A trust within a trust

Trusts continue to be a particularly useful tool in estate planning and the succession of wealth. A ‘sub-trust’ or ‘sub-fund’ is, at its simplest, a trust within a trust. They can be created for a variety of reasons and their terms may differ to the main trust, or it may simply be that a limited class of beneficiaries may benefit or certain assets are segregated for some reason.

Sub-trusts have commercial applications and are often used in the context of unit trusts (where investors might subscribe for units of one or more classes attributable to a particular sub-trust) or employee benefit trusts (sub-trusts are often used to identify funds that may only benefit a certain group of people, such as a named employee and their family).

Reasons for a sub-trust

In the case of private clients, sub-trusts may not necessarily form part of the initial structuring discussions, but they should be considered in appropriate circumstances, which might include:

• the provision of benefit for a distinct group of beneficiaries or for a particular purpose;
• situations in which the trust assets need protection, in relation to a family dispute or to cater for different needs within the beneficial class;
• allowing for descendants of blended families to benefit in accordance with a parent’s wishes; or
• the need to protect assets for individuals who are incapable of managing their finances.

In the context of a standard discretionary trust, beneficiaries will usually have a discretionary interest in the trust fund. The trustees will have the power to decide the nature and extent of benefit any one beneficiary may receive, and when that benefit will be distributed. However, if they wish to hold a portion of the trust fund upon terms that are specific to a beneficiary or group of beneficiaries, the trustees can exercise their overriding powers to do so (subject to the specific drafting of those powers). For example, the trustees may wish to acquire a property for occupation by one of the beneficiaries. The trustees may grant an interest in possession to the beneficiary, the effect being a right to occupy it during their life for as long as the beneficiary wishes to do so. The terms of the trust on which that property is held will differ from the terms of the main trust that continues to hold the remaining assets, following the use of an overriding power to create the sub-trust.

The creation of a sub-trust may enable the trustee to ring-fence particular trust assets that may be subject to claims by others. For example, if a beneficiary owns their own business and that business is in a poor financial position, a portion of trust assets may be appointed onto terms for the benefit of the other beneficiaries. That effectively excludes the beneficiary who may be vulnerable from any entitlement to that portion of the trust fund, which they might realistically never have expected to benefit from, not being a settlor and being in a class of discretionary beneficiaries. Trustees should take care when considering the creation of sub-trust in the context of creditors or divorce proceedings. In the latter case, the family courts will usually have powers to vary nuptial settlements and will assess a variety of factors in determining a particular beneficiary’s expectation of benefit. A sub-trust can be useful if it is created in advance of any suggestion of a dispute and in accordance with a letter of wishes. If it is obviously created as a reaction to a relationship breakdown, it will be construed as obstructive and may not achieve the desired objective.

Blended families are becoming more common. Their implications are presenting interesting issues for modern private client practitioners. Sub-trusts may offer a useful mechanism when creating succession plans for blended families. To take a simple estate plan, a settlor may settle assets onto a discretionary trust for the benefit of their spouse and children. After the death of the settlor and the surviving spouse (who might be regarded as the primary beneficiary during their lifetime), it is likely that the children will then be regarded by the trustee as primary beneficiaries. Problems may arise if the settlor has children outside of their marriage and wishes to guarantee they are taken care of. Trustees may consider giving effect to that wish by creating a sub-trust, the assets of which are held for the benefit of the child in question.

Sub-trusts can also simply be used to separate provision for a vulnerable beneficiary from provision for other recipients of the main trust. For example, if a trust has been established for the benefit of two adult children and a teenage child, a sub-trust can be created for the younger child to ensure they can attend school, university, buy a house and work; in effect, giving them the same start in life their older siblings enjoyed. It can prevent an imbalance in the treatment of the beneficial class and ensure that the children are treated equally, despite differing ages and circumstances, so far as possible.

Mechanical considerations

A trust may have any number of sub-funds. Normally, the same persons or entities are trustees of all the trust property, but it is possible for separate trustees to be appointed for one or more of the sub-funds. If a trust is being administered by a professional trust company, it may be that the creation of a sub-trust will lead to an increase in fees for that service. That will likely depend on the difference in terms of the main trust and the sub-trust, and the resources that need to be allocated to governance and administration of the property held on the terms of the sub-trust.

Creation of a new settlement and tax considerations

It can be difficult to ascertain whether a settlement upon trust results in a single trust (divided, possibly, into more than one separate sub-trusts or sub-funds) or more than one trust. Where the trustees have used overriding powers to appoint new trusts over trust property, it is possible that this will trigger the creation of a new and separate trust.

If a new trust is created,[1] the result will be a disposition of the underlying trust property and any tax implications will need to be carefully considered.

If a trust is considered to be divided into separate sub-funds, it is treated as a single trust for tax purposes. Although the sub-trusts the authors deal with are governed by Guernsey law, it is commonplace for the assets to be subject to tax in another jurisdiction. It is quite often the case that a trustee administers multiple sub-trusts but there are separate investment managers appointed to manage the investments of each. Any gains or losses of a separate portfolio will be attributed to the trustee but as trustee of the particular sub-trust on which the separate portfolio is held. The trustee may be required to calculate the performance of the trust (as a whole) for tax purposes. One sub-fund might therefore suffer a loss, which can be used to offset a gain made by another sub-fund.

The trustees may also consider exercising their powers to appoint the assets of one sub-fund onto the terms of an entirely new trust. Again, the tax consequences of creating a separate settlement and making the relevant elections will need to be carefully considered as the trust and the separate sub-trust will be treated separately for tax purposes.

Establishing trusts is a large part of succession planning and sub-trusts can be used as sensible planning tools. However, their wider implications should be considered carefully.