Important Guidelines Regarding Charitable Trusts

charitable trust
What is a trust?

Whilst trusts are frequently seen as a fundamental element in the planning of an estate, a business, investment or family financial affairs, there is generally an erroneous view that a trust is a legal entity like a company or an individual.

A trust is not a separate legal entity. It is a relationship which exists where A (Trustee) holds property for the benefit of B (Beneficiary).

The nature of the relationship is critical to an understanding of the trust concept.

The trustee can be an individual, group of individuals or a company. There can be more than one trustee and there can be more than one beneficiary. Where there is only one beneficiary the trustee and beneficiary must be different if the trust is to be valid.

Trusts are recognized by the court under its equitable jurisdiction. The courts will very strictly enforce the nature of the trustee’s obligations to the beneficiaries so that, while the trustee is the legal owner of the relevant property, the property must be used only for the benefit of the beneficiaries. Trustees have what is known as a fiduciary duty towards beneficiaries and the courts will always enforce this duty rigorously.

There are different types of trust however the scope of this article is Charitable Trusts.

Charitable Trusts

Charitable trusts are philanthropic trusts that benefit from concessional taxation treatment and deductions to taxpayers for gifts to the charitable trusts.

In very basic terms, a charitable trust is a form of legal vehicle which allows the transfer of gifts from an individual, family or corporation to a charity. It is created when an initial sum of money is settled on the trust, usually by a wealthy benefactor who, in doing so, relinquishes all rights to the funds.

The settled funds, known as the corpus, are usually invested by the trustee and the income from this investment is then distributed to charitable organisations for the promotion or advancement of the particular “charitable purposes” specified in the trust instrument.

The “special purposes” of a charitable trust must, quite obviously, be charitable in nature and include public, as distinct from private, purposes.

Charitable trusts are particularly popular because of the tax benefits they attract.

Powers, rights and duties of a trustee of a charitable trust

A charitable trust is administered by the trustee(s) whose powers are conferred upon them by the trust deed, legislation and by the court. These powers can include powers to sell trust property or to carry on business on behalf of the trust.

Trustees also have certain rights, including a right to an indemnity out of the trust assets for liabilities incurred in the authorised conduct of the trust and a right to approach the court if the trustee is in doubt as to the rights or interest of any person as against the trust. In NSW, the relevant legislation is the Trustee Act 1925 and the Charitable Trusts Act 1993.

Trustees also have basic duties, which have been discussed and developed through a long line of case law. These include duties to adhere to and carry out the terms of the trust, to properly invest the trust funds, to keep proper accounts, and to exercise reasonable care in managing the business of the trust.

Commissioner of Taxation v Bargwanna [2012] HCA 11 (Bargwanna Case)

This High Court decision is a helpful authority in respect to how funds of a charitable trust must be applied.

In Bargwanna Case, the trustees of a charitable trust applied trust funds settled on a charitable trust by a wealthy benefactor to, among other things, offset the interest payments on the trustees’ personal home loan.

Further the trustees in Bargwanna Case breached the trust by mingling the trust funds with other earnings from the business accounts of the benefactor of the trust.

Whilst the trustees made some distributions to various public charities, it was held that the trust was not administered as was originally expected.

The problem started when the trustees applied for endorsement by the Australian Tax Office that the trust was a charitable trust and was accordingly an entity exempt from income tax pursuant to Division 50 of Part 2-15 of the Income Tax Assessment Act 1997 (ITAA)

The Commissioner claimed that the trustees had failed to satisfy the ITAA’s requirement that the application of the trust fund must be applied for the purposes for which the trust was established.

The trustees were held liable for intermingling of funds, the failure to obtain interest on trust money and the use of the interest offset account was not in line with carrying out the charitable purposes.

The High Court upheld the Commissioner’s refusal to endorse the trust as exempt from having to pay income tax under Division 50 of the ITAA 1997.

The Bargwanna case is a helpful guide for lawyers who draft the trust documents to ensure that the purposes of charitable trust and duties of trust should be made explicit.

The case also confirms that despite what the trust deed says, the powers of the trustees in administering a charitable trust are far from unfettered.

The High Court expressed concern about the use of clauses in the trust deed that conferred such wide powers and said that they should always be read in the light of authorities “which treat such apparently unconfined discretions and powers as not extending to the alteration of the substratum of this trust for charitable purposes”.

In drafting trust deeds it is imperative to ensure that there are no explicit or implied term that provides trustees with a power which is potentially unlawful and if exercised could defeat the purpose of the trust.

Misapplication of funds

The High Court found that there had been a misapplication of the funds of the trust through the mixing with other non-trust funds in the trust account. It was held that the trustees had also failed in their duty to obtain interest on the trust monies and wrongly used the interest offset account in order to reduce the interest payable on their personal home loan.

The High Court found that these acts of maladministration could hardly be considered actions in line with carrying out the public charitable purposes for which the trust had been settled. In reaching this decision, the High Court concluded that the administration of a charitable trust does not differ from that of a private trust.

Charitable Purpose

One of the terms of the trust deed stated that the trustees’ duty was to hold the trust funds “in trust for such public charitable purposes as they shall from time to time determine”.

The main question to be resolved in the Bargwanna case was whether the trust was truly operating for a public charitable purpose.

The terms of the deed conferred broadly expressed discretions on the trustees. However, the court stated that even a broadly expressed discretion is subject to the requirement that the trust fund be held for public charitable purposes. In this case, the court found that the trust fund was not applied for those purposes.

Further the High Court found that even if it was considered that the trust money was administered ‘substantially in accordance’ with the terms of the trust deed, this was insufficient. The majority stated that the term ‘applied’ is not to be understood as meaning ‘substantially applied’ or ‘on the whole, applied’.

Important Guidelines

The High Court found that the actions of the trustees in this regard were not charitable at all, and delivered a helpful analysis of the duties and obligations of trustees of a charitable trust.

  1. Trustee’s actions must be consistent with charitable intent of trust – The High Court confirmed that it is the essence of a charitable trust that it promotes or advances social purposes rather than being a trust for individual beneficiaries.
  2. Trustees must take care to carry out the terms of the trust deed – The trustee of a charitable trust is obliged to conform strictly to and carry out the terms of the applicable trust deed. In doing so, a trustee is obliged to “act with the care that an ordinary prudent man of business would take”.
  3. Charitable trust funds should not be mingled with other property – A trustee of a charitable trust is under a duty to keep the property comprising the trust fund distinct from their own property and from property which was held on other trusts.
  4. Under section 63 the Trustee Act 1925 (NSW) trustees can apply to the Supreme Court for an opinion regarding proper investment of trust funds or for questions in respect to management or administration of the trust property.
  5. Trustee’s personal liability may be mitigated under section 85 of the Trustee Act 1925 (NSW) – The section allows the Supreme Court wholly or partially to relieve trustees of personal liability for breach of trust where it appears to the court that the trustees have “acted honestly and reasonably” and that they “ought fairly to be excused”. However it is recommended that a trustee in doubt about a course of action should seek judicial advice under section 63, rather than proceed and then seek relief under section 85

It is crucial to remember that when a specific trust issue arises there is no substitute for specialist legal, tax and trust advice and the information given in this article needs to be understood in that context.

Corporate Lawyers Sydney at Pavuk Legal can provide you with legal advice in respect of issues, duties and obligations regarding Charitable Trusts.

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