Trust-to-Trust: Be careful if you distinguish between trust beneficiaries
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Trustees should act in the best interests of all the beneficiaries, in line with the terms of the trust instrument.
In the Griessel v de Kock case of 2019 the Court held that the “role of a trustee in administering a trust calls for the exercise of a fiduciary duty owed to all the beneficiaries of a trust, irrespective of whether they have vested rights or are contingent beneficiaries whose rights to the trust income or capital will only vest on the happening of some uncertain future event”.
If income and capital beneficiaries are not the same people, it may present a potential conflict which the trustees would have to manage.
Define beneficiaries well
Beneficiaries are the only persons who can ever benefit from a trust. There is flexibility regarding how the estate planner can arrange who is to benefit from the trust assets. For a start, one can distinguish between those who can benefit from the capital (the assets) of the trust and those who can benefit from the income generated by assets in the trust. One can also “vest” income and/or capital in one or more beneficiaries (which they are entitled to), or only give one or more beneficiaries discretionary or contingent rights (only a hope to receive something) to trust income and/or capital until the trustees have exercised their discretion in favour of such beneficiaries, upon which such distribution vests in the beneficiaries. In some trusts, beneficiaries may have a combination of rights, such as vested rights to trust income and discretionary rights to trust capital (which beneficiaries hope to receive), or vice versa.
This mechanism provides the estate planner with an opportunity to specify which beneficiaries should receive which benefits (income and/or capital) from the trust. This is a personal preference and choice of the estate planner, which needs to be carefully considered by them when the trust is registered.
Potential conflict between different types of beneficiaries
When capital and income beneficiaries are different people, extra care should be taken to ensure that all beneficiaries’ needs are considered. Capital beneficiaries may prefer capital growth and capital preservation, while income beneficiaries may favour maximising income, even if it is at the cost of capital growth or capital preservation. The apportionment of expenses to income and capital beneficiaries may also become a challenge when attempting to establish fairness.
Income should be clearly distinguished from capital in the trust instrument, especially if different people are income and capital beneficiaries. Be mindful how you define “income” in the trust instrument since it may include all “fruits” from assets – such as the occupation of a property – or it can narrowly refer to actual revenue received, such as rental income.
The term “net income” – gross income less expenses – should also be clearly defined, and the trust instrument should allow trustees to distribute both income and net income to capitalise on the benefit of the “conduit principle”. If only income is distributed, the expenses related to the income will not be capable of deduction for tax purposes in the hands of the beneficiary or the trust and will be lost. Capital beneficiaries, on the other hand, may benefit from the distribution of an actual trust asset or from a gain made on the disposal of trust assets, depending on its definition in the trust instrument.
The treatment of unallocated income should also be defined to reflect the founder’s intention – in other words, whether it will form part of trust capital at the end of a financial year, if unallocated, or whether it will keep its nature as income. If the trust instrument is silent, it may be assumed that income and capital will always retain their individual natures.
In the event that income and capital beneficiaries are different, it is good practice to state in the trust instrument that if the income is insufficient for the maintenance of an income beneficiary that trust capital can be used to make good on any such shortfall. This will assist the trustees in optimising the trust’s investment returns while taking into account the needs of all beneficiaries to prevent unintended hardship. Focusing solely on a trust’s short-term income production may have a detrimental effect on the long-term position and value of the trust’s assets, which, in the long run, may negatively impact both the income and capital beneficiaries.
Advice to trustees
Part of the process of taking control of the trust assets is to ensure that money in the trust is properly invested. The trustees begin this process by establishing, where possible, the intention of the founder of the trust. They would then establish the needs of each of the beneficiaries. The trustees are required to establish the short, medium and long-term requirements of the income beneficiaries, as well as those of the capital beneficiaries. Once the needs of the beneficiaries have been established, negotiated, and agreed upon, the trustees can then ascertain their investment powers before making an appropriate investment.
In the Sackville West v Nourse case of 1925, the beneficiary succeeded in a claim for damages for negligence against a trustee who had made an unwise investment. The trustees, therefore, have to perform a delicate balancing act between seeking out safe investments and avoiding risk, versus investing trust assets productively while considering beneficiary needs – for both income and capital beneficiaries. Since an element of risk-taking seems unavoidable, trustees should record and document their reasons in arriving at investment decisions.
Phia van der Spuy is a Chartered Accountant with a Master’s degree in tax and a registered Fiduciary Practitioner of South Africa®, a Master Tax Practitioner (SA)™, a Trust and Estate Practitioner (TEP) and the founder of Trusteeze®, the provider of a digital trust solution.
*The views expressed here are not necessarily those of IOL or of title sites.