible in most legal systems for a trust to have a fixed number of beneficiaries and for the trustees to have discretion as to how much each beneficiary receives, or to have a class of beneficiaries from whom they could select members, but provide that the amount to be provided is fixed. Most well-drafted trust instruments also provide for a power to add or exclude beneficiaries from the class; this allows the trustees greater flexibility to deal with changes in circumstances (and, in particular, changes in the revenue laws of the applicable jurisdiction). Characteristically, discretionary trusts provide for a discretionary distribution of income only, but in some cases the trustees also have a power of appointment with respect to the capital in the trust, i.e. the corpus. Discretionary trusts are usually sub-divided into two types: * ''exhaustive'', where the trustees must distribute all income accruing to the trust fund; and * ''non-exhaustive'', where the trustees have an express power to accumulate income.


Analysis

In a fixed trust the beneficiary has a specific proprietary right in relation to the trust fund. Each beneficiary of a discretionary trust, in contrast, is dependent upon the trustees to exercise their power of selection favourably. In '' Gartside v IRC''
968 Year 968 ( CMLXVIII) was a leap year starting on Wednesday (link will display the full calendar) of the Julian calendar. Events By place Byzantine Empire * Emperor Nikephoros II receives a Bulgarian embassy led by Prince Boris (th ...
AC 553 the Inland Revenue argued that as each beneficiary might be entitled to income from the trust fund, each should be charged as if he were entitled to the whole of the fund. Perhaps unsurprisingly, the
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rejected this argument. Even where there is a sole member of the class remaining, so long as there is a possibility that another member of the class could come into existence, that member is not considered a sole beneficiary for purposes of taxation liability. '' Gartside v IRC'' concerned a non-exhaustive discretionary trust; however, in ''
Re Weir's Settlement Re or RE may refer to: Geography * Re, Norway, a former municipality in Vestfold county, Norway * Re, Vestland, a village in Gloppen municipality, Vestland county, Norway * Re, Piedmont, an Italian municipality * Île de Ré, an island off the we ...
''
969 Year 969 ( CMLXIX) was a common year starting on Friday (link will display the full calendar) of the Julian calendar, the 969th year of the Common Era (CE) and ''Anno Domini'' (AD) designations, the 969th year of the 1st millennium, the 69th ...
1 Ch 657 and ''
Sainsbury v IRC Sainsbury may refer to: People * Sainsbury (surname) * Sainsbury family, in British business and philanthropy Business * Sainsbury's J Sainsbury plc, trading as Sainsbury's, is the second largest chain of supermarkets in the United King ...
''
970 Year 970 ( CMLXX) was a common year starting on Saturday (link will display the full calendar) of the Julian calendar, the 970th year of the Common Era (CE) and ''Anno Domini'' designations, the 970th year of the 1st millennium, the 70th yea ...
Ch 712, the courts held that the same analysis was equally applicable to exhaustive discretionary trusts. The rights of individual beneficiaries under a discretionary trust being uncertain, it was open to question to what extent the beneficiaries of a discretionary trust (if all of adult age and sound mind) could utilise the rule in ''Saunders v Vautier''. It had been held that beneficiaries under a discretionary trust could do so, although that authority was decided pre-''
McPhail v Doulton , also known as ''Re Baden's Deed Trusts (No 1)'' is a leading English trusts law case by the House of Lords on the certainty of beneficiaries. It held that so long as any given claimant can clearly be determined to be a beneficiary, or not, a ...
'', where to be valid the trustees had to be able to draw up a "complete list" of beneficiaries. That notwithstanding, leading commentators have suggested that provided all of the beneficiaries could be ascertained, they should still retain the right to terminate the trust under the rule, so long as it is an exhaustive discretionary trust.


Duties

The ordinary correlation between beneficiaries' rights and trustees' duties which arises in fixed trusts is absent in discretionary trusts. Although there are clearly duties, it is less clear whether there are any correlating rights. However, it seems clear that the trustees' duty is limited to (a) determining whether to exercise their discretion, and (b) exercising their discretion lawfully under the terms of the trust. Whilst the beneficiaries will have standing to sue the trustees for failing to fulfill their duties, it is not clear that they would gain by such action. In ''
Re Locker's Settlement Re or RE may refer to: Geography * Re, Norway, a former municipality in Vestfold county, Norway * Re, Vestland, a village in Gloppen municipality, Vestland county, Norway * Re, Piedmont, an Italian municipality * Île de Ré, an island off the we ...
'' 9771 WLR 1323 the trustees of a discretionary trust did not make any distributions for a number of years based upon the expressed wishes of the settlor. The trust then fell dormant, and after several more years, the trustees sought directions. The court held that their discretionary powers continued, and that they should exercise it in respect of the dormant years now as they should have done at the time. The court reaffirmed that if trustees refuse to distribute income, or refuse to exercise their discretion, although the court could not compel it be exercised in a particular manner, it could order that the trustees be replaced. The position with a duty to consider exercising discretion in non-exhaustive discretionary trusts is more complicated, as the duty to exercise discretion can be satisfied by deciding to accumulate.


Purposes

Discretionary trusts still serve a useful function, despite their original source of popularity (tax savings) having diminished in most countries. They still continue to be used for these reasons, among others: * to protect improvident beneficiaries against creditors – as the beneficiary has no claim to any specific part of the trust fund, none of the trust fund is vulnerable to attachment by the trustee in bankruptcy of any beneficiary * to exercise control over young or improvident beneficiaries * to create flexibility to react to changes in circumstances * in certain jurisdictions, a discretionary trust can be used to protect family assets from forming part of any
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settlement.Although most jurisdictions simply look through trusts for this purpose, for example, in the
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see section 25 of the
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Popularity and decline

The popularity of discretionary trusts rose sharply after the decision of the
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in ''
McPhail v Doulton , also known as ''Re Baden's Deed Trusts (No 1)'' is a leading English trusts law case by the House of Lords on the certainty of beneficiaries. It held that so long as any given claimant can clearly be determined to be a beneficiary, or not, a ...
''
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AC 424 where
Lord Wilberforce Richard Orme Wilberforce, Baron Wilberforce, (11 March 1907 – 15 February 2003) was a British judge. He was a Lord of Appeal in Ordinary from 1964 to 1982. Early life and career Born in Jalandhar, India, Richard Wilberforce was the son of ...
restated the test for certainty of objects in connection with discretionary trusts. Previously, it had been understood that for the trust to be valid, the trustees had to be able to draw up a "complete list" of all the possible beneficiaries, and if they could not do so, the trust was
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. But Lord Wilberforce held that provided it could be said of any person whether they were "in or out" of the class, as described by the settlor, the trust would be valid. Because under a discretionary trust, no one beneficiary could be said to have title to any trust assets prior to a distribution, this made discretionary trusts a powerful weapon for tax planners. Inevitably, the surge in popularity has led to a legislative response in most jurisdictions, thus in many countries there are now considerable tax disadvantages to discretionary trusts, which has predictably hampered their use outside the scope of charitable trusts. In the
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, for example, the
Finance Act 1975 A Finance Act is the headline fiscal (budgetary) legislation enacted by the UK Parliament, containing multiple provisions as to taxes, duties, exemptions and reliefs at least once per year, and in particular setting out the principal tax rates f ...
imposed a "capital transfer tax" on any property settled on a discretionary trust, which was replaced in the Finance Act 1988 by the inheritance tax.


See also

*
Taxation of trusts (United Kingdom) The taxation of trusts in the United Kingdom is governed by a different set of principles to those tax laws which apply to individuals or companies. Inheritance tax The inheritance tax ("IHT") treatment of trusts was substantially revised by ...
* Personal injury trust


Notes

{{Reflist, 2


References

* Wills and trusts