Estates & Wills & Trusts

Sham trusts: A reminder

By Ian Hull

Trusts offer a number of advantages in the estate-planning context, from deferring taxes, to sheltering assets from creditors. As a result, trusts are being used with ever increasing frequency as an estate-planning tool. Many clients, however, do not necessarily understand or appreciate the proper purpose for the trust vehicle or the restrictions that will apply to their management of the trust assets.

It is important for those contemplating the use of a trust to understand that, if not properly constituted or carried out, the trust they create may be deemed void, and the intended advantages lost.

In order to create a valid inter vivos trust, there must be three certainties: a certainty of intention, a certainty of subject matter, and a certainty of objects. In other words, the person setting up the trust (the settlor) must intend to divest him or herself of ownership of certain assets, and intend those assets to be held by the appointed trustee(s) for identified beneficiaries.

As such, it is important to understand that once the settlor transfers the assets to the trust, he or she neither owns or controls them. The assets will be held for the benefit of the beneficiaries in accordance with the terms of the trust and will be controlled by the appointed trustee(s).

Many clients establishing trusts, however, wish to retain control over assets by:

  1. being appointed the sole trustee,
  2. retaining veto power over any other appointed trustees, or
  3. appointing a compliant trustee(s).

These types of arrangements should be treated with caution, as there is a high likelihood they will result in the trust arrangement being deemed a “sham” and void as a result. If deemed void, the trust is treated as though it never existed in the first place, and as a result, any advantages for which the trust was created, such as tax avoidance or protection from creditors, will be lost.

In other words, a sham trust is one in which the settlor does not truly intend to dispose of the assets settled on the trust, but rather, merely wishes to create the impression that the assets have been disposed of, while in reality maintaining control of them throughout.

If a trust is challenged as a sham, the settlor and trustee(s) will be unable to rely solely on the wording of the trust agreement in order to illustrate their requisite certainty of intention.

The court is authorized to look further to the conduct of the settlor and trustee in setting up and managing the trust to determine whether the trust was validly constituted. If it can be shown that the settlor and trustee(s) intended to deceive or misrepresent the actual transaction from the outset, that trust will be deemed a sham and will be void as a result.

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