It can be important to recognise a bare trust when it arises, say where the correct basis for the ownership of assets needs to be determined.  However, as highlighted in Mudgway the practice sometimes of settling trusts labelled bare trusts can obscure the trustee’s duties and obligations, and by corrolary, the beneficiaries’ rights. 

Although there is no legal definition of bare trust, the Income Tax Act has limited provisions where the interests held by the trustee are deemed to be held by the beneficiary directly.  In this way the legislation provides support for the proposition that a bare trustee is to be disregarded, or perhaps to be considered, to be barely there.  Care must be taken with this analogy as not all bare trustees are created equal and while some can do no more than act on directions, others have powers that empower the trustee to act independently of the beneficiary.

References:

• Re Brockbank [1948] Ch 206
• Burns v Steel [2006] 1 NZLR 559

To qualify for a RCS a person must first be able to show a limited level of assets.  However, if a person has transferred assets to a trust during that person’s life-time, this will not of itself, prevent a person qualifying for a RCS.   In fact gifting rules, permit gifts of $6,000 per annum for the five years prior to an application and $27,000 per annum outside the five year period.

The issue of beneficial interests in assets while still meeting RCS criteria is complex and raises difficult questions of social policy and means engineering.

As at January 2011, 10.2% of applications for a RCS declared the existence of a family trust.  A year and a half later that figure had increased by nearly 20% to over 12%.  The significance of this, given the number of trusts in New Zealand (currently estimated at over 400,000 with more than 167,000 homes owned by trusts), and the static RCS budget, cannot be overstated.

Since the abolition of gift duty, incalculable sums have been gifted to trusts by way of debt forgiveness and through direct gifts.  Many of those donors will not appreciate that those gifts may forever extinguish any later ability to claim a RCS.   The simple facts are:

• New Zealand has an aging population
• the RCS budget has not increased following the abolition of gift duty
• increasing numbers of applicants have gifted assets to trust, thus eliminating those assets from means assessments
• even absent the abolition of gift duty, it could be expected that the RCS budget would be under increasing pressure

Any person contemplating a RCS, whether in the immediate or distant future, should seek advice.

Business Fitness, is hosting a 2 hour webinar presented by Vicki Ammundsen on RCS on Wednesday 22 February.

While in some circumstances the trustee may be able to recover a costs award from the trust, see for example the recent decision in Mawhinney v Auckland Council this most definitely cannot be relied upon.

In Brownlee v McCaslin, which involved a beneficiary seeking to enforce her rights against the trustee, the trustee was ordered to personally meet the beneficiary’s costs.  In that case there was only one trustee so there was no question as to differing liability.

However, this will not always be the case.  In Devcich v AMI, a case involving an (eventually) unsucessful claim against an insurer in respect of fire damage where one of the trustees was found to have been responsible for the fire), all trustees were found liable for the insurer’s costs, but at differing levels.  Of concern to some professional trustees will be the fact that even the trustees who had no knowledge of one trustee’s fraud were liable for costs, although not on an indemnity basis (the highest level of costs) as was the case for the fraudulent trustee.

A recent amendment to the Income Tax Act 2007 has clarified the position and now provides that a trustee can substitute cash distributions to beneficiaries for RWT credits.  A trustee who does so is then entitled to a credit to the extent that cash has been substituted for RWT credits. 

On first reading the mechanism by which this is achieved in the Income Tax Act is somewhat confusing and reads more like origami instructions.  However, perseverance will provide elucidation as to the mechanism, which is demonstrated by this example.

Example

The trustees of the Aspiring Trust derive $100.00 interest income.  After payment of resident withholding tax at 33% this equates to $67.00 cash and $33.00 RWT credits.

The trustees resolve to distribute the entire interest payment to Thomas, a beneficiary of the Aspiring Trust who has a marginal tax rate of 17.5%.

The  distribution is effected by a $67.00 cash to Thomas from the interest income received by the trustees and a further cash payment (referred to in the legislation as a substitution payment) of $15.50 together with $17.50 (of the original $33.00 RWT credit).  The tax on $100.00 for Thomas (given his marginal rate) is $17.50.  This means that Thomas receives cash of $82.50 ($67.00 + $15.50) and $17.50 of RWT credits.  Accordingly, Thomas has no further tax liability.

The trustees then offset the substitution payment made to Thomas of $15.50 against the remaining $15.50 of RWT credits and are in a revenue neutral position.

References:  

• Income Tax Act 2007,  s LB 3(1),(4),(5), RE 2(6)
• Vicki Ammundsen, Taxation of Trusts (ed 2), CCH New Zealand Limited 2011 at 15-090

This means that if a person is bankrupted any gifts made within the 2 years prior to bankruptcy are voidable as against the Official Assignee (this means that any gifts must be paid back to the bankrupt’s “estate” and can be used to satisfy creditors).  Further any gifts made between 2 and 5 years prior to bankruptcy are voidable against the Official Assignee unless the recipient of the gift can prove that the bankrupt was able to pay his or her debts without the property that has been gifted.

There is no statutory test of what it means to be able to pay debts.  However, case law provides useful guidance as to what the test of being able to pay debts is.  The principles of which can be summarised as follows:

• although the concern as to the ability to pay debts is with the present, it may be appropriate to also consider the recent past and whether the donor has been able pay debts as they become due over that time
• account must be taken of all debts both current and outstanding
• “as the become due” means legally due, that is that payment can be demanded or required
• it is not necessary to have cash to hand to meet all debts.  However, there is a need to strike a balance between liquid and illiquid assets.  It is not a matter of simply measuring assets against liabilities, or to say that given enough time to assets could be realised and debts paid.  There is an element of immediacy in the requirement to extract cash from non-cash assets where there is insufficient cash on hand to meet due debts
• the test is objective, not subjective.  That means that the test is not from the perspective of the person making the gift
• while conversion of some assets can be taken into account, it is also necessary to consider the possibility of further debts falling due while assets are being converted.  Accordingly, the period of consideration may span some days, weeks or months rather than a single point in time
• the test measures ability – not willingness.  A person may be solvent, with debts owing and able to meet the debts, even though the person has elected not to
• a person can be able to pay by having recourse to third party borrowings, and
• a debt is not due and payable if an unsecured creditor is not making demand and does not intend to.

Each case needs to be assessed on its own merits having consideration to the principles noted.  However, as the person who must prove ability to pay is the recipient of the gift (not the person who makes the gift) it is important that the recipient is in a position to do so.

Now that gift duty has been abolished and it is possible to make substantial gifts, prudence dictates the importance of retaining evidence of the donor’s ability to pay debts without reverting to any gifted property prior to making and accepting any substantial gift.  Where the recipients are trustees of a trust, they would be wise to ensure that they retain any evidence as to solvency together with any deeds of gift or other documentation relating to the gift.

References:

• Re Northridge Properties Limited (SC) Auckland M46/75, judgment of Richardson J, 13 December 1977
• Re Universal Management Limited (HC) (1981) NZCLC 98,238 at 98,246
• Taylor et al v Official Assignee in the Bankruptcy of the Property of Bronwyn Carol Taylor [2011] NZCA 630

Decided cases provide, it not absolute rules, some useful guidance.  As a starting principle compound interest is not imposed for the purpose of punishment; rather, in the trust context it is imposed when the courts are of the view that justice requires such an award.  Not entirely helpful perhaps.  At what point will justice intervene?  Generally, this can be expected where not only has the trustee acted wrongly, but the trustee has also profited from his or her wrongdoing, which will not always be the case, and in fact, which more often that not, is not the case.  However, where the trustee in breach has used trust monies in trade (or other personal enterprise), so that the trustee has profited from the trust monies, then compound interest may be awarded.

This can be re-stated as a 2 step test.  The first step is to identify the breach of trust, and where that is the case, then step two is to determine whether there was a degree of personal profit.

The next consideration, regardless of whether any interest is compounding or not, is from what date the interest runs.  While in some matters, courts routinely apply interest from the date of judgment, there is no fixed rule.  In a trust context the starting point where a beneficiary has been deprived of trust funds is to apply interest from the date the funds were first wrongly applied.  Where a matter has taken some time to get to court, this can still amount to a significant penalty even if only simple (non-compounding) interest.

References:

• Equitycorp Industries Group Ltd (in stat man) v R (no 51) [1196] 3 NZLR 690 at 696, 697
• Wallerstein v Moir (No 2) [1975] QB 373 (CA) at 397
• Victoria Street Apartments Limited (In Liquidation) v Treasury Technology Distribution Limited & Ors CIV-2009-404-008377 unreported judgment of Duffy J delivered 15 December 2011

It is also worth noting that when a person is bankrupted, any assets held on trust do not generally form part of the bankrupt’s estate.