16 Nov Trust Fund Basics – Losing Control
The Weekender / Business Day 12/13 Aug 2006
Use of the trust fund began in the middle ages when knights went off to battle and wanted to preserve their wealth and protect their dependants should they not make it back. Trusts are frequently recommended to clients for a variety of good reasons by estate planners.
They must be correctly established and carefully managed, however – as highlighted in a recent case that was argued before the Supreme Court of Appeal between a husband, Mr. B, and his ex-wife, Mrs. B.
The Court decided that assets purposely held in a family trust fund were in fact under the control of Mr. B, who was one of the trustees. The trust was essentially a sham.
For Mr. B this had serious consequences. All the trust assets were deemed to be owned by him personally, and were to be equitably shared with Mrs. B in their divorce proceedings.
According to estate-planning expert Paul Flude of Louis Group International Trustees SA, this decision should sound a warning bell for all those who have used discretionary trust funds in their personal financial and estate planning.
You can be sure that South African Revenue Services (SARS) has taken note of the arguments put forward by Mrs. B’s lawyers, and it is only a matter of time before a case comes before court with SARS, for example, seeking an order that estate duty be paid on trust fund assets.
So where did Mr. B go wrong?
To understand this, we need to understand a little about the legal framework surrounding trusts.
A trust fund is essentially a collection of assets and liabilities vesting in the trustees to be administered by them in terms of the trust deed for the benefit of the beneficiaries.
The trust deed is a legal agreement (contract) between the founder of the trust and trustees which sets out how the trust is constituted and how it is to be administered.
It expressly sets out that all assets transferred to the trust become trust assets under the sole control of the trustees.
The Trust Property Control Act, which regulates trusts, requires that all trust deeds are registered with the Master of the High Court and that no person may act as a trustee until they have been issued with letters of authority to do so my the Master.
Trusts have been used for many years as an integral part of financial and estate planning.
They can protect assets against creditors, reduce the estate duty payable on death, and provide an efficient structure for the care of one’s dependants.
However, as Mr. B discovered, all these benefits may be lost if the trust fund is not correctly established and administered.
In making his decision for the Court in the case between Mr. and Mrs. B, the Judge looked, first, at the provisions and requirements of the trust deed (the legal-framework) and, second, at how the trust assets were actually administered (the management of the trust). The Judge noted among other factors that:
“The founder of the trust was Mr. B’s father and the only other trustee was Mr. B’s brother (bringing into question the impartiality and independence of the trustees).”
“Mr. B had the right in terms of the trust deed to discharge his co-trustee and appoint someone else (especially problematic in cases were there are only two Trustees).”
“Mr. B had seldom consulted with his brother regarding the administration of the trust assets and had effectively treated them as his own.”
“In an application for credit facilities, Mr. B had listed the assets of the trust as his own.”
“Mr. B had insured in his own name a beach cottage owned by the Trust.”
The Judge accordingly decided that the Trust was Mr. B’s alter ego, the trust assets were under his de facto control and, consequently, Mr. B was deemed to be the owner of the Trust assets.
To avoid the pitfalls highlighted by this and other cases relating to trusts which have recently come before our courts, Flude advises trustees take the following steps
- Know and understand the duties of trustees arising from both the Common Law and Trust Property Control Act
- Carefully read and understand the provisions of the trust deed of any trust of which you are a trustee
- Comply with all the administrative requirements of the trust deed, especially those regulating what the trustees are empowered to do and how the decisions of the trust are to be made
- Ensure that a qualified independent trustee such as a lawyer, accountant or a trust company is appointed to the trust and that the independent trustee is party to all trust decisions
- Keep a minute book recording all the decisions of the trustees and books of account recording the trust’s financial dealings
- Ensure that letters of authority exist for each of the Trustees, and that at all times there are as many trustees appointed as required by the trust deed and
- Remember that the fundamental principle of trusts is the separation of ownership.
Once you have transferred assets to a trust fund, Flude says, remember you have placed the control of the assets in the hand of the trustees. You don’t own those assets, the trust does. Just let it go.
Debbie Netto-Jonker, CFP™, is founder of Netto Financial Services and was financial planner of the year in 2001.