When recommending a structure to conduct a business or hold an investment, advisors should consider a number of issues, primarily the income taxation consequences of the structure, the ability to access applicable capital gains tax reliefs upon a sale of a capital appreciating asset, the asset protection benefits of the recommended structure and how the structure works to ensure that control of the asset passes to the next generation upon death in a succession plan.  Legal and accounting advisors routinely recommend a discretionary trust structure for these purposes. However, it is important to highlight the difficulties that a discretionary trust structure poses in planning for succession and how those difficulties are best addressed.

 The diverse and often competing values between business and family are often not taken into account by advisors when recommending the use of trusts in the establishment of a family business or undertaking an investment and most importantly, are not taken into account when providing recommendation for succession.

Whilst discretionary trusts are frequently the most advantageous structure to take account of income tax and capital gains tax benefits, and when properly structured are the most advantageous structure for the purposes of asset protection, the same cannot be said in the sphere of succession planning.

At their most complex, family businesses may have differing tiers of ownership, management and influence by members of a single or extended family, and in some family businesses, these are the same people or group of people, who therefore have almost total influence over the business.  In other family businesses, ownership may rest with a broad range of individuals, but management responsibility rests in whole or in part with only a limited number of them, or even with non-family employees.  How people involved in the running of the business procure succession of the business to them where the business is owned by a discretionary trust is problematic.

Broadly speaking, a discretionary trust is recommended for income tax, capital gains tax and asset protection planning purposes for the key reason that no individual has an entitlement to any of the assets of the trust, and therefore cannot claim ownership, or be deemed to have ownership of them in the circumstances that a beneficiary is in financial difficulty.  In family law cases the situation is more complex but the same broad principle applies.  The trustees of the trust have the widest possible discretion, and can determine to whom income is distributed, or if an asset is sold how the proceeds and the capital gain are to be applied.  This concept, which provides such a benefit in tax planning and asset protection, is the reason why trusts should only be recommended for succession purposes, where the issue is fully considered because the asset is owned by the trust and not by any one beneficiary of that trust and therefore is not an asset that can be passed by a will.

By way of example, if Fred and Mary run a family business through a trust and their daughter Bernadette is involved in that business whilst their two sons John and Marcus are not and have undertaken successful careers in other endeavours, should Fred and Mary wish Bernadette to obtain ownership of the business after their death, they cannot merely say in their will that they pass the business to Bernadette.  It is not their business to give, it is the trusts.

There is no one answer which will always solve this difficulty.  Issues which should be considered are:

  1. The entering into of a family constitution (previously frequently called deeds of family arrangement) whereby the family records its internal agreements.  This can be as simplistic as setting the rules for family meetings, or alternatively providing an outline of inheritances and the division of assets upon death and other related rights and entitlements.
  2. Ensuring that the accounts of the trust are maintained in such a way as to diminish liabilities to family members which can be called up by those family members in the event of a death or dispute.
  3. Ensuring that the position of the trustee of the trust is carefully considered, and where possible succession is planned for this position.  If there are individual trustees, the position of trustee does not as a general matter of course fall to the executors of the estate of the deceased trustee.  Where the trustee is a company, the shares in that company can be passed by a will to persons whom the deceased wishes to exercise a degree of control over the trust and therefore the trust assets.  This degree of control is primarily exercised by shareholders having a power to appoint directors of the company.
  4. Most fundamentally, control of any discretionary trusts rests with the parties now most commonly called appointors, because the appointors have the power to remove a trustee and appoint an additional or replacement trustee.  Therefore, in the above example in relation to the business conducted by Fred and Mary, if there was a corporate trustee, they could gift their shares in the company by their wills to Bernadette, and subject to the will being challenged in that respect, control of those shares would allow Bernadette to appoint directors of the trustee company and therefore control the trust.  However, for absolute protection, provision should also be made for Bernadette to be the appointor of the trust following the death of Fred and Mary, because by that way she can control the trust and its assets.  Consideration must always be given to the possibility that Bernadette may have external influences which could affect her ability to exercise the power of appointment, for example her own financial difficulties, or matrimonial difficulties involving Family Court property proceedings.

In conclusion, merely recommending a trust for a family in business for the purposes of the taxation and asset protection benefits which will be derived, is not always the best answer for a family where succession is an issue.  Families should also be mindful of these difficulties, and importantly, as part of any succession planning should continually review and update appointor provisions of discretionary trusts.