Sunday, December 16, 2012

Discretionary Trusts and B.C.'s New Family Law Act

This follows my post of November 19, 2011, in which I described how the British Columbia’s new Family Law Act, which will come fully into force on March 18, 2013, might affect property one spouse has inherited on a marriage breakdown. I described how the way the legislation is structured, the inheritance itself is excluded from family property that is divisible between the spouses, but any increase in value in that property after it was inherited and since the marriage began is family property which will be divided, usually equally between the spouses.

I did not discuss in my article property that is left in a discretionary trust, in which one of the spouses is a beneficiary. Let me give you an example. Supposing a mother in her will leaves part of her estate to a trustee to manage for her son and his children. She gives her trustee the power to decide if-and-when to make payments from that part of her estate to her son, and any one or more of his children. These kinds of trusts are fairly common, and are sometimes used to allow a child to take advantage of lower tax rates in a trust that is creating in a will, sometimes to provide for a child with a disability, or for a child who has financial problems.

On the mother’s death in our example, the trust has funds of $300,000. Fifteen years later, there is $700,000 in the trust. The son, who was already married when his mother died, separates from his wife, and divorce proceedings begin.

How the trust treated under the Family Law Act?

Apart from the new Act, the son might reasonably say that none of the assets in the trust should be treated as family property divisible between the spouses. This is because he is only a discretionary beneficiary, and he has no entitlement to anything until the trustee decides to make a payment to him.

But the way the new Act is drafted it unclear how the trust will be treated.  Section 85 (1) (f) excludes from family property:

(f) property held in a discretionary trust
(i) to which the spouse did not contribute,
(ii) of which the spouse is a beneficiary, and
(iii) that is settled by a person other than the spouse;

This would exclude the $300,000 that went into the trust on the mother’s death from a division of family property on the breakdown of his marriage.

But section 84(2) (g) includes as family property:

(g) the amount by which the value of excluded property has increased since the later of the date
(i) the relationship between the spouses began, or
(ii) the excluded property was acquired.

Because section 85 (1) (f) refers to “property held” in a trust, rather than an interest in the trust, these sections could be interpreted to include the $400,000 growth in the value of the trust funds, which on an equal division means that the separated wife is entitled to $200,000 from the trust, even though her husband has no entitlement unless and until the trustee decides to make payments to him. In other words, the wife’s rights to the trust property may be greater than her husband’s, even though they are derived from his interest in a trust created by his mother for the benefit of him and his children.

Now let’s consider the absurd results that could occur if we change the beneficiaries of the trust a little. Supposing the mother creates a similar trust in her will but the beneficiaries are all four of her children, and all of their children. If in our example, all four of the children had marriage breakdowns at around the same time, their spouses could each be entitled to $200,000, representing in each case, half of the increase in value of the trust property, for a total of $800,000. But there is only $700,000 in the trust.

I suspect this was not intended by the Legislative Assembly when the Family Law Act was passed, and represents a drafting error, that could be fixed with some amendments. For example, section 85(1) (f) could be amended by replacing the words “property held in a discretionary trust” to “an interest in a discretionary trust.” This wording would be consistent with the fact that the husband does not own the property in the discretionary trust. Rather, he has an interest in the trust as a discretionary beneficiary.

I hope that the government will amend this provision before the new Family Law Act comes into effect.

1 comment:

Anonymous said...

It looks like the only hope for parties with assets in a discretionary trust is a finding of significant unfairness under FLA 95(1)(a).