Contents

Chapter 5
Investment powers

Apportionment of receipts and outgoings between capital and income

Proposal
P19 Apportionment clause
(1) New legislation should provide that a trustee may:
(a)apportion any receipt or outgoing in respect of any period of time between the income and capital accounts, or charge any outgoing or credit any receipt exclusively to or from either income or capital as the trustee considers to be just and equitable in all the circumstances and in accordance with accepted business practice;
(b)transfer funds between capital and income accounts to recover or reimburse an outgoing previously charged to the account that is to receive the funds where such corrections are fair and reasonable and are undertaken in accordance with accepted business practice;
(c)transfer funds between capital and income accounts to recover or deduct any receipt previously credited to the account from which the funds are to be recovered where such corrections are fair and reasonable and are undertaken in accordance with accepted business practice; and
(d)deduct from income an amount that is fair and reasonable to meet the cost of depreciation, and add the amount to capital, in accordance with accepted business practice.
(2) New legislation should provide that:
(a)if a trust deed includes a clause that attempts to exclude P19(1) then that clause is of no effect; and;
(b)any clause in a trust deed is invalid to the extent that it is inconsistent with P19(1).
Please give us your views on this proposal.

Current law

5.24Current rules on the apportionment of receipts and expenses depend on whether a particular receipt or expense is classified as income or capital. If the trust deed is silent on apportionment, under case law the type of expense determines who bears it. Generally, expenses of an income nature are borne by income beneficiaries while expenses of a capital nature are borne by capital beneficiaries. However, the case law rules also depend on other factors, such as for whose benefit the expense was incurred, to determine expense apportionment.152
5.25There may be uncertainty over the correct apportionment in some situations as it may be difficult to assess who benefited from a particular expense. In other situations the apportionment can cause considerable inconvenience because it requires complex calculations of very small sums of money.153  Apportionment of income and outgoings over time where the person entitled to income changes part way through the relevant payment period can cause difficulty.

5.26Many trust deeds enable trustees to exercise discretion as to how to apportion both receipts and expenses between accounts and over time. But, if the trust deed is silent on the matter, trustees must apply the complex apportionment rules.

5.27In addition to the case law rules, there are a number of specific provisions in the Trustee Act that deal with apportionment in certain situations. Section 83, for example, contains special rules as to apportionment on purchase, sale or transfer of fixed income assets and shares in certain situations.

Issues

5.28The current default rules on apportionment are complex and difficult to apply. Most trust deeds contract out of them and enable trustees to exercise discretion on apportionment. The question is whether the default rules governing the apportionment of outgoings between capital and income should be reformed to reflect current practice.

Options for reform

5.29The options we considered are:

(a)retaining the status quo; or
(b)giving trustees the power to apportion a receipt or an outgoing between income and capital accounts, or to charge an outgoing exclusively to or credit a receipt exclusively to income or capital and to apportion a receipt or outgoing in respect of any period of time, in accordance with accepted business practice where they are satisfied that it is just and equitable to do so.

5.30If option (b) is favoured, then several related changes probably should also be made to allow trustees to:

5.31We put some of these proposals forward for comment in the Fourth Issues Paper.154  The proposals in option (b) are broadly modelled on reforms recommended by the British Columbia Committee. The British Columbia Committee proposed that trustees have the power to apportion or charge an outgoing if it is just and equitable, in accordance with sound business practice, and in the best interests of beneficiaries. The Committee also recommended trustees have the power to transfer funds between capital and income accounts to recover or reimburse an outgoing previously charged to the account that is to receive the funds. It recommended that trustees be able to deduct from income an amount that is fair and reasonable to meet the cost of depreciation and add the amount to capital.155  The British Columbia Committee proposed also, although only in respect of discretionary allocation trusts, that trustees should be able to allocate receipts and outgoings to the income and capital accounts as the trustee considers just and equitable in all the circumstances.156

5.32It should be noted that the changes proposed in option (b) would not alter in any way the tax status or liability that attaches to any receipt or outgoing. The reforms would give trustees discretion as to how they apportion outgoings and receipts for the purposes of trust law without breaching their obligations as trustees. That would not affect the treatment of those receipts and outgoings for tax purposes.

Discussion

5.33We favour option (b) over the status quo, as did most submitters who responded. The current rules on apportionment are difficult to apply and it can be hard to determine who benefits from particular expenditure or should receive a receipt. We consider it would also be confusing and unhelpful, given our proposals in the previous section, to try to retain the rules on apportionment. Many, if not most, newer trust deeds already allow trustees to exercise their discretion and apportion a receipt or an outgoing between income and capital accounts or to charge an outgoing exclusively to or credit a receipt exclusively to income or capital. Trustees similarly have discretion when apportioning between accounts on the basis of time. If trustees are granted this discretion then logically they should also be permitted to change their minds subsequently or correct mistakes. The proposal also ensures that income beneficiaries are not unduly favoured due to a failure to allow for depreciation.

5.34The proposed reform leaves it to trustees to allocate or apportion receipts and outgoings justly and equitably between income and capital accounts under a trust, and to disregard the traditional legal categories for income and capital accounts for that purpose. We consider that this power will assist trustees in maintaining an even hand between different classes of beneficiaries.

5.35The proposed reform includes a requirement that allocation of expenses to capital or income is undertaken in accordance with accepted business practice. The New Zealand Law Society (NZLS) considered that guidance on what constitutes accepted business practice in this context could be helpful. Some submitters proposed changing the term “accepted business practice” to “generally accepted accounting practice” so that trustees would have to comply with financial reporting standards (GAAP’s) promulgated by the External Reporting Board under the Financial Reporting Act 1993. However, we are not persuaded that requiring trustees to comply with prescriptive financial reporting standards would be appropriate. We think that compliance with such standards would provide trustees with a safe harbour, but should not be necessary in all situations.

5.36It is arguable that including the words “in accordance with accepted business practice” may actually be unnecessary as this will be implied by the duties on trustees, but we see value in including this broad standard to give an indication of the type of practice that will be acceptable.

5.37We consider that imposing a requirement on trustees that they exercise their discretion in the best interests of all beneficiaries is likely to cause confusion and therefore be unhelpful. The NZLS noted that any requirement that the discretion be exercised in the best interests of beneficiaries might cause confusion because the interests of different classes of beneficiaries will not be consistent with each other. Life interest and remainder beneficiaries are all beneficiaries of the trust, and the decisions regarding the application of expenses to income or capital will inevitably result in an outcome that is not in the best interests of one of those categories of beneficiaries. Trustees are already subject to a duty to act in good faith and consider the respective interests of each beneficiary, so little would be added by requiring any discretion to be exercised in the best interests of all beneficiaries.

5.38Most submitters supported trustees having a power to transfer funds between capital and income accounts to recover or reimburse an outgoing previously charged to the account. Some submitters agreed that the British Columbia approach provided a good model. The NZLS considered that trustees should only be able to do this if it was just and equitable and in accordance with ordinary business practice. If trustees are granted discretion to decide whether to apply an expense to income or capital then trustees should also be permitted to change their minds subsequently.

5.39Most submitters also favoured allowing trustees to deduct a reasonable cost of depreciation from income. The option enables assets to be maintained for the capital beneficiaries. Submitters considered that trustees should only be able to deduct an amount from income to provide for depreciation if satisfied that this is just and equitable and is in accordance with normal business practice. Trustees should also be permitted to reverse (in whole or part) any deduction made from income to the provision for depreciation in the event that the property is sold for more than its depreciated value.

5.40The proposed reform should also replace section 83 and the other provisions of the Trustee Act that contain special rules relating to the apportionment of receipts and outgoings between income and capital. Sections 83, 84, and 85 of the Trustee Act need not be carried forward into a new statute. They are obscure, difficult to apply and can result in impractical outcomes. Instead, we propose that trustees should be able to allocate or apportion receipts and outgoings justly and equitably in these circumstances.

New approach should apply to existing trusts

5.41Our proposed reforms replace the existing case law rules on apportionment by giving trustees the discretion to allocate expenses and receipts between income and capital. We are also proposing that this new approach to apportionment should apply to existing as well as new trusts and that it should apply to all trusts regardless of any provision or contrary intention expressed in any trust deed. In other words it should be a mandatory rule and express provisions in a trust deed dealing with apportionment cannot replace it. We consider that the best option is to simply replace all the existing rules with the new apportionment provision we have proposed.

5.42The other option would be to make the new apportionment rules a default provision that could be modified or excluded by the terms of a trust. In our view that alternative is likely to cause significant confusion, inconsistency and unfairness. All existing trust deeds have been drafted against the background of the current case law rules on apportionment. Clauses addressing apportionment have been drafted to avoid the complexity and problems created by some of the current rules. While newer trust deeds may have given trustees the type of discretion we have proposed in our preferred approach, others will not have. Instead they will have probably only addressed specific rules, such as the rule in Howe v Earl of Dartmouth (which requires certain residual personal estate to be sold). If the new apportionment provision we have proposed were only a default provision, such clauses in trust deeds would probably exclude the new rule and would continue to apply instead. This would cause some confusion as such deeds would have been drafted within such a different context that they would be difficult to interpret and apply. It may also result in unfairness.

5.43The Commission proposes instead that the new apportionment provision should apply to all trusts from the date that a new Act containing the provision comes into force. The new provision is flexible and will give trustees discretion to apportion as they consider just and equitable in all the circumstances and in accordance with generally accepted business practice. Clauses on apportionment included in trust deeds would only be valid to the extent that they are consistent with the new provision. Trustees would be required to consider any specific instructions on apportionment that had been included in the trust instrument.

5.44The Commission is aware that it has not previously consulted on the proposal that the proposed apportionment clause should be a mandatory provision and apply to existing as well as new trusts. We have also not previously consulted on those aspects of the proposal in P19(a) and (c) that allow trustees to apportion receipts on a just and equitable basis. We therefore particularly welcome comment and feedback on these proposals.

152A Modern Trustee Act for British Columbia, above n 143, at 53.
153Capital and Income in Trusts, above n 150, at 9.
154Fourth Issues Paper, above n 142.
155See cl 35 of the proposed Trustee Act in A Modern Trustee Act for British Columbia, above n 143, at 53–54.
156Cl 36, at 54.