Listen to Sham and Secret Trusts.
This week on Hull on estates, Ian and Suzana discuss Sham and Secret Trusts.
Sham and Secret Trusts – Hull on Estates Podcast #105
Suzana Popovic-Montag: Hi and welcome to Hull on Estates. You’re listening to Episode #105 of our podcast on Tuesday, April 8th, 2008.
Welcome to Hull on Estates, a series of podcasts for the Canadian legal community dealing with issues and insights surrounding estate planning in Canada. Hosted by the lawyers of Hull & Hull, the podcast will touch on some key considerations when planning estates and Wills. Now, here are today’s hosts.
Ian Hull: Hi Suzana, its Ian Hull here.
Suzana Popovic-Montag: Hi and it’s Suzana Popovic-Montag. How are you today?
Ian Hull: Just great. We’re celebrating what, 105 now? We haven’t been doing this since 100 so good to be back, good to think about some issues that have been rumbling around in my mind. Just want to remind everyone to feel free to call in to our call-in number at 206-350-6636.
Suzana Popovic-Montag: Or you can drop us an e-mail at our gmail address which is firstname.lastname@example.org. Or, of course, you can visit us at our blog which is estatelaw.hullandhull.com.
Ian Hull: So Suzana, I know that when this launches into the internet, we are going to both actually be out of the country. I’m not going to be as nearly as exotic a spot as you are. But you’re off to Vienna and Prague to test the world markets on estate law and on law generally at a great conference. What your trip triggered in my mind was I thought we might have a discussion today about was issues that have, sort of, a broad and international perspective. And that, of course, ties into trust law generally. Where you’re going, both jurisdictions in Prague, it’ll be slightly different, I think it’s more of a civil code, but the Vienna system as well you’re going to be tied into the – learning a lot about the civil code. But the common law and where to cross the border is governed, trust laws are fairly consistent. And one of the things that they use tremendously in planning in Europe is, of course, trusts to avoid what can be very draconian and overwhelming tax liabilities on death. The classic scenario, certainly in the U.K., that a lot is written about and much case law comes out of, is situations where you create a trust that isn’t really a trust and we call it, of course, sham trusts. Another scenario is, of course, where you might have a situation where you created a secret trust or a semi-secret trust. So I thought it might be fun to talk a little bit about those angles on trust law. And why don’t we start with the sham trust, if that’s ok.?
Suzana Popovic-Montag: That’s great, Ian and I know you’ve written quite a bit on this topic and I think it’s a really interesting one. It doesn’t necessarily – it isn’t necessarily something that we see a lot of but it definitely is something that is on the rise in terms of the literature that’s out there. What a sham trust really is and I guess the best way to, sort of, start with a description of it, is to start with the concept of a bare trust which is a simple trust in that the trustee is a repository of the trust property and he or she or it has no real active management duties to perform.
Ian Hull: And, of course, we’re talking about sham trusts, trying to essentially avoid sham trusts because if it is called a sham trust, then CRA and, of course, the Courts won’t give you the protections nor the tax advantages that may or may not exist. So your comment about the bare trust is crucial because that can be a useful and legitimate tool to create a trust relationship. There are, of course, really the opposite to a trust, proper trust with the three certainties or a bare trust as you’re describing, which is a proper trust with the three certainties only with a see-through flow-through in terms of the responsibilities. The opposite would be the sham trust itself. And that’s where the Courts and CRA get a little fussy about it.
Suzana Popovic-Montag: And on the face of it, it really does appear to be a trust in the sense that there is a trustee, there is a beneficiary and equitable rights are created in those beneficiaries.
Ian Hull: So in a situation where a sham trust has been held by the Court, a trust has been held to be a sham trust and not legitimate for the purposes being sought, is where the Court finds that the only real duty of the trustee is to do what the settlor says. And I know that’s sort of a bit vague but the Courts often go on and say well, you know, they describe these sham trusts as pretend trusts.
Suzana Popovic-Montag: And they do that because the common intention of the parties in these kinds of circumstances, the Court will find, is that it was not to actually create a trust with its associated rights and obligations.
Ian Hull: And really the Court just gets frustrated and a little cranky with people who create these sort of trust arrangements because they see them as an act or a document that is intended to mislead third parties.
Suzana Popovic-Montag: And I know sometimes the cases will actually go so far as to say and I’m just quoting from one of the cases that I am thinking of, that it’s an illusion basically, that it’s calculated to lead the tax collector, i.e. CRA, away from the actual tax payer. And so what it ultimately does is creates this façade of a reality of a trust, when in fact there isn’t one.
Ian Hull: Alright, so let’s talking about determining if it is a sham trust and what the Courts will look at.
Suzana Popovic-Montag: Well I think the first thing that they start with, of course, is the actual terms of the trust.
Ian Hull: And then they tend to talk about it being really a question of control.
Suzana Popovic-Montag: And in that sense, you know, it seems to be that they’re looking at whether or not the settlor has maintained control notwithstanding the fact that a trust has, on the face of it, been established.
Ian Hull: And one of the tests that I’ve seen in the case law is that the Courts will say, is the trust a mere alter ego of the settlor and that’s all?
Suzana Popovic-Montag: Now, Ian, I think we sort of understand the concept of a sham trust. And what would you say would be sort of a good example of that, that you’ve seen recently or where people would want to try to create these situations and then ultimately not be successful because a Court finds that, in fact, it’s not a valid trust?
Ian Hull: Well the classic one that we see in Canada is the off-shore trust. Of course, off-shore trusts can be a good idea, they’re not all sham trusts, for sure. They create excellent tax planning, estate planning and creditor protection availability for wealthy clients. But if it’s not done correctly, you do create the difficulties that a Court from another jurisdiction will be looking through the trust and determining whether or not it is a sham.
Suzana Popovic-Montag: And I guess that sort of underscores the importance of working possibly with counsel in the jurisdiction where you’re trying to establish that trust, as well, in order to create something that hopefully will sustain the test by a Court.
Ian Hull: And, of course, and you know again, talking about the positives, is these trusts, the bare trusts in particular, can be a useful tool, these off-shore trusts can be useful tools, they create a tremendous amount of ability for wealthy clients to have confidentiality. And while they have to in Canada, of course, declare their worldwide income, they don’t necessarily have to have it openly documented for others to see what exists and where it exists.
Suzana Popovic-Montag: And so there definitely are advantages to it. But what would you say would be a consequence of the fact that it’s a Court or someone who would ultimately determine, I guess CRA, that it isn’t in fact a valid trust?
Ian Hull: Well I think the key is, I mean many times these sham trusts are established for tax reasons. But the trust… where the Courts, what the Courts will do is, is that they’ll say, if it is indeed a sham trust, the trust assets are then taxed as if it was in the hands of the settlor. So, you know, any of the advantages that you may have tried to create are lost.
Suzana Popovic-Montag: And I guess most importantly, the creditor protection and, I guess, as well the loss of confidentiality to some extent, as well.
Ian Hull: For sure and I think that’s – you know, in many situations, a bit of a deal breaker.
Suzana Popovic-Montag: I think if we just spend a couple minutes, we’ve got some time here, Ian, to turn to the concept of secret trusts. And I know I’ve heard you speak about them in the past and you say, you know, what they really amount to is taking the trust concept as we understand it at law and then becoming, you know, agent 007s.
Ian Hull: Absolutely. It’s the James Bond trust. And this trust, if done properly, can be a useful tool to again, it doesn’t elude CRA, but it might elude people who want to keep their assets more confidential and it’s an on-shore opportunity and an off-shore. But it’s an on-shore opportunity to create a situation where the assets transfer from the settlor or a testator, depending if it’s someone who’s passed away, to a beneficiary, but through a third party.
Suzana Popovic-Montag: And the advantage there is that, of course, trusts can remain private documents, whereas Wills are potentially very public. And so if you’re trying to create an arrangement where you’re providing for a beneficiary-trustee relationship without it necessarily being known by everyone, you try to create this kind of secret trust arrangement.
Ian Hull: That’s right. And I mean, so the client really in this situation wants to make a gift but the nature of that gift they do not want to make public for whatever reason. And I think of an easy illustration was one that I ran into on a case that talked about a situation where the individual had a lot of wealth, wanted to pass on some of that wealth to the child after death, didn’t want the child really – not that the child should know, but didn’t want the public to know just how wealthy that child was going to be, because he feared people would prey on that child and try to take advantage of that child’s financial circumstances.
So the steps were to leave it through to a third party, hold it on a secret trust, the terms of which we’ll talk about in a moment here. But the terms of which are disclosed properly and then the identification of the terms of the trust can, sort of, hold their own.
Alright, so we’re just about winding up, but I just want to remind, sort of, when I think about it, I’m reminded of the secret trust because the key is, is that the trust is typically not reduced in writing, the trustee will typically keep the money for him or herself, which obviously creates its own problems, but it is one that you need to have in some way, either through provisions of the Will or some way, articulated what the terms of the trust are.
Suzana Popovic-Montag: And that really is the key because this arrangement, by very virtue of the fact that it is a secret one, has to somehow be, as you say, reduced to provide the settlor with as much guarantee or as much protection as possible, in light of the fact that, you know, there are these inherent difficulties with it.
Ian Hull: So, in conclusion, you need, sort of, the essential ingredients to pull off a secret trust, is of course, you need a trust with the three certainties.
Suzana Popovic-Montag: And you also need an intention of the deceased to actually benefit the secret beneficiaries.
Ian Hull: You need communication of the trust terms to the trustee and/or the beneficiary.
Suzana Popovic-Montag: And thirdly, you want to have acceptance by the trustee or the beneficiary which is going to be sufficient to actually induce the testator not to execute a Will to that effect.
Ian Hull: Terrific. Okay well, thank you very much, Suzana, good to be back on Hull on Estates. Hope that was certainly interesting for me to review these reasonably unique trust questions, but they do pop up from time to time and can be an important part of an estates practice. So I remind everyone to feel free to call in to our call-in number, 206-350-6636.
Suzana Popovic-Montag: Or, of course, feel free to send us an e-mail at email@example.com or visit our blog and webpage at estatelaw.hullandhull.com. Thanks very much, Ian
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