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Are the lights changing for discretionary trusts?

Feature Articles

Cite as: Jan/Feb 2010 84(1/2) LIJ, p.34

A High Court decision has confirmed new "trust-busting" powers for the Family Court.

By John Glover

An individual’s “control” of a discretionary trust may become “property” for the purposes of s79 of the Family Law Act 1975 (FLA).

As confirmed by Kennon v Spry,1 persons who control trusts and can benefit themselves or their spouses from trust assets may be ordered to transfer such (other) property as the Family Court determines.

Discretionary trusts used in other contexts are not directly affected by Kennon v Spry. However, the decision is likely to have a significant “gravitational” effect.

Kennon v Spry

In 1968, Dr Spry (the husband) created a non-exhaustive, discretionary trust of which he was trustee, over which he retained a power of variation (the trust). Potential beneficiaries included himself, his siblings and the issue and spouses of these persons.

The husband married in 1978. He and his wife had four children and were divorced in 2003.

The trust was varied three times. In 1983, for land tax reasons, the husband excluded himself as a potential beneficiary. In 1998, the wife (and the husband again) excluded themselves as potential beneficiaries. This was a time of matrimonial difficulty. Finally, in 2002, the husband/trustee directed that all the capital and income of the trust be transferred equally to separate trusts for the benefit of each child.

Shortly before the transfer to the children’s trusts, the wife made an FLA application for property settlement and maintenance. The application was heard at first instance before Strickland J in the Family Court. His Honour used s106B of the FLA to set aside each of the beneficiary exclusions, as well as dispositions to the children’s trusts. Exposed in this way, the husband was found to have “property” in the trust assets as a “party to the marriage”, which could support an order under s79 that he transfer a substantial sum of money to the wife.

Majorities of the Full Court of the Family Court and the High Court of Australia confirmed the correctness of this order, for differing reasons.

Two strands of the High Court’s reasoning will be considered here, while the reasons of Kiefel J and the persuasive dissenting judgment of Heydon J will be ignored.

All members of the High Court assumed that the 1998 and 2002 but not the 1983 transactions were avoided and that the husband had effectively excluded himself as trust beneficiary.

The first strand comes from the judgment of French CJ, supported by no other justice. At [67], his Honour assumed the “coupling” of three things:

  • the husband’s legal title as trustee;
  • his power to distribute the whole fund to the wife; and
  • the wife’s equitable right to be considered.

By reason of this “coupling”, assets of the trust were found by his Honour to be the husband’s assets – hence “property of the parties to the marriage or either of them” divisible under FLA s79.

French CJ’s reasoning to this conclusion was similar to that in his earlier decision as a judge of the Federal Court in Re Richstar Enterprises,2 where his Honour stated that: “a beneficiary who effectively controls a trustee of a discretionary trust may have what approaches a general power and a proprietary interest in the income and corpus of the trust”.

Facts of Kennon v Spry were unlike those in Richstar. The Spry trustee had effectively excluded himself as trust beneficiary in 1983. Nevertheless, French CJ linked the trustee’s legal title with his power to distribute to the wife and her right to be considered in order to find a comparable property interest in the husband.

It is the author’s view that the conclusion is a little remarkable and, with respect, at variance with equitable principles.

In the first place, finding that the husband had a beneficial interest in the trust based in his power to appoint to the wife and the wife’s right to be considered surely means that the dispositive power must be exercised in the wife’s favour. Where has the discretion gone? Only through illegal and fraudulent denial of discretions which qualified his dispositive power could the Spry trustee act consistently with the Chief Justice’s findings. Claims of the Spry siblings, their issue and their spouses could not be considered if the wife’s rights were to equal the greatest benefit that she could possibly receive.

In the second place, any “power” of the husband, in respect of property in which he had no beneficial interest, is no more his or anyone else’s property than is “the power to write a book or sing a song”. Heydon J made this point in dissent at [180].3 The fact that exercise of the power may result in property (for the power-holder or someone else) does not mean that the power is itself property. Power is a capacity to act and not a thing which one owns. Equity jurisprudence has distinguished between powers and property for centuries.4

Another strand of reasoning in Kennon v Spry is that of Gummow and Hayne JJ at [130]. Their Honours isolated the following doctrinal features of the case:

  • the wife’s equitable right of due administration of the trust;
  • the husband’s “fiduciary” duty to consider when and how the power should be exercised; and
  • the fact that the power could have been exercised by appointing the whole of the trust assets to the wife.

The trust fund was property of the wife by reason of the “combination” of these things. Section 79, for the purpose, was given a distributive effect not argued for on behalf of the wife at first instance, or any stage of appeal. Their Honours stated at [141]: “ . . . because, during the marriage, the husband could have appointed the whole trust fund to the wife, the potential enjoyment of the whole of the fund was ‘property of the parties to the marriage or either of them’”.

A little inconsistently, in view of his earlier finding, French CJ accepted this reasoning at [83]. Criticisms levelled at his Honour’s judgment in relation to the trustee’s power and what the trustee “could have appointed” are equally applicable to the joint judgment. Property and powers were mixed again.

Gummow and Hayne JJ observed at [94] that the sense of “property” defined by the FLA was specific to the Act. But “property” is not defined by the FLA . Sub-s4(1) provides that:

property, in relation to the parties to the marriage or either of them, means property to which those parties are, or that party is, entitled, whether in possession or reversion.

“Property means property”, in other words.5 The general law’s sense of “property” is necessarily implied – a point which their Honours minimised with the curious observation that “the legal definition of property is not a term of art”.6

The wife’s “property” right of due administration was then ascribed with a significant characteristic in the joint judgment. The measure and value of the administration right combined with effective control of the trust was held to equal the trust fund itself. It could be “cashed out”, in other words.

The significance of Kennon v Spry is concerned with readiness of the Court to see an equivalence between the trust fund and the administration right plus control. In the author’s view, new law was made. Previous authority had provided that, before favourable exercise of a trustee’s discretion, rights of due administration conferred no beneficial interest in trust assets and were of no value.7 Control of the trust made no difference. Notably, the UK House of Lords decision in Gartside v IRC8 denied that discretionary beneficiaries (or objects) had interests susceptible of measurement and valuation.

Gartside v IRC

Gartside was a tax case. It concerned whether estate duty was payable when an object of a discretionary trust died. Both House of Lords judgments held that a relevant object did not have an “interest in possession” in the statutory sense. Lord Reid saw this as implicit in the words of the relevant Finance Act. Relevant provisions, he said (at [607]) involved taxable “interests” which “extended” to specific parts of the trust fund. An object’s expectancy was too formless to “extend” in this sense.

Lord Wilberforce expressed the same conclusion more expansively. An object’s right to be considered, he said, was an expectancy, which of nature lacked the necessary quality of “definable extent” that taxing statutes require.

Gartside judgments of Lords Reid and Wilberforce were specific to the relevant UK Finance Act. Members of the Court of Appeal below unanimously reached an opposite conclusion. Slightly different legislation elicited different conclusions in UK cases decided both before and after Gartside.9 Authority of Gartside involving the rights of discretionary beneficiaries is legislation-specific.

The general law

Traditional approaches to the discretionary trust are illustrated by the Federal Court decision in Kawasaki (Australia) Pty Ltd v ARC Strang Pty Ltd.10

Joint venturers asserted that a pre-emption clause was triggered when ARC transferred shares held as discretionary trustee to itself in its own capacity.

Goldberg J held that there was no relevant “transfer” in this event.11 “There is no beneficiary,” his Honour said, and “no disposition of the beneficial interest in the shares” when a discretionary trustee transfers shares to itself. At the most, the “beneficiaries” have a “right to have the trust administered”.12

Taxation law

The effect of Kennon v Spry on tax law is limited by the fact that general law “property” is no longer a connective used in the definition of any federal or state tax liability.13 Only a single provision includes the word “property” in the Income Tax Assessment Act 1997 (Cth).

A CGT asset is defined in s108-5(1) of that Act as:

(a) any kind of property; or

(b) a legal or equitable right that is not property.

“[A]ny kind of property” is followed by an extension which denies “property” any controlling influence on what constitutes a CGT asset. The Income Tax Assessment Act 1936 has at least 10 “property” definitions. However, nowhere in the Act is the word used as the critical connective to establish a tax liability. Taxation of trust income, for example, in Division 6 of the Act, makes no reference to “property”.

The Duties Act 2001 (Vic) (DA) is comparable to the Income Tax Assessment Acts where “property” is concerned. Only estates or interests in Victorian land, shares and interests in shares and other specific assets are within the extended meaning of “dutiable property” under DA s10. Other examples of “property” are irrelevant.

Discretionary trusts are referred to in relation to “land rich” duty in DA s75. This is an anti-avoidance provision, which applies where linked entities owning land and not land itself are transferred. Aspects of majority judgments in Kennon v Spry highlighted above are overcome by this provision. Persons are taken to “own” or otherwise be “entitled” to property in discretionary trusts if they are objects of those trusts. Every person eligible to benefit is attributed with the otherwise ownerless property. In the author’s view, courts should avoid taking what might be perceived as “short-cuts” like this. More than one person owning 100 per cent of the same asset is a problem for judges.

Social security law

Part 3.18 of the Social Security Act 1991 (Cth) attributes interests in “controlled private trusts” for the purposes of means tests associated with Centrelink pensions. Section 1207V of the Act provides that a trust is “controlled” if an individual (and associates) holds an aggregate of 50 per cent or more of the “beneficial interests in [the trust’s] corpus or income”.

Section 1207V is difficult to apply to discretionary trusts. Beneficial interests in corpus or income are questionable before the exercise of dispositive discretions.

Testing this in relation to discretionary trusts, Kenny J in Elliott v Secretary, Department of Education Employment and Workplace Relations14 remarked that the expression “beneficial interests in the corpus or income of the trust”:

“signifies interests that, when taken together, would, practically speaking, permit the individual (acting alone or through his or her associates) to control the disposition of trust capital and income in some way, so that the individual (acting alone or with his or her associates) can enjoy the economic benefit of the trust”.15

Property can be inferred from control in this way. Objects of discretionary trusts are attributed with proprietary interests in trust assets if they have both control and a right of due administration of the trust. The majority approach taken in Kennon v Spry is anticipated, to a degree. Control plus a due administration right is treated as measurable and to equal the value to the underlying trust fund.16

Bankruptcy law

Had the estate of Dr Spry been sequestered under the Bankruptcy Act 1966 (Cth) (BA) shortly before the facts of Kennon v Spry occurred, would his ability to control the family trust have been property which vested in Dr Spry’s insolvency trustee?

In Re Burton,17 the Federal Court decided that the combination of a bankrupt’s status as discretionary beneficiary and a power of appointment enabling him to install a controlled trustee did not amount to “the property of the bankrupt” within the BA definition. The trustee’s power of selection was a “fiduciary power”, his Honour held, which could not be legally exercised for the bankrupt appointor’s benefit in accordance with equitable rules.

No doubt this is correct on general law principles. However, the statutory definition of “property” applicable to the vesting of property in bankruptcy trustees under BA s58 goes beyond the general law. “[T]he property of the bankrupt” in s5(1) means:

  1. property divisible amongst the bankrupt’s creditors; and
  2. any rights and powers in relation to that property that would have been exercisable by the bankrupt if he or she had not become a bankrupt.

“Property” for the purpose of defining what vests in bankruptcy trustees includes defined “powers”, which in turn imply “control” in the sense used by the majority in Kennon v Spry.

Hence “the property of a bankrupt” definition might apply to Dr Spry despite his beneficial interest disclaimer. For there is no requirement that the power be exercisable for the holder’s benefit. Nor is measurement and valuation of the trust property required for s58 purposes.

Other “property” definitions apply to different parts of the BA. None is comparable to the “property means property” definition in the FLA. Defined scope of “property” cannot be divorced from the statutory context in which the word appears.18

Finding that “property” divisible among a bankrupt’s creditors under the BA included a right to appeal from a legal judgment, the majority of the Full Court of the Federal Court in Fuller v Beach Petroleum NL19 said:

“[P]roperty when used in modern statutes may, in its context, include rights and interests which are created by statute and which would not be identified as proprietary by traditional conveyancing law”.

This dictum in Fuller’s case related to extended definitions of “property” noted in the BA. Less persuasively, the majority in Kennon v Spry reached the same conclusion on the basis of the FLA’s empty “property” definition.

Conclusion

Challenges to immunities associated with the ownership of property through discretionary trusts have occurred in several contexts. Majority judgments in Kennon v Spry are only a more stark example of what is happening elsewhere. Discretionary trusts are becoming more transparent.

JOHN GLOVER is a barrister practising in Melbourne and a professor of law at RMIT University, Graduate School of Business and Law, teaching taxation, equity and trusts. He practises in all commercial areas, with a particular emphasis on trusts and taxation. He is co-author of Principles of the Law of Trusts, Lawbook Co.

The numbers in square brackets in the text refer to the paragraph numbers in the judgment.

1. (2008) 251 ALR 257; (2008) 83 ALJR 145; (2008) 40 Fam LR 1; [2008] HCA 56.

2. Re Richstar Enterprises: ASIC v Carey (No 6) (2006) 153 FCR 509, [44].

3. Quoting Re Armstrong (1886) 17 QBD 521, at 531-532.

4. See G Thomas, Thomas on Powers (1998), [1-05]-[1-08].

5. The definition is empty: “in possession or reversion” qualifies “entitled” and not “property”: see The Marriage of Duff (1977) 29 FLR 46 at 55-56 (FC) in a passage quoted by their Honours at [95].

6. “With one specific and precise meaning”: at [93], per Gummow and Hayne JJ.

7. See, e.g. Commissioner of Stamp Duties (NSW) v Buckle (1998) 192 CLR 226; and R & I Bank of Western Australia Ltd v Anchorage Investments Pty Ltd (1992) 10 WAR 59 at 79, Owen J.

8. [1968] AC 553.

9. See Attorney-General v Heywood (1887) 19 QBD 326; Re Nelson (note) [1928] Ch 915 and Leedale v Lewis [1982] 3 All ER 808 (HL).

10. (2008) 247 ALR 333; see also Public Trustee v Smith [2008] NSWSC 397.

11. At [71]-[72].

12. At [73], referring to Commisioner of Stamp Duties (Qld) v Livingstone (1964) 112 CLR 12 at 22 and [1965] AC 694, Barns v Barns (2003) 214 CLR 169.

13. With small exceptions: e.g., the Trusts Recoupment Tax Assessment Act 1985, s3.

14. (2008) 249 ALR 182 (Federal Court of Australia): decided shortly before Kennon v Spry on 27 August 2008.

15. Note 14 above, at [49].

16. The Department’s right to aggregate trust assets was denied in Eliott’s case: discretionary beneficiaries had insufficient “control” of their ancestor’s will trusts.

17. (1994) 126 ALR 557, Davies J, at 560.

18. Noted by Dawson and Toohey JJ in Cummins v Claremont Petroleum NL (1996) 185 CLR 124 at 145.

19. (1993) 43 FCR 60 at 67, Gummow and Whitlam JJ – reversed in Cummins v Claremont Petroleum NL, note 18 above.

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