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Plenty magazine: Winter 2007. Book excerpt Mark Maxwell Illustration Anna Crichton.
Family trust expert Mark Maxwell is so concerned about the number of dodgy trusts operating in New Zealand that he’s written a book, Trusts – A Kiwi Sham? Maxwell reckons more than 75 per cent of New Zealand’s 250,000-odd trusts may be flawed. That means your assets may be at risk from ex-spouses, business creditors, government departments and even your kids – anyone, in fact, who feels owed and thinks your trust can be busted. Here’s the problem: we set up trusts and then fail to look after them.
Trust management, or the lack of it, is the number one issue facing trustees. Why? Because thousands of new trustees simply don’t know what is expected of them. Those challenging a trust will argue that a true trust relationship does not exist. So how do you prove it does? Is it enough to produce some documents recording its establishment?
The short answer is no, and the longer there’s no proper management, the easier it will be to prove that those who established the trust (the settlors) have carried on as if it were never set up.
Experts disagree whether inadequate or non-existent trust management will, in itself, make a trust a sham. I believe that, more often than not, it will. A sham trust has all the appearance of a trust, while the true intention is something different. It could be a sham from the outset, or become a sham over time. The most common situation is where trustees don’t make their own decisions and instead merely follow the instructions of the settlor.
Simply: if a trustee is not discharging their duties properly then it can be argued that the trust is a sham. If you’re a trustee, here’s what you need to focus on.
Document management
Document management is important for trustees. Being able to produce quality trust-management documentation is the fastest way to put off a would-be challenger and goes a long way towards proving that the trustees understand their duties and are discharging them well.
You need to understand what documents are required and have a system to manage it. One master file should contain all documentation and correspondence. Each trustee also needs a personal file with a copy of the trust deed and minutes of meetings. Original documents, such as the trust deed, should be kept secure in a safe place.
Minute book and resolutions
You must keep minutes and resolutions recording all decisions made. What is recorded, and when, will be a matter for the trustees to determine. It is essential, however, to complete an opening resolution recording the trust’s creation, receipt of the initial trust settlement and any purchase of initial assets.
Other early minutes might cover the appointment of various advisors, the opening of bank accounts, setting investment strategy and the like. Trustees will continue to make decisions over time and while they may decide not to record minor points until the next annual meeting, any major decisions should be discussed and documented when they happen. A common example would be the sale of a trust property that is providing a home for the beneficiaries. This requires a record detailing the process from start to finish, with real estate contracts drawn up in the names of all the trustees.
The paperwork need not be onerous; it just requires a little forethought. Note that you need minute only the decisions, not the reasons behind them. It may be entirely appropriate at times to record trustee discussions, but it could also provide evidence for anyone looking to challenge a trust. Trustees should always think carefully about what is put in writing.
Beneficiary Schedule
Trustees have a duty to act impartially towards beneficiaries. You should at least consider their needs at the annual trustees’ meeting. How can you do so if you know little or nothing about them?
As a minimum, record beneficiaries’ names, addresses, ages, births, deaths, marriages and any special considerations or needs they may have. This is extra-important for independent trustees, professional or not, who may never have met some beneficiaries and will only have information provided by the other trustees (often the settlors) to go on.
Independent trustees should ensure they have sufficient information on all beneficiaries to exercise sound judgment. Remember, trustees are required to act personally.
Asset and liability schedule
Trustees have a duty to know the current position of the trust. It seems obvious that they should record assets owned and liabilities owed. In my experience, too many unfortunately do not.
The schedule does not have to be complex. For simple trusts a straightforward list will do. More complex trusts may require full financial statements prepared by an accountant. The most important thing is that a schedule of some sort exists, that all trustees have a copy, and that it is regularly updated.
Gifting schedule
Regular gifting is a feature of most trusts, so a schedule is vital to ensure that transactions happen on time and that gift-duty liability is not inadvertently created. Many rely on professional trustees to keep records, but too often they see it as a job to ‘get out of the way’ and don’t give it the attention it deserves. In addition, the industry has priced gifting fees at between $150 and $350 per year, which often is not enough for the time it takes to get it right.
Gifting is not always as simple as subtracting $27,000 from last year’s debt balance, preparing a Deed of Forgiveness of Debt and Gift Statement, having it signed and sending it to Inland Revenue.
Trustees should also check for other transactions that may have impacted on last year’s balance. Mortgage principal repayments and additions and alterations to trust properties are common examples.
Omitting such transactions will mean that the trust’s financial position is incorrect. Worse, it may even create a gift-duty liability to Inland Revenue. Getting it wrong can have costly consequences.
Financial Accounts and Tax
Annual accounts should be prepared for every trust. If you decide to do it yourselves, it is simply a matter of recording transactions during the financial year.
If you are not certain of your taxation responsibilities, get advice from a suitably qualified expert, such as an accountant.
Inland Revenue requires all income-earning trusts to file an annual tax return and many trusts also have GST and Fringe Benefit Tax obligations.
More complex trusts may need a professional to prepare financial accounts, file tax returns and advise on tax-efficient structuring. The cost of getting things wrong far outweighs the size of accountancy fees.
Investment Strategy
One of the greatest risks facing trustees is in the duty to invest prudently. Trustees are not required to make outstanding profits or ‘beat the market’, but need to understand the trust’s goals, decide on a strategy to achieve those goals, implement the strategy and monitor it.
It may sound strange, but the actual returns are almost less important than the process employed. This is why having a clearly written strategy is so vital. No one gets it right all the time with investing, but trust beneficiaries regularly have unrealistic expectations.
If no clear strategy is in place, trustees lay themselves open to claims they should have performed better. Beneficiaries may even seek compensation from them personally. It’s even more risky to deviate from an agreed strategy in search of spectacular returns without recording the reasons why – especially if the investment doesn’t perform as expected.
Seek investment strategy advice if you are short on experience. Remember, though, advice is just that – advice – and many experts have vested financial interests. As a trustee, you make the final decision, so it is important to understand the strategy and not to follow advice blindly.
Insurance
Trustees have a duty to protect the assets they control. If you fail to insure them at all, or for less than full value, you may have to compensate beneficiaries if trust property is lost or destroyed. In effect, such trustees are ‘self insuring’ without even being paid a premium. It simply doesn’t make sense.
Independent trustees need to be especially careful. Some people don’t believe in insurance. This is their privilege when assets are in their own names and they carry the risk but, if those assets are transferred to a trust, the trustees have to insure them. Independent trustees must demand assets are insured, or resign. If you lack insurance experience it’s sensible to find a broker to meet the trust’s needs and review insurance annually.
It is vital to instruct insurance companies when assets are transferred to a trust. Failure to include the right names on the policy could see any claim refused. Seek confirmation from them in writing.
Annual Trustee Meetings
A formal meeting should be held at least once a year, or more often if a trust is complex. There needs to be an agenda and all trustees should attend.
Meetings should review all relevant matters, such as investment strategies, insurances, beneficiary needs and asset maintenance. Record minor decisions made since the last meeting and consider appointing one of you to handle upcoming tasks.
If possible, ask professional advisors to the meeting. Any additional cost is well worth it to ensure lawyers, accountants, trust managers and investment advisors are working as a team. It also supplies specialist advice on the spot, which aids robust decision making.
Record the decisions made. Trustees need to sign the minutes afterwards as a true reflection of proceedings and each of you should keep a copy in your personal trust file.
This is an abridged excerpt from Trusts – A Kiwi Sham? It’s available from all good bookshops or online at www.integritytrust.co.nz, where you can also evaluate the soundness of your trust with author Mark Maxwell’s free Trust Bust Test.
Reprinted by permission. Copyright 2007 Plenty magazine Winter 2007
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