A discretionary trust in Canadian and English trusts law is a trust where the
beneficiaries and/or their entitlements to the trust fund are not fixed, but are
determined by the criteria set out in the trust instrument by the settlor. It
is sometimes referred to as a family trust in Australia or New Zealand. Where
the discretionary trust is a testamentary trust, it is common for the
settlor to leave a letter of wishes for the trustees 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 trusts. 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 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. 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 [1968] 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 House of Lords 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 [1969]
1 Ch 657 and Sainsbury v IRC [1970] 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 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, 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 determining
whether to exercise their discretion, and 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 [1977] 1 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 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 divorce settlement.
Popularity and decline The popularity of discretionary trusts
rose sharply after the decision of the House of Lords in McPhail v Doulton
[1971] AC 424 where Lord Wilberforce 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 void. 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. See also
Taxation of trusts Personal injury trust
Notes References