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Trustee Discretion: Where Absolute does not mean Unfettered

Trusts, and discretionary trusts in particular, are a staple of estate planning for their flexibility and adaptability. They can address a multitude of situations such as: managing assets for spouses, minors, persons with disabilities or vulnerabilities; asset protection and preservation; business wealth and succession; and incentivizing activities such as education. Trusts are not just for personal planning as they can form the basis for active charities and foundations or be used for business purposes such as mutual funds or an alternate to a corporation.

Whatever the flavour of trust, a key to their effective functioning is the trustee powers, which can be subject to varying degrees of discretion. Trustee powers can cover issues such as the following, which may not all be included in a particular trust deed:

  • Income and capital distributions
  • Determining the distribution date
  • Selling and mortgaging real property
  • Ability to make loans or borrow+
  • Investing trust property
  • Acquiring and selling trust property
  • Retaining advisors, agents and experts
  • Settling new trusts or transferring assets to other trusts
  • Removing and replacing trustees
  • Adding and removing beneficiaries
  • Amending the trust deed
  • Making tax elections
  • Settling claims

What is the difference between a Fixed and a Discretionary Trust?

The term “fixed” versus “discretionary” refers to the power of trustees to distribute income and capital.

An example of a fixed interest trust is one where a beneficiary is entitled to receive all of the income during their lifetime, and no one else has a right to the capital, such as alter ego, joint partner or spousal trusts. Here, the trustee does not have discretion whether or not to pay income to the specified beneficiary; however, the trustee may still have discretion as to the timing of the payments during the year and the amounts, provided all of the income for a particular fiscal year of the trust is paid or payable to the income beneficiary.

A special example of a discretionary trust is the Henson trust, which states in its provisions that the income and capital does not vest in the primary beneficiary. Instead, the only interest the beneficiary has is to payments of interest or capital actually made to or for their benefit. As a result, it is the remainder beneficiaries who are the true beneficiaries and the primary or life beneficiary is the object of a power of appointment instead, which may be fiduciary in nature.

Henson trusts are used for disability planning purposes to manage assets for persons who may not be able to manage them personally, although this is not always the case. The other purpose is to prevent erosion of benefits under the Ontario Disability Support Program Act. Henson trusts can be either inter vivos or testamentary.

The distinction between trusts that are fixed versus discretionary is also relevant for income tax purposes as discretionary trusts are subject to the 21-year deemed disposition rule, but not fixed trusts. Where the rule applies, the trust is deemed to dispose of all of its property on the 21-year anniversary at fair market value, which can trigger capital gains or losses in the trust. In the case of gains being triggered on which taxes will be payable, this could cause liquidity issues in the trust.

Section 108(1)(g) of the Income Tax Act’s definition of a trust clarifies what is meant by “fixed” for the purpose of the ITA and certain trusts to which it applies by requiring all interests to have vested indefeasibly at the particular time. As a result, qualifying fixed interest trusts are not subject to the 21-year deemed disposition rule.

How can discretion be absolute, but not unfettered?

This seeming contradiction was at issue in the case of Walters v. Walters, 2022 ONCA 38 (CanLII), which involved the interpretation of a Will that gave the trustees of a spousal trust the right to encroach on capital in their absolute discretion for the benefit of the spouse to ensure his comfort and well-being.

Paragraph [8] of the appeal case reads as follows:

[8]         Ollie’s last will and testament, dated October 18, 2006, provided Gerald with a life interest in her Estate, remainder to her three children. Paragraph 4(b) of the will states:

I DIRECT my Trustees to hold the residue of my estate in trust for my husband, GERALD CECIL FREDERICK WALTERS, for his lifetime, and I DIRECT my Trustees to keep such residue invested and to pay to or for the benefit of my husband, GERALD CECIL FREDERICK WALTERS, by monthly or other convenient instalments the net income derived from the residue of my estate. In addition, I DIRECT that my Trustees shall have the right to pay such part or parts of the capital of the residue of my estate as my Trustees in their absolute discretion consider necessary or advisable to or for the benefit of my said husband from time to time. I wish to advise my Trustees that my husband’s comfort and welfare are my first consideration and for this reason, it is my desire that my Trustees exercise their powers to encroach on the capital in a manner which will ensure his comfort and well being.

The trustees of the spousal trust for Gerald were his and Ollie’s children, and the relationship between the parties broke down leading to litigation. Gerald claimed that the trustees were required to encroach on capital in order to ensure his comfort and well being. Conversely, the trustees argued that they had an absolute discretion with regard to encroaching on capital and that their mother had set out a wish and not a direction.

After a thorough analysis, the appeal court stated:

[48]      To sum up, court intervention into the exercise or failure to exercise a discretionary power flows from a trustee’s fiduciary status. The court may intervene even where the testator has conferred an absolute discretion on the trustee. Mala fides and improper consideration of extraneous matters are encompassed by this analytical framework. Applying this framework to this appeal, the focus of the appeal was the application judge’s intervention on the basis of the Trustees’ consideration of extraneous or irrelevant matters.

The Court of Appeal found that the application judge’s intervention was fully justified. In other words, the trustee of Gerald’s trust had broad, but not unfettered discretion.

For further reading about trusts, some earlier O’Sullivan blogs

Special Needs, Special Trusts (2018)
Using Trusts: The Future is Bright (2016)
Family Law – Family Trusts: What Happens When a Marriage Breaks Down? (2015)
Planning with Discretionary Trusts for the Matrimonial Home (2014)
Trusts – It’s Not All About the Tax (2012)

— Blair L. Botsford

The comments offered in this article are meant to be general in nature, are limited to the law of Ontario, Canada, and are not intended to provide legal or tax advice on any individual situation. Before taking any action involving your individual situation, you should seek legal advice to ensure it is appropriate to your personal circumstances.