Be careful of unintentionally turning a discretionary trust into a vesting trust

Families set up trusts to achieve the benefits of asset protection and Estate Duty minimisation. Asset protection trusts include a large spectrum of legal structures that are set up in order to mitigate the effects of divorce, attacks from creditors, and bankruptcy on the part of the beneficiary. Their main objective is the protection and maintenance of trust property for the benefit of the family members of the founder, often in perpetuity.
 
An unintended consequence is sometimes achieved when the estate planner is allowed to dictate in the trust deed how their assets should be treated, such as a percentage allocation to each beneficiary. Typically, the beneficiaries have a personal right to claim their portion of the trust benefits from the trustees at the time of a certain event specified in the trust deed. This of often done to allow the estate planner to control assets in the trust during the life of the trust, as well as upon the happening of an event, such as the death of the estate planner, or the termination of the trust. In many instances the accountant or lawyer drafting the trust deed adds these clauses to retain a measure of control for the estate planner or founder, without the estate planner even realising the consequences. This is typical of the older trust deeds. Any clause in a trust deed affecting the absolute discretion of trustees to deal with trust assets may render the trust a vesting trust, with dire consequences.
 
SARS defines a vesting trust as a trust where the income (both of a revenue and capital nature) and/or assets of the trust are vested in the beneficiaries. In other words, the beneficiaries have vested rights to the income (both of a revenue and capital nature) and/or capital of the trust. Any income and capital gains earned by the trust vest in the beneficiaries. The trustees are not given discretion to deal with trust assets, and the beneficiaries and their benefits are fixed and predetermined. It was held in the ITC 76 case of 1927 that a “vested right was something substantial; something which could be measured in money; something which had a present value and could be attached”.
 
The unintended consequences are that the benefits of asset protection (and estate planning) are lost and the income and capital gains are taxed in the hands of the vested income and capital beneficiaries during their lifetimes. In the event of the death of the beneficiary prior to payment, the deceased beneficiary’s interests, i.e. their personal rights, are transmissible to their heirs, and these interests must be included in their estate for Estate Duty purposes. The exposure of assets to creditors and the loss of the Estate Duty benefit will ‘undo’ the benefits of the trust structure. Read through the trust deed, or get the help of a professional to read through the trust deed and remove any problematic clauses.