The majority of trusts established offshore are described as 'discretionary trusts' due to the wide powers granted to the trustees in the trust deed. In these trusts the trustees decide which beneficiary should benefit from the trust, in what form the benefit should take and the timing of those benefits. Potential benefits of establishing a discretionary trust may include tax efficiencies, freedom to bequeath assets on death without restriction and protection against future creditors.
However, the use of discretionary trusts in recent years has come under attack from revenue authorities and individuals who consider that the establishment of the trust has affected them adversely. This latter category might include children who anticipated receiving assets on the death of their parents who learn that, under the terms of an offshore settlement established by their parents, the trustees have been directed to hold the trust fund for the exclusive benefit of grandchildren. Additionally creditors of an individual will wish to ensure that assets have not been placed in trust purely to defeat their claims.
For a discretionary trust to withstand attack it is vitally important that the trustees are not seen to carry out every instruction given to them whether in respect of the investment of the trust fund or distributions to beneficiaries. Trusts which are found to be under too strong an influence from someone other than a trustee run the risk that the courts will consider them to be a sham and will set aside their provisions.
So what can be done to ensure that a discretionary trust does not make itself vulnerable to attack? It is important for anyone who is about to establish a discretionary trust to fully understand that he is relinquishing control over those assets. For the trust to be effective they must appreciate that whilst they may offer guidance to the trustees, ultimate decisions must be left to the trustees. In view of this, careful thought must be given as to which assets are suitable to place in trust and the extent of an individual's wealth for which it makes economic sense to be held in trust.
These issues depend entirely on the circumstances of the individual and what is right in one situation will be wrong in another. However, in the normal course of events it may not be advisable to place an individual's entire wealth into a discretionary trust but instead place only those assets which are not required for day to day living.
Whilst the trust deed will probably allow the appointment of the person establishing the trust as an investment adviser, this will be a strong pointer to a court that the individual has not given up control of the trust assets and again will place doubt on the validity of the trust.
The ability of a trustee to demonstrate that they have control of the trust's assets and have managed them solely for the benefit of the beneficiaries of the trust will be the strongest defence against claims that a trust is a sham. When selecting a trustee it can be seen that it is vital that they fully appreciate their responsibilities and are prepared to take an active role in managing the trust property. More can be read on the important subject of selecting trustees in our article of March 1996.
In summary, discretionary trusts are only as effective as their trustees. If trustees are too keen to keep their clients happy, they may unwittingly jeopardise the interests of their clients.
This article provides a general outline on the subject at the time of writing (July 1996). It is not intended to be exhaustive nor to provide legal advice in relation to any particular situation and should not be acted on or relied upon without taking specific advice.