Assets in alter ego trusts treated as if they belonged to founder

IS YOUR trust your alter ego

(an extension of yourself)? If so, it may exist, but it will be disregarded, and the courts will treat the assets as if they belonged to you.

An alter ego trust occurs where the requirements for a valid trust are present when the trust is established, but the trustees of the trust are puppets, acting mainly under the instruction of the founder or another trustee.

An alter ego trust is also present where the trust property is treated by the founder or a trustee as if it were personally owned by him or her, instead of belonging to the trust.

This is different from a scenario in which you never intended to create a “genuine” trust from the outset; in other words, you created a “smokescreen” or “sham” trust. Unlike an alter ego trust, this type of trust never comes into existence.

SIGNS OF ABUSE

How do you determine whether a trust is an alter ego trust?

The following are signs of abuse, either in relation to the trust deed or in the actions of the trustees and/or founder:

• There is no independent trustee;

• The trust deed gives the founder and/or trustee the power to amend the trust deed without the consent of all the trustees;

• The founder has retained some level of control in the trust deed;

• Clauses in the trust deed undermine the fact that the trust is separate from the trustees;

• The trustee acts contrary to the terms of the trust deed;

• There is a dominant trustee who dictates how trustee decisions are made;

• The trustees are not acting with the necessary care, diligence and skill expected of them in terms of the Trust Property Control Act;

• The trust is not properly administered;

• It is evident that the trustees do not meet; and

• Accounting records, minutes and resolutions are not properly drawn or attended to.

CONSEQUENCES

What are the consequences of an alter ego trust? As a general rule, if a trust is regarded as an alter ego trust, it does not imply that the trust does not exist, or that the rights of the beneficiaries are nullified. The trust continues to exist, but the court will “look through” the trust – in other words, it will pierce the veil, or veneer, of the trust.

There have been many divorce cases where one of the spouses has attacked the trust in an attempt to have the assets included in the hands of the other spouse. Regardless of the fact that a trust generally forms an integral part of one spouse’s, or both spouses’, estate planning, neither party has a claim on the assets held in the trust, unless the trust form has been abused by a spouse, in which case the spouse could be accused of an alter ego scenario. If the court finds that the trust is an alter ego of the spouse, it may, in certain cases, order that the assets of the trust be taken into account when dividing them between the spouses and the trust’s creditors.

Spouses who achieved success were those who married before 1984 and did not have the benefit of accrual in terms of the Divorce Act prior to that date, when the accrual system was introduced. Spouses married under the Matrimonial Property Act (introduced in 1984) did not achieve the same success, because the courts do not have the discretion to include assets that do not physically belong to either of the spouses in a divorce settlement, and can apply only the Matrimonial Property Act’s strict mathematical formula in order to calculate the accrual.

In 2011, the courts, for the first time, expressly allowed creditors to attach trust assets. In a 2012 case, where the creditor attempted to attach the trust’s assets (which was connected to the trustee), the court held that, in appropriate circumstances, the veneer of a trust can be pierced in the same way as the corporate veil of a company.

HOW DECISIONS ARE MADE

When is a trust at risk?

Be careful of the manner in which you communicate with your fellow trustees over email or in writing. Never instruct them, or simply inform them, that you have performed a transaction. Always use language that demonstrates collaborative decision-making by the trustees. Remember that you act in your capacity as a trustee of the trust and not as personal owner of the trust assets. This mindset is critical in preventing the trust from being declared an alter ego trust.

It is acceptable for the estate owner, who acts as a trustee, to appoint and remove trustees during his or her lifetime. Provided all the trustees are allowed to participate in the trust’s decisions and are permitted to exercise their discretion, such a requirement (in isolation) will not be indicative of an alter ego trust.

Certain trust instruments stipulate that the estate planner, in his or her capacity as trustee, should be part of a quorum, and that he or she can veto decisions. Provided all the trustees are allowed to participate in the trust’s decisions and are permitted to exercise their discretion, such a requirement will not, in isolation, be indicative of an alter ego trust.

However, be mindful of the fact that all distributed trust income and capital gains will be taxed in the hands of the donor/ funder if he or she can veto distributions. A casting vote, on the other hand, is problematic, and should not be allowed.

It is acceptable for the estate planner, who acts as a trustee, to be required to sign documents on behalf of the trust during his or her lifetime. Such a requirement will not be indicative of an alter ego trust.

It is accepted practice that, if the beneficiaries stay in the trust’s house for free, they pay for the maintenance costs. Even if the beneficiaries do not pay rent, it is advisable to draft a rental contract stipulating these arrangements in order to avoid having the trust labelled an alter ego trust.

CONCLUSION

It is important to demonstrate that the trust is structured and managed as a separate entity to the founder, one particular trustee, and its beneficiaries. The “cost” of having a trust declared your alter ego may be significantly higher than the effort required to administer it properly.

Phia van der Spuy is a registered Fiduciary Practitioner of

South Africa and the founder of Trusteeze, which specialises in trust administration.