There are many reasons why a discretionary trust may be wound up, including where:
- the trust’s purposes have been fulfilled
- the trust’s vesting date is drawing near.
Whenever a trustee is considering winding up a solvent trust, they should develop a process for that winding-up and, where possible, agree it with the trust’s stakeholders.
Why might a discretionary trust come to an end?
A discretionary trust will usually have an expiry or ‘vesting’ date in the trust deed that is linked to the expiry of a certain number of years from establishment (limited to 80 years) or to the occurrence of a specific event (for example, the death of a certain person). You can read more about vesting dates and how to plan for them here.
Succession planning/generational change
It is relatively straightforward to pass control of a discretionary trust through generations where, for example, the parents established the trust but retire or pass away. Of course, good estate planning is always required to ensure that the right outcomes are achieved and control passes without dispute.
However, once under the control of the next generation, these parties may not have the same vision for the trust’s assets or future, or may, for example, agree with siblings to split their ‘interests’ and go their separate ways.
Realisation of all the trust’s assets and/or the trust’s purposes having been fulfilled
These circumstances often have in common the conversion of the trust’s assets from illiquid investments (such as a property or family business), or a specific investment such as a partnership interest or equity investment, to cash. Often in those circumstances the trustee may consider reinvestment. However, the trustee may also consult with stakeholders and decide it more prudent for those stakeholders to make future investments via clean vehicles, including because of the trust’s historical tax profile or trading position.
Also, if a trust is maintained with only cash or minimal assets, the trustee is likely to continue incurring annual costs, such as accounting and tax services, for so long as the trust continues. Terminating the trust brings these requirements to an end. It also obviously brings to an end the trustee’s responsibility to appropriately invest those assets.
In some circumstances (for example, in the context of a family law dispute) a Court may make orders for the winding-up of a discretionary trust.
Joint decision of all the beneficiaries
A trust may also come to an end where all the beneficiaries of the trust have the relevant legal capacity and make a decision to require the trustee to distribute the trust property to those beneficiaries. This is difficult in the context of a discretionary trust, but possible where there is a clear potential pool of eligible beneficiaries.
Why is it important to validly terminate and wind up the trust?
Whatever the circumstances of the trust’s termination, it is important that the trust is validly wound up. The main advantage is so that the trustee, beneficiaries and other stakeholders can be confident that assets have been realised, liabilities effectively dealt with, all taxes paid and all related matters catered for.
What are the usual steps to terminate and wind up a discretionary trust?
Review the trust’s deed: does it set out a process or key responsibilities, or contain default distribution clauses?
The trustee will need to carefully consider the terms of the trust’s deed to confirm the powers and obligations placed on the trustee when distributing trust property (both income and capital) to beneficiaries. Often the trust deed will not contain specific obligations regarding termination of the trust. In those circumstances, the trustee still needs to:
- comply with its general obligations
- act within its trustee powers
- consider how the exercise of its powers will be affected by the trust’s deed.
For example, the Cleardocs discretionary trust deed:
- allows the trustee to bring forward the vesting or termination date for the trust (with the appointor’s consent, if there is one)
- allows the trustee, at any time before vesting and termination of the trust, to distribute all of the trust property to one or more of the eligible beneficiaries
- provides for default distributions of that trust property when the trust vests, unless the trustee has exercised its power to make specific distributions.
Accordingly, the trustee should think carefully about the date it set as the vesting date, and ensure all relevant distributions are made before that date, unless the trustee is content for the default distribution clauses to apply.
In some cases the trustee will also need to review the terms of other related instruments. For example, the terms of a Court order or, where the trust is terminated pursuant to an agreement executed by all the beneficiaries, the terms of that agreement (to the extent it is binding on the trustee).
Engage with stakeholders
The trustee will need to determine who the trust’s deed requires the trustee to consult with or seek approval from. For example, the Cleardocs discretionary trust deed requires that if the vesting day is to be brought forward then the trustee must obtain the appointor’s consent (if there is an appointor).
Although beneficiaries do not technically have any control over, or the right to be consulted regarding, the winding-up of the trust, it is advisable for the trustee to consult with beneficiaries to help avoid disputes in the future. This will also allow for the anticipated tax effects of distributions to different beneficiaries to be taken into account and for the distributions to be tailored accordingly.
Identify beneficiaries and consider their eligibility to ensure that the trustee makes valid distributions
The trustee will need to carefully assess the possible beneficiaries of the trust upon termination, and ensure that distributions are only made to eligible beneficiaries. Sometimes this will be very straightforward when the trustee only intends to make distributions to named beneficiaries. In other cases, some trust deeds (not the Cleardocs deed) may refer to only certain classes of beneficiaries receiving capital, and a wider or narrower class receiving income.
Where there is any ambiguity, a trustee may apply to a Court for leave to distribute trust property.
The trustee should also carefully consider the timing and appropriate recording of all decisions to distribute the income and capital of the trust as part of the winding-up process.
Consider and seek advice about the financial and tax implications of winding up the trust
The tax and other financial consequences of distributing trust property upon termination are often the most complex considerations and require careful planning in order to avoid unfavourable and unintended outcomes.
For instance, if trust property includes land then duty would normally be payable on the distribution, subject to the availability of duty exemptions for discretionary trusts.
In all cases, professional advice should be sought about the most effective and efficient distribution of trust property to avoid unexpected stamp duty, capital gains or other tax or transfer implications. To support its decisions and provide certainty of those outcomes, the trustee should compile complete final accounts for the trust and ensure that all the trust’s final tax and accounting obligations are fulfilled.
Realise the trust’s assets
This step will be largely influenced by consultations with stakeholders and professional advisers as to the best financial and tax outcomes for the trust and its beneficiaries. The trustee will need to plan carefully for the appropriate timing and formalities for realising the trust’s assets.
Extinguish all the remaining debts and liabilities
All the trust’s liabilities must be fully discharged (or a suitable amount held in reserve) before the trustee distributes the trust property to the beneficiaries.
Where this does not occur, the trustee may find itself liable for the trust’s debts without the possibility of being repaid from the trust’s assets.
Maintain complete and detailed records of the winding-up
Accurate and detailed records of the actions taken to wind up the trust will help avoid any future ambiguities and can be used to provide the trustee, the beneficiaries and any third parties with an accurate picture of the final state of affairs of the trust. Diligent record-keeping will also help the trustee to ensure it has evidence of having fulfilled its duties upon termination of the trust.
When will the winding-up be complete?
In cases where the trust is brought to an end through the exercise of a power to terminate, the trustee’s duties and powers continue to exist for a reasonable period to allow the trustee to protect the trust assets and to wind up the trust.
Where a trustee has fulfilled all its obligations and the trust property has been wholly administered (distributed or used to discharge trust liabilities so that there is no remaining trust property), the trust will be considered to have come to an end.
|Susannah Stanford | Lawyer
Tel +61 3 9258 3767