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On March 18, 2013, B.C.’s new Family Law Act (FLA) came into effect to replace the Family Relations Act (FRA). One of the reasons behind the change was to encourage families to resolve their disputes outside of the B.C. court system. To achieve this, the FLA provides more clarity on the division of assets upon marital breakdown. However, as with most new legislation, there are specific provisions that have raised concerns among professionals. One particular area of concern for tax and estate advisors relates to how an interest in a discretionary family trust is treated.
In B.C., discretionary family trusts are used extensively by business owner-managers to facilitate income splitting, multiply the capital gains exemption, purify a company and for estate planning purposes. Beneficiaries of a discretionary trust are entitled to a distribution only if the trustees choose to allocate something to you. In other words, you may get something or you may get nothing – what you get is out of your control.
Under the old FRA, an individual’s interest in the trust was considered a marital asset only to the extent that it was ordinarily used for a family purpose. This was generally determined by the courts on a case-by-case basis. Under the FLA, however, an interest in a discretionary trust is considered an excluded asset. If the value of an excluded asset increases during the relationship, this increase is split evenly between the spouses. Seems simple and sounds fair, right? Well, maybe not.
The key issue is that the excluded asset is not the beneficiary’s interest in the discretionary trust. Rather, the FLA looks beyond the interest in the trust to the property owned by the trust itself. In the case of an owner-manager, this property is usually the shares of their companies. Therefore the excluded asset is the growth in the value of the shares and it is this growth that is shared equally.
There are some very significant and often illogical consequences that can result from this wording. Consider this scenario: Mr. & Mrs. Smith set up a discretionary family trust 15 years ago which owns the common shares of their company. In that time period, these shares have increased in value from $0 to $10,000,000. The Smiths have four adult children – all of them married - who are beneficiaries of the trust.
Suddenly, on March 19, 2013, all four children enter into divorce proceedings. Because each child has an interest in a discretionary trust, each of their spouses can claim 50% of the growth of the common shares – i.e. $5,000,000 per spouse. This means that $20,000,000 of total value will be transferred away from the four Smith children. This is a rather interesting result – some may say scary – since the shares are only worth $10,000,000 in the first place.
Another concern is that the children are beneficiaries of a discretionary trust. The Smith children each have an obligation to pay their spouses $5,000,000, yet there is no obligation for the trustees to distribute anything to them. As noted above, they may get something, they may get nothing.
Although this is an extreme situation, obviously the outcomes do not appear to be equitable, fair or even make sense. There has been talk that the legislation will be amended to deal with these concerns, but to date nothing has been addressed.
Does this mean that trusts are dead? No. There are still very valid reasons to use a trust. This is just another factor that needs to be taken into consideration when making the decision to set one up. Hopefully the legislation will be amended to help alleviate some of the issues.
Note that the FLA applies to a person who has lived in a marriage-like relationship for at least two years. This means that common relationships and same sex couples have the same rights under the FLA as married couples. There are numerous other changes considered by the FLA that have not been addressed in this blog.
Related Topics:Family; Legislation; Trusts
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