Taxation Magazine/2006 Volume 158/Issue 4086, 30 November 2006/Articles/The certainties of trusts -Taxation, 30 November 2006, 218

Taxation

Taxation, 30 November 2006, 218

30 November 2006

The certainties of trusts

Trusts

Keith Gordon

is a barrister, chartered accountant and tax adviser. He practises from Atlas Chambers (telephone 020 72697980, www.atlaschambers.com) and can be contacted by e-mail at keith@keithmgordon.co.uk.

© Reed Elsevier (UK) Ltd 2006

Keith M Gordon MA (OXON), ACA, CTA, barrister considers the legal ingredients that are necessary for atrust to exist.

After the fiasco of the changes to the inheritance tax rules for trusts earlier this year, an article about thecertainties of trusts might seem like a bad joke. However, the 'certainties' are the legal ingredients that arenecessary for a valid trust to exist.

Anecdotal evidence suggests that the changes announced by the Chancellor on 22 March 2006 and thesubsequent policy realignment were the result of a fundamental ignorance among Treasury ministers andofficials about the nature of trusts. As readers of Taxation will know, trusts are more often than not used fornon-tax reasons, although this fact seems to be lost on Government spokespeople and on certain parts ofthe popular press. Furthermore, while many arrangements can be clearly seen to be trusts, there are manyarrangements, which are also trusts, though their status as such will not be obvious to a layperson (or aGovernment minister, one supposes). Other arrangements might appear to be trusts but, in law, are not.

What is a trust?

As with any concept that has been developed over time -- principally by the courts -- there is no single orconcise definition of what exactly a trust is. The accepted definitions all feature two classes of person: thetrustees and the beneficiaries. The membership of these classes can overlap.

One definition is that a trust is a relationship in which property is owned by the trustees for the benefit of thebeneficiaries so that the benefit of the property accrues to the beneficiaries rather than the trustees.

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Key Points

· Definition of a trust.

· Certainty of intention: importance of what the trust terms say.

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· Certainty of subject matter: clarity of what is subject to the trust.

· Certainty of objects: who are the beneficiaries?

· Why a trust can fail.

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However, the above should not be considered a conclusive definition but rather a starting point. For example,this definition does not make it clear that the trustees cannot deal with the property in any way they like;instead, they must act in accordance with the terms of the trust itself. See the EXAMPLE.

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Example

R and M are husband and wife. R then divorces M and marries his secretary, G. Following his remarriage, Rprepares a will which provides that, after his death:

· G is entitled to live in R's property for the rest of her life, but

· on G's death, the property then goes to the children of R's marriage with M.

R subsequently dies without revoking this will.

This is a trust. It is not a particularly rare type of trust. And, Government ministers please note, it is a trustwhich is not designed for tax avoidance or other nefarious purposes.

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In the EXAMPLE, I do not identify the trustees. Typically, they might be R's executors but they need not be.They might include G and/or one or more of R's children. The beneficiaries of the trust are G and R's childrenfrom his marriage with M. There might also be some residual class of beneficiaries to cater for the fact that Gmight outlive R's children. However, that will be made clear by the document by which the trust is created, inthis case R's will.

The trustees will 'own' the trust property in that it will be the trustees' names that will appear at the LandRegistry or on a bank account. In other words, to the outside world, the trust property will be owned by thetrustees. However, the trustees' right to deal with the trust property will be limited in accordance with theterms of the trust. Lawyers often distinguish, therefore, between the trustees' form of ownership ('legalownership') from the rights of the beneficiaries ('beneficial ownership').

The other important feature of there being a trust is that G's rights to the property are limited. G can live inthe property. Depending on the precise terms of the trust, she might be able to rent it out and receive therental income; G might also be able to persuade the trustees to sell the property and buy a replacement.However, what G cannot do is sell the property and pocket the proceeds. This is because the terms of thetrust provide that the capital belongs to the children from R's previous marriage.

Similarly, the children, while being beneficiaries of the trust, do not have the right to live in the property or tosell it until G's death. Until then, they must wait patiently for their interest to vest.

The certainties of trusts

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For a trust to exist, three things have to be certain when the trust is established. First, the person creating thetrust must want to create a trust ('certainty of intention'); secondly, the property subject to the trust must beclear ('certainty of subject matter'); and, finally, the identity of the beneficiaries must be clear ('certainty ofobjects'). I shall discuss these in turn. Although these three matters are distinct, it was held in Mussorie BankLimited v Raynor (1882) App Cas 321 that uncertainty in one aspect can have 'a reflex action upon thepurported settlor's previous words' when creating the purported trust.

These certainties are important as the courts need clarity if they are to enforce a trust. For example, if a courtis unsure whether a trust of property concerns Whiteacre or Blackacre, it will not hazard a guess at thesettlor's intentions. If one or more of these certainties is absent, the trust will 'fail'. The consequence of sucha failure will depend on the circumstances of the case and this is considered further below.

Certainty of intention

The certainty of intention requires the person creating the trust to intend to create the relationship whichconsists of a trust. This does not mean that the creator of the trust must consciously intend to establish atrust. For instance, in the EXAMPLE above, R might not realise that his will is creating a trust for his wife andchildren. What is important is that the terms by which the property will be owned after R's death will be suchthat give rise to a trust rather than outright ownership.

Many of the historical cases that consider the certainty of intentions deal with wills in which money has beenleft to an individual in the hope or confidence that the money would be applied for the benefit of another.Traditionally, such expressions were held sufficient for a trust to exist. However, in 1871 the courts took astricter approach and these earlier cases should now be considered of doubtful authority (Lamb v Eames(1871) LR 10 Eq 267). There is an exception in situations where a testator had deliberately followed aprecedent from a previous case and was clearly intending to create a trust.

Such disputes can usually be avoided by ensuring that the declaration of trust contains the words 'on trust' orupon trust'. However, as stated before, a trust can be created by someone with no knowledge, or evenpurported knowledge, of trust law. A good example was in the Court of Appeal case Paul v Constance [1977]1 WLR 527. See BOX 1.

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Box 1: Paul v Constance

In Paul v Constance, Mr Constance received a sum of money following a work-related injury which heinvested in a bank account in his sole name. At the time, Mr Constance was separated from his wife andliving with, but not married to, Mrs Paul. When Mr Constance died intestate, his estranged wife claimed thefunds as hers under the intestacy rules. Mrs Paul, however, claimed a beneficial interest in half the funds.

The evidence in that case showed that Mr Constance would have opened a joint account but for the fact thatit would have revealed the fact that Mrs Paul was not Mr Constance's wife and, in the early 1970s, this mighthave caused Mrs Paul unnecessary embarrassment. Furthermore, during the lifetime of the account, therewere a number of credits relating to some modest bingo winnings enjoyed by Mr Constance and Mrs Pauland one significant withdrawal which appeared to relate to the couple's joint expenditure.

Mrs Paul also gave evidence that, on several occasions, Mr Constance had commented that the money inthe account was as much hers as it was his. In the circumstances of the case, the court held that MrConstance was declaring a trust of which he and Mrs Paul were beneficiaries.

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Certainty of subject matter

As suggested above, a declaration of trust must specify clearly what property is to be held on trust.

For example, suppose an individual who owned two residences were to declare a trust over his 'home';without extrinsic evidence a court would have difficulty in determining which property was to be subject to thetrust. A similar problem arose in the case of Boyce v Boyce (1849) 16 Sim 476. See BOX 2.

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Box 2: Boyce v Boyce

In Boyce v Boyce, the deceased's will left his properties to his daughters on terms that the elder shouldchoose which of the properties she wanted and the younger should be entitled to the other. In the event, theelder daughter pre-deceased her father and, consequently, she made no choice under the will.

The court held that the gift to the second daughter failed for want of certainty.

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The courts have held that testamentary gifts have failed to qualify as trusts where wills have been too vagueto interpret with any certainty, for example, a gift of 'the bulk of [the testator's] estate' (Palmer v Simmonds(1854) 2 Drew 221). However, in Re Golay's Will Trusts [1965] 1 WLR 969, a gift of 'a reasonable income'was held to be specific enough in the circumstances. In that case, the will also provided that the executorsshould permit the beneficiary to 'enjoy one of [the testator's] flats during [the beneficiary's] lifetime'. Althoughthe will on its own did not specify which flat was to be enjoyed by the beneficiary, it did provide a mechanismby which the choice of flat could be made by the executors.

A number of cases concern wills which make a gift, usually to a widow, followed by a subsequent gift of'whatever is left [on the first beneficiary's death]' to other beneficiaries. In some cases, the original gift hasbeen held to be an absolute gift to the widow with the subsequent 'gift' merely a non-binding expression ofhope. However, in Re Last [1958] P 137, Mr Justice Karminski held that a similar gift gave rise to a trust withthe first beneficiary having only a life interest. Although the conclusions in these cases appear to contradicteach other, I would submit that they can be justified. The important thing is to identify the particular testator'sintentions by considering each testamentary disposal in context.

Certainty of subject matter can also be a difficulty when dealing with fungible assets and other similar assetswhich are not usually specifically designated. These have been relevant in two cases involving corporateinsolvency. Customers of the insolvent companies had paid for goods but had not had them delivered beforethe companies went insolvent. The customers therefore argued that parts of the companies' stock wereactually being held on trust. This would have had the result that the undelivered stock would not have beenpart of the companies' net assets, to be divided among all the creditors, but the beneficial property of thepurchasers.

In Re London Wine Co Ltd [1986] PCC 121, it was not possible for the courts to determine which bottles ofwine represented the property of which purchasers and, therefore, there could be no trust. A similarconclusion was reached in Re Goldcorp Exchange Limited [1995] 1 AC 74 in respect of gold bullion.However, those customers whose bullion had been segregated were able to assert that a trust had beencreated.

It should be noted that amendments to the Sale of Goods Act 1979 (with effect from 19 September 1995)would now give rise to a different result in such cases. However, one case that would not have been affectedby these amendments was Hunter v Moss [1994] 1 WLR 452. In that case, the settlor declared an oral trustover 50 shares in MEC Ltd, a company in which the settlor owned 950 of the 1,000 issued shares. The Court

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of Appeal unanimously held that such a trust was valid and did not lack certainty of subject matter. However,it should be noted that the decision has attracted some academic criticism. In particular, the court did notseem to address the possibility that the settlor, having made the oral declaration, could have proceeded tosell 50 shares in the company and invest the proceeds elsewhere. In the same way as in Re London WineCo Ltd, it was impossible to determine which bottles of wine belonged to the customers and which did not, itwould not be possible to ascertain whether (and to what extent) the shares sold represented trust funds.

Certainty of objects

Finally, a court must be able to identify precisely the beneficiaries of a trust if the trust is to be enforced. Untilthe early 1970s, this required one to be able to list every beneficiary. However, in McPhail v Doulton [1971]AC 424 this rule was relaxed for discretionary trusts. For such trusts, the test is now whether, for anyparticular person, it is possible to say with certainty that the person is in or outside the class of beneficiaries.

In addition, the terms determining the class of beneficiaries must be conceptually certain. Conceptualcertainty will therefore exclude trusts for the benefit of a testator's 'friends'. But, it has been held that aperson's 'relatives' is sufficiently certain a concept (Re Baden's Deed Trusts (No 2) [1973] Ch 9).

Finally, a discretionary trust must be administratively workable to be upheld. In R v District Auditor ex parteWest Yorkshire County Council, a trust purporting to benefit the [2.5 million] inhabitants of the county of WestYorkshire failed as administratively unworkable.

Failure of a trust

The consequences of a trust failing for lack of certainty will depend on the circumstances. If a personpurports to declare a trust over property and the trust fails, whichever certainty is lacking, then thedeclaration will be invalid. There will therefore be no disposal of property by the person.

If property is actually transferred but the attempted trust fails, there are different possible outcomes. If thereis insufficient certainty as to the transferor's intention to create a trust, the transfer will be treated as anabsolute gift. If either of the other certainties is lacking, the transferee will hold the property on a 'resulting'trust for the transferor. Where the purported trust was established under a will, the transferee will hold theproperty on a 'resulting' trust for the residuary beneficiaries of the estate.

Informality brings problems

Professionally drafted trust documentation should not give rise to difficulties as far as certainties areconcerned. However, practitioners should remember that in more informal situations, something that is calleda trust might not be a trust and vice versa.

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