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The Value of a Beneficiary’s Interest in a Trust - Part 2

18/01/2016


​This article was originally published in the December 2015 issue of The Montreal Lawyer.

Discretionary Trusts

A discretionary trust is a trust in which the settlor has given the trustee(s) full discretion to decide which (and when) a beneficiary or defined group of beneficiaries is to receive the income or the capital of the trust. With such trusts, the trustees have the power to decide who the beneficiaries will be, the settlor will have identified or described a specific class of beneficiaries (which can include unborn individuals). It is an arrangement under which trust property is set aside, or earmarked, with directions that it be used for the benefit of another, (i.e., beneficiary). It provides that the trustee (whether appointed or otherwise required by law to administer the property) has the right to accumulate — rather than distribute to the beneficiary — the annual income generated by the trust assets or a portion of the assets. Depending on the terms of the trust instrument (trust deed), the annual income can either be accumulated for future distributions to the income beneficiaries or added to the corpus of a trust for the benefit of the remaindermen (those are who entitled to the balance of the estate after a particular portion of the estate has been distributed). The trustee of a discretionary trust has the full discretion to give or deny the beneficiary any benefits under the trust. The beneficiary cannot compel the trustee to distribute or use any of the trust property to the beneficiary’s advantage.

Valuation of Interest in a Discretionary Trust

If the trust is a discretionary trust, the valuator must con​sider, in addition to the respective factors enumerated above with respect to the valuation of non-discretionary trusts, the fiduciary powers of the trustee(s), in which case the valuator often will consult with legal counsel, as may be appropriate.

Each of the following factors must be considered and evaluated:

  • Settlor’s overall intentions in the context income tax or estate/succession plan;
  • Composition of the trust capital;
  • Value of the trust capital;
  • Assumed rates of return on trust capital;
  • Relationship between beneficiary(ies) and trustee(s);
  • Obligations of trustee(s), as specified by settlor/testator;
  • Possibility of a change of trustee(s);
  • Relationship between the beneficiary(ies) and trustee(s);
  • Likelihood of trustee(s) exercising power in favor of certain of the beneficiaries;
  • Obligation of trustee(s) to maintain an even hand vis-à-vis all beneficiaries;
  • Number of beneficiaries;
  • The rights of other beneficiaries;
  • Ages, health and needs of the other beneficiaries;
  • Life expectancies of other beneficiaries;
  • Letter of Wishes, if any, and possible access thereto;
  • Legitimate expectations of the other beneficiaries;
  • Contingent taxes;
  • Degree of control by one particular beneficiary (as trustee or through relationship to trustees) vis-à-vis other beneficiaries;
  • History of distributions to beneficiaries; and
  • Willingness of trustee(s) to provide beneficiaries with documents, information or reasons regarding exercise of discretion, etc.

The Canada Revenue Agency has stated the following:

“It would be unreasonable to conclude that the Fair Market Value of an interest [in] a discretionary trust holding property with significant value has no value simply because it is difficult to measure. In the absence of any term of the trust that would direct the trustees to favour one beneficiary over another, the even handed principle would suggest that value of each beneficiary’s interest was approximately equal. Where the facts support a finding that one beneficiary has a lesser chance of receiving a distribution from the trust than another beneficiary, it may be appropriate to discount the value of one interest and increase the value of another.”

Often, the valuator will consult with counsel with respect to certain provisions of the trust deed or will, as well as any other factors that can have a direct bearing on the economic benefits that would be expected to inure to the particular income or capital beneficiary of the trust.

Example of Discretionary Powers Afforded the Trustee

“In this Trust Agreement, I have authorized certain discretionary distributions to or for the benefit of designated persons for the suitable support, maintenance, health, and education of such persons. My intention is that the Trustee shall take into account the following factors: (a) the other assets (excluding any personal residence and automobiles and other tangible personal property held for personal use) and the income from other sources of such persons and of any person legally obligated to support any of them; (b) any private or governmental medical insurance or other medical payments to which such persons may be entitled; (c) their relative ages, needs, and customary standard of living; (d) my desire to afford any of such persons an opportunity to enter into a business or profession if the Trustee shall determine in the discretion of the Trustee that it appears more likely than not that the venture will be successful; and (e) such other factors as the Trustee considers relevant. In addition, the Trustee shall have the power to purchase a home for such persons in the name of the trust, rather than making a distribution directly to such persons for such purchase if the Trustee determines, in the discretion of the Trustee, that such a course of action would be in the best interests of such persons.”

Conclusion​

The Fair Market Value of an interest in a non-discretionary trust will consider such factors as the value of the trust capital, the asset mix, rates of return, beneficiary’s life expectancy, the estimated timing and amounts of the distributions, encroachment rights, history of distributions, taxes, etc. However, in valuing a beneficiary’s interest in a discretionary trust, additional factors must be considered, such as the fiduciary powers of the trustees, the settlor’s/ testator’s overall intentions, history of distributions, rights of other beneficiaries as well as their ages, health and needs, the relationship between the beneficiary and the trustee(s), the obligation of trustee(s) to maintain an even hand, the testator’s Letter of Wishes (if any), availability of information from the trustee(s), possibility of change of trustee(s) etc.

As with other types of assets, the bottom-line test of the Fair Market Value of an income interest or capital interest in a discretionary trust is, “What would an informed and prudent arm’s length party, who is uncompelled to transact, pay for a life interest or reversionary interest?” As there is no definitive economic interest (unless the vendor of the trust interest happens to be the sole beneficiary) in the income or capital of the trust, the Fair Market Value of an interest in a discretionary trust would have, at best, “speculative value” and can even be $1.00 or nil. In the real-world, life interests and reversionary interests are sold in England for a capital sum in the open market by way of public auction!