Can the Family Trust Be Used as an Estate Planning Tool?

Estate Planning and Litigation

I have been asked a number of times recently whether there is still any use for the family trust as an estate planning tool. The issue has arisen as a result of the property law provisions in the new Family Law Act, and the concern that any increases in value of property held in a discretionary trust throughout the course of a relationship could be subject to family property claims. Fortunately, recent amendments to the Family Law Act have improved the situation meaning that despite ongoing concerns, the family trust remains a useful planning tool.

By way of background, the Family Law Act came into force replacing the former Family Relations Act approximately one and a half years ago on March 18, 2013. For a broad overview of the property division regime under the Family Law Act, please see my earlier article, “Major Changes with New Family Law Act – Division of Property”.

At a high level, property under the Family Law Act is either “family property” subject to equal division upon separation, or “excluded property”, which is not subject to division. One class of excluded property was contained in s. 85(1)(f) of the Family Law Act as it existed prior to May 26th, 2014, which read as follows: (f) property held in a discretionary trust

(i) to which the spouse did not contribute,

(ii) of which the spouse is a beneficiary, and

(iii) that is settled by a person other than the spouse;

Despite the fact that property held in a discretionary trust meeting the above description was excluded from the definition of “family property”, the increase in value of that property was subject to division as family property due to the effect of s. 84(2)(g) which specifically includes as family property : (g) the amount by which the value of excluded property has increased since the later of the date

(i) the relationship between the spouses began, or

(ii) the excluded property was acquired.

The primary concern with these provisions was that it meant any increase in value of the actual property held by the discretionary trust, as opposed to the increase in value of the beneficiary’s interest in the trust, became family property to be divided equally between spouses.

The consequence of this language would potentially entitle a spouse to half the increase in value of the property held by the trust despite the fact that there may be other beneficiaries of the trust, and despite the fact that the beneficiary spouse has no guarantee of ever receiving anything from the trust, due to its discretionary nature.

As an illustration of the potential problem, imagine that a parent settled a discretionary trust with two children as the beneficiaries. The only assets of the trust are shares in a corporation and such shares were cumulatively worth $100 at the time that each of the children married their current spouses (an unusual case of month apart sibling weddings). Since the marriages took place, the shares have increased in value to $1,000,100. If each of the children were to separate from their spouses now, then each of the children’s spouses would be entitled to one half of the growth in value of the assets of the trust – the result being that each spouse of the beneficiaries would be entitled to $500,000.00 and only the initial $100 would be left for the intended beneficiaries.

The situation would be even more problematic if there were three beneficiary children separating from spouses, as each of the spouses would be entitled to $500,000.00, which is more than the value of the trust property itself.

The above scenario could not have been what was intended by the legislature. Perhaps in reaction to the outcry from trusts practitioners, the government introduced amendments to the trust provisions of the Family Law Act on May 26th, 2014 which have to some extent remedied the issues presented in the original draft of the Family Law Act. Essentially, under the new wording, it is no longer the increase in value of the assets of a discretionary trust which is considered family property; instead, it is the appreciation of the beneficiary’s interest in the discretionary trust which is divisible family property.

Although the amendments have improved the situation, all is not better. The new legislation mandates that valuation of family property is to be based on fair market value. Technically, a beneficiary’s interest in the discretionary trust should be worth nil, since the beneficiary’s right to the underlying property of the trust or any distribution is entirely at the discretion of the trustee. However, the legislature clearly had the intent of putting some value on an interest in a discretionary trust and accordingly, it is quite likely that the court will find a way to attribute value to these interests in some or all circumstances. In order to do so, the court may look at the number of other beneficiaries and the nature and frequency of distributions.

Such analysis is not unlike what the court would do under the former Family Relations Act. Despite the potential for trust interests to become family property, there are still benefits to creating family trusts and ways to minimize risk that a beneficiary’s interest is valued in a way that is contrary to trust law.

Prospective spouses should also consider (or their parents should encourage them to consider) entering into marriage agreements where appropriate, which, so long as they are entered into under fair circumstances will be given greater deference under the new Family Law Act. We encourage readers to contact us to discuss their specific circumstances, and the utility of certain planning tools for their long term goals.

Christine Eilers
Former Associate Lawyer in Trusts and Estate Law
Lindsay Kenney LLP – Vancouver Law Firm