Trusts are fairly common in corporate structures. There are several types of trusts which are setup depending on the intended purpose of the trust. A commonly encountered trust is the ‘Discretionary’ Trust. The discretionary trust is characterised by its irrevocable nature and the trustee having fully discretional dispositive powers.
The irrevocable nature of a trust means that a settlor cannot revoke the trust assets once they have been settled on trust. This ensures that the assets cannot be returned to the settlor, but will be held on trust and managed in terms of the trust deed, for the benefit of the beneficiaries of the trust. For the purposes of this article, the focus will be on the beneficiaries of trusts.
Beneficiaries
A beneficiary is a named individual or an identifiable class of beneficiaries as described within the trust deed. The Trust assets are maintained and managed for the benefit of the beneficiaries. Only individuals named within the trust or who fall under a class of beneficiaries may benefit from the trust assets.
Equitable Ownership
A beneficiary is typically considered to have equitable ownership interests in the trust, such interest being defined within the trust instrument. The nature of this type of ownership is considered to be a hybrid right, a mix of in personam and in rem rights enforceable against the trustees who commit or threaten to commit a breach of trust.
How to Identify the Type of Trust from the Trust Deed
We identity the type of trust by looking at the powers conferred upon the Trustee.
Discretionary dispositive powers means that the trustee may make distributions to one or more beneficiaries or members of a class of beneficiaries at its own discretion, as opposed to say a contingency trust or a fixed trust, where the amounts and timing of the distributions are clearly defined within the trust deed, for example, income in favour of beneficiary A for life remainder for B upon A’s demise.
The difference between such trust types lies in the trustees’ responsibilities to distribute trust assets. The trustee is bound to abide by the rules of the trust, therefore, in the case of fixed interest trusts, the distributions are set out within the trust deed which will stipulate exactly who is to benefit, in what manner and when and therefore the trustee has a duty to carry out distributions from the trust assets in this manner. To do not do so would be a breach of trust.
In the case of discretionary trusts, the trustee is given a power to distribute. A duty implies a mandatory obligation, whereas a power is an authority that the trustee may or may not exercise. It confers a considerable degree of flexibility upon the trustee. So long as the trustee acts within the terms of the trusts and the statutory powers conferred by trust legislation, the Trustee has wide discretion over which beneficiaries’ benefit, how much and when, if at all. This power is typically conferred over both income and capital.
In light of this difference between duty and powers to distribute, it is therefore important to determine which is being conferred upon the trustee via the terms of the trust deed.
Rights of the Beneficiaries
What does this mean for the beneficiaries? This means that the rights of such discretionary beneficiaries are considerably less than those of other types of trust like a fixed interest trust in so far as they do not have an equitable ownership in the trust property, they have no rights to terminate the trust nor do they have rights to compel the trustee to act.
Hence, a discretionary beneficiary is not guaranteed to benefit from the trust, he only has a ‘hope’ of receiving a distribution.
Under Maltese law this is set out in Article 9 of the Trust and Trustees Act:
“(10) It shall be lawful for a trustee to be granted the discretion on as to which beneficiaries are to benefit, the quantity of any benefit, at what time and in what manner beneficiaries are to benefit and such other powers relating to the appointment, application or advancement of trust property.
(11) A beneficiary in whose favor a discretion to appoint or advance property may be exercised shall have no rights in or to specific trust property until such time as such discretion is exercised by the appointment, application or advancement of such trust property in favor of such beneficiary.”
What Does this Mean for Service Providers when Onboarding Trusts?
The FIAU Implementing Procedures part I (hereafter referred to as the ‘FIPI’) defines beneficial owners of Trusts to be the following:
(i) settlor;
(ii) trustee(s);
(iii) protector (where applicable);
(iv) beneficiaries, or where the individuals benefiting from the trust have yet to be determined, the class of persons in whose main interest the trust is set up or operates; and
(v) any other natural person exercising ultimate control over the trust by means of direct or indirect ownership or by other means.”
At the offset this would seem to imply that due diligence needs to be conducted on all parties of the trust, including all beneficiairies, however when the trust forms part of a structure, the FIPI further states:
“Whenever the shares in a body corporate (the customer) are held in trust, the subject person is not expected to identify and verify all of the beneficial owners of the trust (i.e. the parties indicated in paragraph (b) of the definition of beneficial owner provided for in the PMLFTR) as the beneficial owners of the said shares. Given that the customer would here be the body corporate and not the trust itself, determination of the beneficial ownership of the shares and of the body corporate itself requires that the subject person:
(a) determines who is the beneficiary of the trust; and
(b) considers whether the said benefit, together with any other direct or indirect interest that individual may have within the body corporate, is sufficient to meet the conditions at law to be considered as a beneficial owner of the said body corporate (that is, whether the beneficiaries are ultimately entitled to 25%+1 or more of the shares, or more than 25% of the voting rights). This does not exclude the possibility that there may be someone exercising control via other means. Where no such person is identified (i.e. either as a beneficiary or as otherwise exercising control), the beneficial owner would be the senior management officials of the customer (i.e. the company).”
However, this gives rise to further queries in the case of discretionary trusts in so far as how to determine a discretionary beneficiary’s entitlement to the assets of a trust (namely the shares owned in the underlying company). If the trustee holds discretion as to how much a beneficiary may receive and if he may receive a benefit, how can such entitlement to benefit be calculated? In short, it cannot. Additionally, we cannot factor in control via other means, as discussed earlier on, discretionary beneficiaries have very little rights in the trust itself.
Under section 4.3.2.5 the FIPI acknowledges this conundrum and gives provision for such circumstances in the following:
“It is acknowledged that situations may arise in which the beneficiaries may be identified in the trust instrument or other written instrument by the settlor, but the said beneficiaries may either be unaware of their entitlement under the trust or, for their benefit to materialise, it would be necessary for the trustee to exercise its discretion or for a pre-determined condition to occur. In these circumstances, a subject person may opt to identify the beneficiaries on the basis of the information contained in the trust instrument, or any other document used to verify the trust, and seek on a risk-sensitive basis to obtain the additional information that may be necessary to establish an adequate risk profile. The subject person would then eventually collect any additional identification information that may become necessary and carry out verification of identity once a pay-out is made.”
The final sentence being of note here, in that once a pay-out is made, full identification and verification is to occur. This means that even in the case of a discretionary trust, if a beneficiary has benefitted from the trust, they are to be treated as beneficial owners and hence full due diligence is to be carried out accordingly.
Conclusion
For the purposes of onboarding and ongoing monitoring of Trusts by subject persons within the financial services industry it is important to firstly identify the kind of trust as well as the nature of the beneficiaries and their right to benefit from the trust. Secondly it must be determined whether a distribution was made to any beneficiaries. Upon identifying beneficiaries who fall under the description of the paragraph above, due diligence procedures can be simplified as per the guidance provided in the FIPI, which ultimately may lead to less frustration from clients and provide a more efficient approach to onboarding structures which contain trusts.
About the Author
This article has been authored by Stephanie Portelli, Team Leader - Trust Administration & Projects.