Tuesday, April 27, 2021

Exclusion of settlor and the notional settlor (claws) or clauses** as the case may be

Today’s post looks at the rationale behind excluding settlors and notional settlors of trusts. 

Almost all trust deeds contain a clause excluding the settlor of a trust from being a beneficiary, in order to ensure the trust is not subject to adverse tax consequences as a ‘revocable’ or resulting trust under section 102 of the Tax Act. 

Some deeds, however, take the restriction further by prohibiting distributions to any ‘notional settlor’, in addition to the actual settlor. 

For example, a trust deed may include a provision along the following lines: 
1.1    ‘A person who has transferred property for other than full consideration in money or money’s worth to the Trustee to be held as an addition to the Trust Fund (herein called ‘the excluded persons’), or any corporation in which and the trustee of any settlement or trust in or under which any excluded person has an actual or contingent beneficial interest, so long as such interest continues, is excluded from the class of Beneficiaries.’ 

Where this type of a clause exists, a beneficiary will likely be excluded from receiving distributions, if they have: 
  1. made interest-free loans to the trust;
  2. sold an asset to the trust at less than market value; or
  3. gifted cash or other assets to the trust.
As the main beneficiaries of a trust will have often contributed amounts to a trust in one or more of the ways mentioned above, the risk of invalid distributions being made, where such a clause exists in a deed, are significant and anecdotally we understand this issue is one the Tax Office reviews regularly. 

Generally the inclusion of provisions excluding a ‘notional settlor’ are seen as unnecessary given section 102 only applies to the creation of a trust, not contributions to an already existing trust. 

** for the trainspotters, the title today is riffed from the Elvis Costello song ‘Temptation’.  Listen hear (sic):