Source: https://www.cwilson.com/trusts-and-estates-freezes-under-part-5-of-the-fla-walking-on-thin-ice/
Timestamp: 2019-02-17 09:35:53
Document Index: 466004264

Matched Legal Cases: ['art 5', 'art 5', 'art 5', 'art 5', 'art 5', 'art 5', 'art 5', 'art 5', '§2']

Trusts and Estates Freezes Under Part 5 of the FLA - Walking on Thin Ice
Since the coming into force of the Family Law Act, S.B.C. 2011, c. 25 [FLA], much has been written about the implications of the family property provisions dealing with trusts, particularly with respect to their application to discretionary trusts. Part 5 of the FLA moved British Columbia from a regime in which argument focused on whether assets were ordinarily used for a “family purpose” to an excluded property regime that defines property as being either “family property” or “excluded property”.[1]
The goal was to “make the law simpler, clearer, easier to apply, and easier to understand for the people who are subject to it”.[2] Despite this object and significant commentary on the impact of these changes on family trusts, we remain in a state of legal uncertainty given the limited judicial consideration of the trust provisions in Part 5.
Clark Wilson LLP recently had an opportunity to consider how a court may apply these provisions in the context of an estate freeze orchestrated by one of the spouses. Fortunately, we were able to reach an agreement that satisfied both parties. Opposing counsel and I observed, however, that it would have been interesting to try the case, and helpful to obtain judicial comment on the law.
The purpose of this paper is to provide a general overview of the property provisions that may apply to discretionary trusts, with particular attention to how Part 5 may be applied to trusts settled as part of an estate freeze. I will not attempt to repeat the analysis presented by various contributors to the Continuing Legal Education Society of British Columbia dealing with discretionary trusts under the FLA[3]. Instead, I intend to briefly summarize the relevant sections with reference to recent case law to provide context for how these provisions may apply in cases involving estate freezes. In doing so, given the relative lack of case law, I propose to canvass certain cases under the former Family Relations Act, R.S.B.C. 1996, c. 128 [FRA], and decisions from other jurisdictions, to the extent that similar principles may be relied on under the FLA. Finally, I propose to outline possible arguments that may be invoked when faced with a case involving a discretionary trust in the context of an estate freeze. This will primarily be concerned with what may be thought of as “First Generation” estate freezes, i.e. those carried out for the tax and estate planning of one of the separating spouses, as distinct from “Second Generation” estate freezes carried out by the parent of a spouse.
Statutory Framework: Trust Property vs. Trust Interests
The FLA addresses trusts in a number of subsections defining both family and excluded property in such a way that “clearly draw a distinction between property and a spouse’s beneficial interest in property”[4]. This is not new, as under the FRA, the courts would similarly analyze whether the family property was properly considered the trust property itself or a spouse’s interest in a trust.[5]
The developing case law suggests that determination of family property will turn on whether the “deeming” provisions contained in ss. 84(2)(f) or 84(3) apply. If so, the trust property itself may be family property with the result that trusts valued at millions of dollars may be argued to be subject to division. If not, the spouse’s discretionary interest may be family property, which may then be argued to have no value. The identification and valuation of family property may be determined not only according to the interpretation of the definition of “family property”, but also based on policy and judicial notions of fairness.
Trust Assets as Family Property
The inclusion of trust assets as family property brings into conflict principles of black letter trust law with goals of equity and fairness in dividing family assets.[6] Where a spouse is a trustee, they hold only legal title to property for the benefit of others. Where the spouse is a discretionary object, they have no right to demand a distribution from the trust, and their potential entitlement may lack a proprietary or possessory interest in the trust property such that it cannot be ascertained[7]. If a spouse is both a trustee and beneficiary, they owe fiduciary duties to the class of beneficiaries as a whole. In the context of family law, the goal is to identify and divide family property, and these assets may appear to be out of reach based on how they are held.
In British Columbia, the Legislature appears to have attempted to reconcile this tension by deeming trust assets to be family property when certain criteria are met. Accordingly, whether assets held in a discretionary trust will be family property appears to depend on whether a spouse “contributed” or “disposed” of that property. Although there has been limited judicial consideration of these terms, the case law provides some guidance about how these provisions may be applied.
Justice Dardi recently outlined the analysis to be undertaken under ss. 84(2)(f) and 84(3)[8]. The court must first consider whether s. 84(3) applies, which provides:
(3) Despite subsection (1) of this section and subject to section 85 (1) (e), family property includes that part of trust property contributed by a spouse to a trust in which that part of trust property contributed by a spouse to a trust in which
Justice Loo relied on this provision in obiter in Baryla v Baryla, 2017 BCSC 1759, a case involving a claim by a husband that shares in a family company were held in trust for the children, such that they were not subject to division[9]. The spouses were the president and secretary of the company. Each held 50% of the initial common shares. Additional common shares were issued to the spouses in trust for the children. There was no evidence to support the husband’s arguments that the children had paid for the shares, received dividends, and filed tax returns claiming the dividend income as theirs, and the judge found that no interest in the company was excluded. She went on to note that:
60 … Moreover, pursuant to s. 84(3) of the FLA, “family property” includes that part of a trust property contributed by a spouse to a trust in which “(b) the spouse has a power to transfer to himself; or (c) the spouse has a power to terminate the trust and that part of the trust property reverts to the spouse.” Mr. Baryla has both of those powers.
Although the terms of this trust are not clear and the decision does not contain detailed analysis regarding the means by which the property was “contributed” to the spouse, it appears that the issuance of shares by a company controlled by the spouse was sufficient to trigger s. 84(3).
If s. 84(3) does not apply, the court will go on to consider whether s. 84(2)(f) is triggered:
“Dispose” will be interpreted broadly using the definition contained in s. 29 of the Interpretation Act, R.S.B.C. 1996, c. 238, which is “to transfer by any method and includes assign, give, sell, grant, charge, convey, bequeath, devise, lease, divest, release and agree to do any of those things”.[10]
In MCV, s. 84(2)(f) applied to the capture property settled by the husband onto a trust. He had purchased a property before the relationship, and after its commencement, he settled it onto a trust for creditor protection and estate planning purposes. He was the settlor, one of two trustees, and a beneficiary. It was a fully discretionary trust that gave the trustees broad powers, including to add or remove beneficiaries and to distribute to any of the beneficiaries. The husband could add trustees, fill trustee vacancies, and appoint successor trustees. The distribution date was the earlier of the date determined by the trustees and 80 years after the trust was settled. On that date, the trust was to be distributed as the trustees determined or to the husband’s children or their issue per stirpes.
The judge found that it was the increase in value of the trust property itself, not the husband’s interest, that was family property. Because he had transferred the property to the trust, he had “disposed” of it within the meaning of s. 84(2)(f). He did so after the relationship began and, as one of the trustees, he had broad powers to direct the disposition of the property. His estate planning and creditor protection objectives were not relevant as the effect of the transaction was the deliberate divestment of his interest in potential family property. The Legislature intended to discourage such transactions and to recapture potential family property disposed of by a spouse. Because the property was acquired prior to the relationship, the family property was the amount by which the property itself had increased in value.
Trust Interests as Family Property
While there is not yet any case law applying the provisions determining and valuing discretionary trust interests as family property, two cases have contemplated this situation.
In S.L.M.W. v. M.R.G.W., 2016 BCSC 272, Justice Steeves found that the spouse’s interest as one of four discretionary beneficiaries constituted family property. The husband owned a property in New Zealand that was then settled onto a trust. The spouse was one of two trustees, along with his solicitor. The beneficiaries were the husband, his children, his sister, his parents, and any grandchildren or more remote issue. The husband did not have a vested interest in the trust property, did not have the power to transfer to himself any of the trust property, and did not have the power to terminate the trust (although on termination, the trust property reverted to him).
The judge noted that family property includes a beneficial interest of a spouse in property. Because the trust was settled prior the parties’ relationship, the family property was the increase in value of the husband’s beneficial interest. The court invited further submissions, but the parties were able to resolve this issue.
The other decision, Stober v. Stober, 2015 BCSC 2505, was an interlocutory decision of Justice Skolrood appointing an expert to value the parties’ interests in a discretionary trust. The parties disagreed as to whether their interests were family property. The husband argued that if the court answered this question affirmatively, it would need evidence as to valuation. As discussed below, the judge accepted this point and appointed an expert valuator. There were no further reasons.
Trusts as Family Property Under the FRA and in Other Jurisdictions
A theme in cases decided under the FRA and in other jurisdictions that aligns with the apparent purpose of the deeming provisions in the FLA is the importance of control by a spouse over a trust and looking beyond the trust instrument to the reality of the situation. For example, in Tremblay v. Tremblay, 2016 ONSC 588, the judge held that the central question was the husband’s ability to control whether distributions were made for his benefit. At para. 32, the judge outlined certain factors that may be relevant to determining the extent to which a beneficiary can directly or indirectly control the trustees:
1. any evidence with respect to the founding intent of the trust — was the trust designed to effectively allow control by the beneficiary?;
2. the composition of the trustees, including whether the beneficiary is a trustee;
3. any requirement, including veto powers, that the beneficiary be part of any trustee decisions;
4. any history of past trustee actions which demonstrate direct or indirect control by the beneficiary;
5. any powers of the beneficiary to remove trustees, or to appoint replacement or additional trustees; and
6. the relationship of the beneficiary to the trustees — are the trustees independent and at arm’s length or are they instead family members or other persons who may not act independently?[11]
As a result, the “realities” of a discretionary trust may be relied on to argue that trust property is family property, as well as to argue the appropriate value, if any, of such family property, as is discussed below. In recent years, our Court of Appeal has confirmed the appropriateness of this approach in cases applying the FRA. In Purtzki v. Saunders, 2016 BCCA 344, the Court accepted that a trust was “discretionary in name only”, holding that it functioned more as a fixed trust in that the father had always enjoyed unfettered use of its only significant trust asset. It was likely that he would continue to enjoy this benefit, as the trustees would honour his wishes. Also, he was the source of the trust property. More recently, in H.S.S. v. S.H.D., 2018 BCCA 199 at para. 99, a case considering unfairness under the FRA, the Court affirmed the correctness of looking at the reality of the situation to analyze the likelihood that a spouse will receive a benefit. The Court cautioned that “trust interests that are contingent and discretionary generally should not inform the analysis… as consideration of the mere possibility that an asset will be distributed to the party is not probative of economic independence or self-sufficiency”, likening such speculative distributions to potential inheritances. However, the Court went on to affirm the relevance of looking to all the circumstances, on the basis that “sufficient certainty that a party will actually enjoy the benefit of his or her interest in trust assets can bridge this gap”.[12]
Given the objects of fairness in family law, it is assumed that courts will continue to look at control by a spouse over a trust and the reality of a trust to both identify and value family property.
Valuation of Discretionary Trusts as Family Property
The issue of valuation is also likely to vary depending on whether the trust assets or interest is properly considered family property. While the latter is likely to involve greater dispute given the possible irrelevance of fair market value, the former may also be contentious where, for example, the interests of other beneficiaries are at stake. For that reason and given the relative lack of case law, this discussion considers valuation of discretionary trusts in general.
As a matter of trust law, an interest in a discretionary trust is a mere hope of receiving a benefit and is incapable of valuation[13]. A discretionary beneficiary has no legal or equitable right to demand distribution of income or capital, and has merely a right to require the trustees to properly exercise their discretion. This has been accepted by some courts[14]. However, the inclusion of a beneficial interest as family property under s. 84(1)(a)(ii) and the express exclusion of discretionary interests under s. 85(1)(f) where certain criteria are met contemplates determining or assigning a value to such interests.
The closest we have come to judicial consideration of how to value a discretionary interest under the FLA remains the decision in Stober, where Justice Skolrood appointed an expert to value the parties’ discretionary interests. Because the value of family property is to be based on fair market value, pursuant to s. 87, the court will need evidence of fair market value. This is so even if the opinion is that, given the nature of the interest, the concept of fair market value has no application to beneficial interests in a discretionary trust because of the likely absence of any market for such interests.
Case law decided under the FRA and in other jurisdictions is instructive in analyzing and building arguments relating to valuation. The cases have varied between assigning no value to a discretionary trust, crafting an “if and when” order by which a beneficiary spouse must divide any benefit ultimately received, adopting a pro rata valuation based on number of beneficiaries and fair market value of trust assets, and looking to the “realities” of a trust to value the interest as equal to the full value of the trust property[15]. These approaches are discussed in a number of CLE papers, and I will not attempt to repeat that analysis here, apart from to provide a brief overview.[16]
The differing valuation methods have attempted to account for the contingencies associated with discretionary trusts in a manner that fairly divides family property. Recent appellate authority suggests that courts will attempt to assign a value to these interests, even if that value is nil, rather than to make an “if and when” order. In Purtzki v. Saunders, 2016 BCCA 344, the Court agreed that an “if and when” order not to be suitable based on the circumstances of the trust and the evidence of the husband’s control. In Grosse v. Grosse, 2015 SKCA 68, the Court noted that although an “if and when” order avoids dissolving the trust or burdening the spouse with the interest with a high equalization payment, it also forges an indefinite financial bond, and the amount paid may differ from the value of the interest. In the context of family law, such an order may defeat the purpose of the legislation: here, it permitted the husband to determine if and when his interest would be divided and the amount of that division, which was inherently unfair and defeated the equitable division of family property.
This trend suggests that courts will attempt to value a discretionary trust. They are likely to do so by looking beyond the trust deed to all the circumstances, such as those argued at para. 32 of Stober:
1. the circumstances of the owner-spouse, the trust, and the other beneficiaries;
2. the number and ages of the various beneficiaries;
3. the obligations of the trustee(s) under the terms of the trust;
4. the owner-spouse’s overall estate planning;
5. the trustee’s possible plans for the underlying assets of the trust;
6. the obligation of the trustee(s) to maintain an even hand when dealing with all beneficiaries;
7. the fair market value of the underlying assets of the trust; and
8. the expectations and legal rights of the other beneficiaries.
Other approaches to valuation may also be invoked, such as “fair value”, being what is “just and equitable” in the circumstances[17], or value to owner, being what an owner of an interest in property would pay to retain that interest. These have not yet been applied to valuation of discretionary trusts.
Litigating Trusts Settled in Carrying Out an Estate Freeze
Where a spouse has an interest in a trust settled as part of an estate freeze, Part 5 of the FLA provides room for argument regarding whether and how this may be included and valued as family property. Although estate freezes may take different forms, this discussion is concerned with freezes of ownership interests in private companies.
Briefly, the purpose of an estate freeze is to reduce tax liability arising on death. This is accomplished by “freezing” the value of shares at a particular point in time in the form of preferred shares that represent the current value of the company, limiting the size of a taxpayer’s estate on death for purposes of capital gains and probate fees. Often, a discretionary trust is settled at the same time. The company then issues new common shares that, at that time, have only nominal value. These are then purchased by the trust. The beneficiaries are ordinarily the next generation of the family, such that future growth of the company is directed to the children and their issue. Accordingly, the transactions are carried out for tax and estate planning.[18]
A common example of a high net worth family law file involving an estate freeze is illustrated by the following facts. Spouse A is the sole director and shareholder of HoldCo, which owns common shares in OpCo[19]. Spouse A is one of multiple directors and shareholders in OpCo, together with other family members. Spouse A carries out a series of transactions:
1. Spouse A causes HoldCo to surrender its common shares in OpCo, which are valued at fair market value as of a particular date. In exchange, HoldCo receives preferred shares in OpCo with the equivalent value. As a result, the current value of HoldCo’s ownership interest in OpCo is “frozen” and represented in the preferred shares in OpCo owned by HoldCo.
2. A trust is settled, often by a relative or family friend. The initial trust property will ordinarily be a nominal amount of money and possibly a coin or other heirloom. Generally, Spouse A will be a trustee, either alone or with others. The beneficiaries will be the children, though Spouse A is often included as an “escape”, should some eventuality make distribution to the children inadvisable. Spouse A’s HoldCo may also be a beneficiary to permit indirect distribution to Spouse A[20]. The trust will be fully discretionary as to income and capital.
3. OpCo then issues new common shares that have nominal value at the time of issue. These are purchased by the trustee using funds provided by the settlor. As a result, the growth of the company from that time onward is represented in the new common shares held on the trust.
Provided that the relationship remains intact, this scenario is likely to accomplish the Spouses’ shared goal of minimizing tax liability and maximizing wealth passed on to the children. If the relationship breaks down, the parties are likely to take sharply different views on the trust.
Estate Freeze Cases
As with treatment of discretionary trusts more generally, the limited case law bearing directly on trusts settled as part of estate freezes has varied. Two examples illustrate this uncertainty. On the one hand, there is the decision in Kachur v. Kachur, 2000 ABQB 709, where the spouse who carried out the transactions was found not to have any interest as family property. This decision applied the Alberta matrimonial property regime, which did not include a definition of family property.
The husband purchased his brother’s interest in a company, and a family trust was established for tax and estate planning purposes. The existing shares were converted to preferred shares and the value of the company up until that point was represented in those shares. New common shares were issued and purchased by the trust, which then held the growth of the company. The Kachur Family Trust was settled by the husband’s mother. The trustees were the husband and two of his friends. The beneficiaries were the husband, his children, and grandchildren. It was fully discretionary. The trust was to be wound up 21 years after the death of the last surviving child or at any earlier date as the trustees decided. If there was property remaining, the trustees were to distribute it to the beneficiaries or to charity in such proportions as they deemed appropriate, unless there were no surviving beneficiaries, in which case the trust property would be distributed equally between the children’s estates. The trustees also had discretion to amend the trust. The company had paid dividends on the shares held by the trust, which had been distributed equally to the children. The unchallenged evidence was that the trust was created for to benefit the children and to minimize tax.
The wife argued that given its wholly discretionary nature, the children did not have a quantifiable interest in the trust, having only a right to enforce the trustees’ obligation but no right to any particular portion of the trust assets. As a result, nothing should be subtracted from the value of the trust property for purposes of division of assets. The judge rejected this and found that the children’s interest represented 100% of the value of the trust. In doing so, the judge relied on the evidence regarding the intention of the trust and the history of its operation. That the husband had renounced his status as beneficiary fortified the evidence that his real interest in the trust had always been nil, but was not necessary to the decision.
This may be contrasted with the analysis and outcome in Grosse v. Grosse, 2015 SKCA 68. The Court applied the Saskatchewan family law legislation, which defined “family property” broadly to include any real or personal property, including (1) an interest in a trust; (2) property over which a spouse has a power of appointment exercisable in his or her favour; and (3) property disposed of by a spouse, but where the spouse has a power to consume, invoke or dispose of the property.
The husband had carried out an estate freeze to hold future growth of his company in trust for the parties’ sons. He was the sole director and shareholder of a company. The trust was settled by the husband’s brother, and the husband, the sons, and any future grandchildren were named as beneficiaries. The husband was the sole trustee and had broad discretionary powers. “In other words, Mr. Grosse had the ability to pay to himself all or any portion of the income and capital of the Trust, as well as the power to wind up the Trust, though to do so would defeat the Trust’s purpose and result in significant tax consequences.”[21]
At trial, the judge held that the husband’s preferred shares in the company and contingent beneficial interest in the trust constituted family property. He had created the trust by disposing of family property, but had retained the power to consume, invoke, or dispose of it. As to valuation, there was no assurance that the husband would end up with any of the trust’s income or assets, but if he did, the wife was entitled to a share of the same. Accordingly, the judge made an “if and when” order.
The Court allowed the appeal, agreeing that the husband’s interest in the trust was family property, but disagreeing with the appropriateness of the “if and when” order. The Court held that the definition of family property should, based on the ordinary meaning of the words and the purpose and scheme of the legislation, be interpreted broadly as intending to capture any type of property interest that a spouse may have. The goal was to ensure that all property interests are identified and considered when making a division. As a result, when determining what constitutes family property, the court must “pierce the veil” of whatever legal entity or device is used to hold property, including a trust or power of appointment, to see what degree of control a spouse actually exercises over the property. Where the spouse retains the power to consume, invoke or dispose of property, the property is deemed by the legislation to be family property and its fair market value is prima facie subject to equal division.
Here, the trust assets were family property and no discount based on the interests of the other beneficiaries was warranted. All three definitions of property applied: (1) he had two “interests” in the trust as trustee and beneficiary; (2) he had a power of appointment over the income and capital of the trust exercisable in his favour as trustee; and (3) he caused the growth shares to be issued to the trust and, as trustee, retained the power to consume, invoke or dispose of those shares. He also continued to be the sole director of the company. The Court rejected the husband’s submission that he could not exercise his discretion improperly or without regard for the purposes and other beneficiaries of the trust, noting the context of determining and dividing family property and that the terms of the trust gave the husband the power to transfer all income and capital to himself without regard for the other beneficiaries. The Court also dismissed the husband’s argument that he was only included as beneficiary and trustee for estate planning purposes. In addition, there was no history of distributions that would make equal division of the trust assets unfair or inequitable. Finally, the sons had only a contingent beneficial interest, and it was up to the husband if, when, and what they would receive; they had no legal or equitable right to demand income or capital. The husband, as trustee and beneficiary, had sole control, with the result that he could choose to take for his sole benefit whatever portion of the income and capital he desired. As a result, the full value of the trust was family property.
Estate Freezes Under the FLA
Based on the case law, the transactions involved in an estate freeze, and the language and purpose of the FLA, there are a number of arguments that may be made regarding the determination and valuation of family property where a client has orchestrated an estate freeze. To return to the example above, Spouse A is likely to argue that, at most, it is only the value of the preferred shares owned by HoldCo and their beneficial interest in the trust that is family property. This is because the deeming provisions in ss. 84(2)(f) and 84(3) do not apply to include the trust assets in family property, such that s. 84(1)(a)(ii) includes only Spouse A’s beneficial interest:
1. HoldCo and OpCo are separate legal entities from Spouse A. Under s. 84(2)(a), Spouse A’s interest in HoldCo is family property. Absent language that expressly permits the piercing of the corporate veil, to treat property owned by a corporation as if it were owned outright as family property, rather than the spouse’s interest in that corporation, would be a radical shift in the jurisprudence[22]. This position is strengthened where Spouse A is only one of multiple directors and shareholders of OpCo. In these circumstances, Spouse A does not control OpCo, and each director owes fiduciary duties to act in the best interests of OpCo.
2. Even assuming Spouse A’s interest in HoldCo is valued as equal to the assets of HoldCo on the basis that they are the directing mind, the family property is thus the preferred shares in OpCo owned by HoldCo. The family property was not reduced because the preferred shares have a value equal to the old common shares. HoldCo received full consideration and there was no “divestment” of family property. The new common shares were never family property.
3. Neither the cash used to purchase the new common shares in OpCo nor the new common shares were “disposed of” or “contributed to” the trust by Spouse A. The settlor provided the funds to acquire the new common shares, which did not exist before being issued by OpCo.
4. The transactions were structured to ensure that Spouse A did not, in law, contribute to the trust. Doing so would have triggered the reversionary trust rules in s. 74(2) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) preventing the family from realizing some of the key tax benefits that the trust was established to provide.
As a result, Spouse A’s position would be that it is only the value of the preferred shares in OpCo and beneficial interest that may be caught as family property because the deeming provisions do not apply. Further, the exclusion contained in s. 85(1)(f) applies to Spouse A’s interest because the trust is a discretionary trust to which they did not contribute and which was settled by someone else. As a result, the increase in value of Spouse A’s beneficial interest is family property, pursuant to s. 84(2)(g).
In contrast, Spouse B may argue that both the preferred shares in OpCo owned by HoldCo and the common shares in OpCo owned by the trust are family property:
1. Spouse A “disposed” of the old common shares by transferring them. It is sufficient that the old common shares were held by a wholly-owned corporation and that Spouse A caused HoldCo to dispose of the property. In dividing family property, the goal is fairness and the court must look through the form of property holding to analyze Spouse A’s control over the property.[23]
2. Spouse A “contributed” the new common shares to the trust by causing OpCo to issue them.[24]
3. Spouse A, as trustee, retains the ability to direct the further disposition of the trust property and, as a beneficiary, has the ability to transfer trust property to themselves.
4. Spouse A was the directing mind of the freeze and caused the transactions to occur.
5. But for the actions of Spouse A, the family property would have included the value represented in the new common shares, such that Spouse A has placed this family property out of reach. As such, Spouse A divested themselves of family property. Part 5 recaptures that potential family property, and the legitimacy of Spouse A’s objectives is irrelevant.[25]
Both Spouses would also be able to argue valuation. Spouse A would rely on principles of trust law and evidence as to the intention behind the estate freeze:
1. The value of family property is to be based on fair market value, such that s. 87 contemplates a different value being assigned in appropriate circumstances. “Fair market value” has no application to a discretionary interest, which is a mere hope of receiving a benefit subject to various contingencies. There is no “market” for such an interest.[26]
2. The inclusion of trusts interests as family property has generally been limited to interests in a trust that are vested (i.e. fixed) or contingent (triggered on certain conditions being met) not on a mere possibility of a bequest in the future.[27]
3. The possibility that Spouse A may, as beneficiary, receive trust property or, as trustee, may wind up the trust and “thaw” the freeze is speculative and not likely to occur. Doing so would undo the planning and trigger tax consequences that the freeze was designed to avoid.
4. The estate freeze was carried out to benefit the children and their interest represents 100% of the value of the trust property:
a. By exchanging the old common shares, the freeze capped the value of Spouse A’s interest in OpCo for capital gains, thereby limiting tax payable by his estate;
b. The freeze caused future growth in OpCo to accrue for the benefit of the children as beneficiaries, allowing this growth to be passed to them without incurring tax;
c. The freeze permits OpCo to pay dividends to the children through the trust; and
d. If the trust includes a term mandating a particular distribution in favour of the children on winding up, this evidences a genuine intention to create an enduring legacy for the children and their offspring.
In contrast, Spouse B will argue the significance of the family law context and the ability of Spouse A to benefit themselves:
1. The Legislature intended discretionary trusts to have value. Section 84(1)(a)(ii) includes a beneficial interest in property and only excludes discretionary interests in the circumstances outlined in s. 85(1)(f). They are therefore capable of being valued as family property.
2. The value of OpCo has accumulated during the relationship as a result of the parties’ joint efforts and its growth stands to be retained by Spouse A alone. This is contrary to the goal of fairness in property legislation and the presumption of equal sharing in the FLA.
3. As trustee and beneficiary, Spouse A may benefit themselves to the exclusion of the children. This would be in accordance with the terms of the trust, not contrary or alien to it.[28]
4. The value of the family property should not be discounted to reflect the interests of other beneficiaries because Spouse A was the source of the trust property and, as trustee, they control the trust effectively as owner of the assets. The other beneficiaries have only a beneficial interest contingent upon the exercise of discretion by Spouse A as to what, if anything, they would receive and the timing and amount of any such distribution.[29]
Depending on the history of the trust, either Spouse may rely on the distributions only to the children or to Spouse A, to both, or to neither to support their position.
A Word on “First Generation” versus “Second Generation” Estate Freeze Trusts
The foregoing analysis assumes that Spouse A carried out the transactions for their own tax and estate planning. Different considerations will apply where the transactions were carried out by the parents of Spouse A. In that case, Spouse B will likely face more obstacles in arguing that Spouse A disposed of property or contributed to property to the trust, which was settled at the direction of their parents. As a result, it is likely that only the discretionary interest may be family property. Depending on whether Spouse A settled the trust, the discretionary interest may be excluded under s. 85(1)(f), and it would only be the increase in its value available for division. In these circumstances, the primary dispute is likely to be with respect to valuation, such that control by Spouse A, evidence regarding the parents’ intentions, and history of distributions, among other factors, will be the focus of the argument.
The emerging case law suggests that a court is unlikely to apply strict trust law principles to ignore assets held on a discretionary trust settled as part of a First Generation estate freeze. Although the facts of each case will dictate the determination and valuation of that property, the language and purpose of Part 5 of the FLA are such that at least a portion of the value of trust assets will be divisible.
Until a decision analyzing the application of Part 5 to an estate freeze trust is released to clarify the law, alternative dispute resolution mechanisms provide an opportunity for creative solutions. Depending on the parties’ objectives, they may agree to terms that a court would be unlikely (or unable) to order, such as the removal of Spouse A or addition of Spouse B as a beneficiary, the appointment of Spouse B as a co-trustee, the creation of separate trusts to be administered by each of Spouse A and Spouse B[30], or the conversion of a discretionary trust to one or more fixed trusts for the benefit of the children. As in all cases involving high net worth clients, tax advice is essential to avoid unintended consequences.
The bar continues to await judicial comment on dynastic family trusts, including those settled for legitimate tax and estate planning. Until then, the family and estates bars, and the clients they advise, are left walking on thin ice in attempting to predict the treatment of estate freeze trusts.
[1] H.C.F. v. D.T.F., 2017 BCSC 1226 at para. 99.
[2] Ministry of the Attorney General — British Columbia, White Paper on Family Relations Act Reform: Proposals for a New Family Law Act (Victoria, BC: British Columbia Ministry of Attorney General, 2010) at 81.
[3] See, for example, Carmen S. Thériault, “WESA, Trusts, and Family Law” (Vancouver: Continuing Legal Education Society of British Columbia, June 2015); and Christine Murray and Kendra Marks, “Valuing Discretionary Trust Interest” (Vancouver: Continuing Legal Education Society of British Columbia, June 2018).
[4] M.C.V. v F.V., 2018 BCSC 96 at para. 92.
[5] For a thorough discussion of this issue, see Nowak v. Nowak, 2014 BCCA 409.
[6] Tremblay v Tremblay, 2016 ONSC 588.
[7] Purtzki v. Saunders, 2016 BCCA 344.
[8] MCV at paras. 88-89.
[9] The legal interest in property that a spouse holds for others has no value as family property: MCV at para. 79.
[10] MCV at para. 89(ii), citing P.G. v. D.G., 2015 BCSC 1454 at paras. 72-73.
[11] See also Creighan v. MacPhee, 2018 PECA 1, leave to appeal ref’d [2018] S.C.C.A. No. 153.
[12] H.S.S. at para. 99.
[13] Donavan W.M. Waters, Mark R. Gillen & Lionel D. Smith, Waters Law of Trusts in Canada, 4th ed. (Toronto: Carswell, 2012) at 1202-1204.
[14] Dillon v. Dillon, 2014 ONSC 2236 at paras. 283-285.
[15] For an example of each, see Kachur v. Kachur, 2000 ABQB 709, Grove v. Grove, 1996 CanLII 2626 (BC SC), Sagl v. Sagl, 1997 CanLII 12248 (ON SC), and Purtzki v. Saunders, 2016 BCCA 344.
[17] Kachur v. Kachur, 2000 ABQB 709 at para. 29.
[18] For a discussion of the methods of effecting an estate freeze, see Mary B. Hamilton, Fiona Hunter & Elaine E. Reynolds, BC Estate Planning & Wealth Preservation (Vancouver: Continuing Legal Education Society of British Columbia, 2002) (loose-leaf updated May 2018) at §2.4.
[19] Depending on tax planning, Spouse B may or may not be a shareholder in HoldCo.
[20] Again depending on tax planning, Spouse B may or may not be a beneficiary of the trust.
[21] Grosse at para. 8.
[22] Nowak v. Nowak, 2014 BCCA 409 at paras. 116-117.
[23] MCV at para. 89; McKenzie v. McKenzie, 2014 BCCA 381 at para. 44; Grosse at para. 28.
[24] Baryla at para. 60.
[25] MCV at para. 98.
[26] Stober.
[27] Nowak at para. 109.
[28] Grosse at para. 33.
[29] Purtzki at para. 77; Grosse at para. 44.
[30] This remedy was ordered in Shopik v. Shopik, 2014 ABQB 41, which was not an estate freeze case. The judge relied on this to distinguish Kachur and the trial decision in Grosse, holding that it was important for the court to retain the structure of the trust in those cases.
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