Winding Up Trusts

Trusts are used to hold, manage and distribute assets during a person’s lifetime and after his or her death. Trusts are often established for tax planning and deferral purposes, while also benefitting those who are entitled to the trust’s assets, the beneficiaries.

Types of Trusts
There are two main types of trusts. The first are inter vivos trusts, which are created by a person while he or she is alive. The second are testamentary trusts, which are created upon death under a person’s Will. Some trusts can be wound up at any time that the trustees decide in their discretion. Other trusts are intended to last for a specific period of time like a spouse’s life.

Why Wind Up A Trust ?
Before a trust is created, there will be careful planning to ensure that the creator’s original intentions will be carried out even if circumstances change. However, some developments are not foreseeable. In these cases, it may become necessary to wind up the trust before its original intended termination date.

A trust is usually wound up for three reasons. Sometimes, the trust may simply become too difficult, expensive or time consuming for the trustees to administer or it has outlined it usefulness. Winding up may also be necessary to avoid the Income Tax Act’s “21 Year Rule” which creates a deemed disposition for trusts every 21 years, requiring the trust to pay capital gains taxes or distribute its assets. Another common reason is that the beneficiaries want to receive their entitlements.

How to Wind Up a Trust
A trust can be wound up early by any of these three ways:

Court Order.
The most formal method is to obtain a court order. This may be used if winding up the Trust is contentious. This method involves: legal costs, court deadlines, bureaucratic delays and passing of accounts of the trustees by the court. It’s possible the court might not approve the winding up.

Unanimous Consent.
A trust can be wound up early if all the beneficiaries unanimously agree to the wind up and the distribution of the remaining assets of the trust or estate. This unanimous consent is sufficient to wind up a trust even if it would contradict the trust creator’s intention that the trust be distributed at a future date.

The key to this method is the beneficiaries’ consent. To consent each beneficiary must be an adult and mentally capable of making this decision. Children and incapable persons who are beneficiaries cannot agree to a winding up even if they have representatives, like guardians.

As a first step, all the beneficiaries must be identified and located. Individual beneficiaries may have married and changed their names, or they may have passed away, with their interest now passing to their children. Similarly, corporate beneficiaries such as charities may have merged or been dissolved.

This sounds simple, but for some trusts it may be impossible to identify all the beneficiaries. A trust may include beneficiaries who will only become entitled to a share of the trust if a certain specified event occurs. A named beneficiary’s future children and grandchildren may be entitled to a share of the trust. Since one cannot know how many children or grandchildren, if any, the beneficiary will have, these unborn children are unidentifiable. If the living beneficiaries are not the only ones who have interests in the trust then it will be impossible to obtain unanimous consent.

This method can be used for trusts which have a life interest beneficiary. A life interest beneficiary is entitled to benefit from a trust throughout his or her lifetime. Upon this person’s death, the trust is wound up, or the remaining assets pass to the other beneficiaries.

A lifetime can be a long time to administer a trust. The trustees may wish to dispense with their duties earlier, or ultimate beneficiaries may want to accelerate their receipt of their interest in the trust. If the life interest beneficiary can legally give his or her interest up, the trust would then be treated as if that beneficiary had passed away. This would allow the trustees to distribute the assets to any remaining beneficiaries and to wind up the trust.

Practical and Administrative Complications
Even if all the parties are co-operative, winding up a trust can be complex. There may be practical and administrative issues. Firstly, the appropriate legal documents would need to be signed, such as: an agreement between the beneficiaries and trustees if winding up by agreement; a renunciation of a life interest in the trust; a resolution of the Trustees to wind up the trust, as well as a release from the beneficiaries of the trustees.

A review of the remaining assets and liabilities will also be required. Distributing the assets may require special tax planning. If the assets include shares in a private company, consideration must be given as to whether there should be a shareholders’ agreement before these shares are transferred to the beneficiaries. Trustees may need to withhold money to pay any final income taxes that become due upon the final distribution. This should be explicitly acknowledged in the agreement to wind up the trust. The trustees may wish to obtain a Tax Clearance Certificate and to be indemnified by the beneficiaries. The trustees may be required to undertake a formal passing of accounts. They will need to present an accounting of their financial management to the beneficiaries and sometimes the court. Finally, there may need to be a discussion about compensation to be paid to the trustees out of the capital of the trust or estate.

Despite careful planning, trusts may outlive their purposes and need to be wound up. Although a trust can be wound up if all beneficiaries consent or a court orders or a life interest beneficiary gives up his or her interest, it can become a complicated process. This is only as an overview. We recommend that you speak to your legal advisors before taking steps to terminate a trust.