A discretionary trust is a trust in which the beneficiaries’ rights in relation to the trust assets are limited to the right to be considered by the trustee when the trustee resolves to distribute income or capital.

Specifically, the trustee has the full autonomy to distribute all of the income and capital of the trust to one or more of the beneficiaries (including to the trustee themselves, if they are a beneficiary) to the exclusion of all other beneficiaries.

While the beneficiaries will also have a range of other rights against the trustee, such as the right to due process and the right to access certain trust documents, no beneficiary has a right to require the trustee to transfer trust assets to them.

This principle was illustrated in the UK decision of Gartside v Inland Revenue Commissioners [1968] AC 553 (Gartside), which held that beneficiaries of a discretionary trust:

• Do not have a proprietary legal or equitable interest in the trust assets and are merely a member of a class of potential beneficiaries in relation to the trustee’s power of appointment over trust income and capital
• Do have the right to insist on the proper administration of the trust.

The Gartside decision has been adopted in numerous Australian cases, including Lygon Nominees Pty Ltd v Commissioner of State Revenue [2005] 60 ATR 135.

There are various other types of trusts in which beneficiaries do in fact have some entitlement to the assets of the trust. For instance:

• The beneficiaries of a unit trust (being the unitholders) have a fixed entitlement in the interests of the trust and that entitlement will have value, in the event the unitholder becomes bankrupt or insolvent
• Various types of ‘hybrid’ trust exist where the beneficiaries have a combination of fixed and discretionary entitlements. For instance, a beneficiary may have a fixed entitlement to all of the income of the trust while the trustee retains discretion as to how any capital distributions are to be made. Again, a beneficiary’s fixed entitlement to income will have value upon bankruptcy or insolvency
• Where a discretionary trust is allowed to vest, the takers-in-default of that trust will acquire fixed entitlements in accordance with the terms of the trust deed
• Once the trustee has passed a resolution to distribute income or capital to a beneficiary, that amount will become an asset in the hands of the beneficiary, regardless of whether the amount is actually paid to the beneficiary

In each of the instances above, the assets of the trust may be exposed to a claim by a trustee in bankruptcy, liquidator or former spouse.

For further information, please contact Patrick Ellwood on 0400 503 111 or patrick@cloverlaw.com.au.

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