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Is it the beginning of the end for discretionary trusts and one-man companies - A change of view point

Date: September 01, 2010

Authors: Michael Pickering B.A., LL.B. (Hons.), LL.M., M. A.

There are suggestions that Australian courts are now changing their approach to the interpretation of statutes with the effect that discretionary trusts are not as useful in avoiding statutory obligations.   In other words, in the words of the Bob Dylan song “… the times, they are a-changin”! 

An early sign of change is the important decision of Justice French in the Federal Court of Australia (as His Honour then was) sitting in Western Australia in Re Richstar Enterprises : ASIC v. Carey [2006] FCA 814 (“Westpoint” case).   Readers will be aware that Justice French was elevated to the Chief Justiceship of the High Court of Australia after His Honour decided the Westpoint case and now holds the most powerful judicial position within the Commonwealth of Australia.

The Westpoint case involved the interpretation of section 1323 of the Corporations Act 2001 which is the source of the power to appoint receivers to the property of investigated persons. The receiver was arguing that he had the power to be appointed to the property of a beneficiary under a discretionary trust notwithstanding that, traditionally, that beneficiary had no entitlement or ownership in any trust property until the trustees had appointed that property. No appointment had been made to Mr. Carey.   The question before Justice French was if a person was in “effective control” of a discretionary trust, did that person’s property include the assets of the trust prior to the trustee’s distribution?   The concept of “effective control” considered by the Federal Court included where the same person was both trustee and one of the class of discretionary beneficiaries, or where the same person was the appointor under the trust and one of the beneficiaries because the appointor has the power to replace the trustee.  

The Federal Court was considering the situation where there was only one trustee or one appointor.   Justice French concluded that where the person was in that type of “effective control”, that person’s property did include the assets of a discretionary trust even before the trustee’s distribution. In other words, the power to distribute property was as good as the receipt of that property itself even though it was theoretically possible for the sole appointor or sole trustee to have distributed property to other beneficiaries and not to that same person in his or her position as a discretionary beneficiary. According to Justice French, in the circumstances of the Westpoint case, it was a good as certain that the controlling person would receive the benefit of the distributions of income or capital or both having regard to past years of distributions.  

Such a proposition has serious consequences in equity law.   Justice French’s reasoning assumes that trustees will in fact favour themselves by distributing trust income to themselves in their capacity as beneficiaries which is completely contrary to the duty under which a trustee operates.   A trustee is obliged under equity (and under statute – see the Trustee Acts of the various Australian states) to act in the bests interests of all beneficiaries and after taking into account all relevant considerations rather than simply benefitting one particular beneficiary and particularly themselves if they are beneficiaries.   Justice French in the Westpoint case attributes trust property to the controller because he or she could effectively direct income where he or she chose. 

A further development occurred in judicial consideration of the discretionary trust in the High Court of Australia’s decision in Kennon v. Spry (2008) 251 ALR 257.   In that case, the High Court reconsidered discretionary trusts in relation to the Family Law Act 1975.   Effectively, the High Court of Australia had to determine whether or not the property of a husband included property in a discretionary trust to which the husband was a trustee but had effectively disqualified himself from being a beneficiary for the purposes of discretionary distributions of trust income or property. Effectively, the High Court decided that discretionary trust “controllers”, who were able to benefit themselves or their spouses, if not themselves, were denied the ability to hide their assets within discretionary trust structures.   Chief Justice French decided to follow his earlier Federal Court of Australia decision in the Westpoint case and decided that discretionary trust controllers had an interest in the trust assets.  

The High Court (by a majority) interpreted section 79 of the Family Law Act so that a trustee’s power to appoint implied a property interest in the thing appointed.   In other words, for the purposes at least of some statutes under Australian law, a power to appoint amounts to a property interest although such a proposition has been rejected in trust law for many decades. If this line of reasoning is continued, and is not overruled (and having regard to the fact that one of the decisions is that of the High Court this seems unlikely) or is negated by statutory reform (again unlikely), then the writing is on the wall for the future of discretionary trusts.

The dominant reasons for the creation of discretionary trusts are to enable the primary asset holder to distance himself or herself from legal ownership either of capital (for risk management purposes) or of income (for income tax or other tax purposes).  If the courts are now saying that if a person controls a discretionary trust in the sense of having an unfettered power to appoint irrespective of whether to themselves or others as beneficiaries, these reasons are negated because courts are able to regard that power as giving the controller the very property rights the discretionary trust was set up to negate. 

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