This is the latest in a line of decisions of the Royal Court concerning an application to set aside a trust for mistake. It is the first decided case after the new Articles 47B to 47J of the Trusts (Jersey) Law 1984, as amended (the "Trusts Law"), came into force. Carey Olsen acted for the Trustee of the Strathmullan Trust.
Background
The settlor established the Trust, which was governed by Jersey law, in 1997, a few months after moving to the Isle of Man from the UK following the sale of his shares in the family business for £2.1 million. This was all following a number of discussions with various advisors about the sale of the shares in the business and a possible move offshore, which discussions focussed in particular on the means by which the family wealth could be preserved. The settlor knew of English inheritance tax and was advised that there was no inheritance tax ("IHT") in the Channel Islands or the Isle of Man. With this in mind, he moved to the Isle of Man and established the Trust.
The Structure
On 4 July 1997, a company was registered in Jersey (the "Company") and the £2.1 million proceeds paid to the Company. The two issued shares in the Company were initially held on trust for the settlor personally. When the Trust was established on 10 October 1997, the shares were transferred to the Trustee as the initial trust property. The only beneficiaries were the settlor and his wife and, later, the Jersey Blind Society was added. There were long stop trusts for charitable purposes.
The Problem
The correspondence leading to the formation of the structure showed that whilst consideration was given to the absence of IHT in the Channel Islands and the Isle of Man, no thought was given to the deemed domicile provisions in the UK tax legislation. This meant that, notwithstanding the settlor's move to the Isle of Man, he continued to be treated as domiciled in the UK for IHT purposes for three years after his move. Significant charges to IHT therefore arose in relation to the transfers into trust with the result that some 25% of the trust fund would ultimately be lost in tax if the Trust continued to subsist.
The Application
The settlor applied to have the Trust set aside on the grounds of his mistake. The Court noted generally that the settlor is the natural applicant in such applications, rather than the trustee, as it is normally the settlor who has made the mistake in setting up the trust in the first place.
Although the settlor could have relied on the newly enacted Articles 47B to 47J of the Trusts Law (in particular Article 47E) the application was instead brought under Article 11 of the Trusts Law, under which the previous cases on mistake had been decided. This provides at Article 11(2) that a trust shall be invalid to the extent the Court declares (amongst other things) that it was established by mistake.
The Court considered first whether Article 11 and Article 47E of the Trusts Law provided alternative bases for an application. The new provisions enable the Court to set aside transfers or dispositions of property to a trust and so achieve the same result as an application under Article 11 – if all transfers into a trust are set aside, there is no property in such trust, and as a result the trust will cease to exist.
The Court noted that Article 11 is concerned with the creation, validity and duration of Jersey trusts whereas Articles 47B to 47J envisage a trust to be in existence before the powers under these articles can be exercised. Further, the articles appear in separate parts of the Trusts Law and there is no provision stating that Article 11 no longer applies. The Court concluded that its powers under Articles 47B to 47J were distinct from those under Article 11 and not introduced only for the purpose of governing the construction of Article 11.
Case Law
Accordingly, the Royal Court was content to decide the application in this case under Article 11 and to apply the principles already established by Jersey cases.
The Royal Court noted that it is clear from the most recent decision of the Supreme Court in Pitt -v- Holt [2013] UKSC 26 that the English courts have departed from distinctions between effects and consequences and that a mistake for which relief may be granted under English law can either be a mistake of fact or a mistake of law. This seemed "broadly to align the approach to be taken by the English Courts in the future with that adopted by the Royal Court".
The Court approved of the approach taken by the Royal Court in previous cases of mistake (re A Trust [2009] JLR 447, re Lochmore Trust [2010] JRC 068, re S Settlement [2011] JRC 117 and re B Life Interest Settlement [2012] JRC 229) and had "no hesitation in continuing to apply existing Jersey case law" to decide the question of whether the trust in this case should be set aside.
The Test for Mistake
The Court reaffirmed and applied the three fold test set out in re Lochmore Trust:
Was there a mistake on the part of the settlor?
The Court confirmed it is well settled in Jersey that a mistake about the tax effects of a particular transaction can be treated as a relevant mistake for the purposes of Article 11.
The Court commented on the complex arguments in the English decisions as to whether relief could also be available in cases of "artificial tax avoidance". Of such arguments, it said these -
"would be further complicated in this jurisdiction by a recognition that the social evil of artificial tax avoidance which puts an unnecessary burden on the shoulders of those that do not adopt such measures might receive a different emphasis where it is not our domestic taxation system which is being avoided. The complexity of such arguments, including the difficulties in establishing what amounts to a social evil where the relevant jurisdiction's legislature can be assumed to have taxed everything that it intended to tax (which makes avoidance, on one analysis, entirely legitimate) emphasises that in the absence of any contentions to the contrary, it is unnecessary to consider such an issue further in this case."
On the facts the Royal Court held that the settlor had made a mistake - he was not aware of the deemed domicile provisions.
Would the settlor not have entered into the transaction "but for" the mistake?
In the view of the Royal Court, the tax consequences of the mistake were serious. The effect of it was that the Trust would not achieve what was intended because IHT would still be due by the settlor's estate on his death in relation to the assets transferred. There were also various other charges which arose. The Court said:
"We have no doubt that he would not have entered the transaction "but for" his mistake in failing to appreciate the effect of the deemed domicile provisions."
Was the mistake of so serious a character as to render it unjust on the part of the donee to retain the property?
The settlor's wife supported the application and the Jersey Blind Society and the Attorney General rested on the wisdom of the Court. There were no other beneficiaries. Therefore, the Court concluded that it would be unjust on the part of the Trustee to retain the trust property and thereby cause a substantial tax loss to the settlor. It further noted that it would be "seriously unjust" to require the settlor to bring litigation against his former tax advisors, the outcome of which might be uncertain.
The Decision
The Court declared that the Trust was invalid under Article 11 of the Trusts Law and set it aside on the ground of mistake. The effect of this was that having been avoided, the Trust was as if it had never existed. Accordingly as a result of the decision, the Trustee held the assets of the trust fund and all profit derived from such assets as bare trustee for the settlor.
Costs
The Trustee sought an order that it could pay itself the costs of the application out of the trust assets if not otherwise paid. Counsel for the settlor said that the Trustee had the benefit of an indemnity from the settlor's tax advisor for the Trustee's reasonable costs in connection with the preparation and making of the application. He said that any further order in favour of the Trustee was unnecessary. However, the concern of the Trustee was that it could be left out of pocket if there are any costs that the advisor refused to pay.
The Court affirmed the principles set out in Des Pallières v J P Morgan Chase & Co [2013] JCA 146 (see a copy of our briefing note on this case). Unless there has been some misconduct on the part of the trustee, then if there are costs which have arisen from a settlor's mistake, the settlor or trust fund should bear those costs.
To the extent there were expenses which the Trustee could not recover from the tax advisor (for instance, because the advisor considered the Trustee's costs unreasonable), the Trustee would be required to convene the tax advisor to the Royal court so that the issue could be resolved and the tax advisor ordered to pay such costs as were due.
Comment
This judgment provides useful comment on the separate powers of the Royal Court under Article 11 and Article 47E to set aside a trust or a transfer into trust on the ground of mistake, in particular the confirmation that Article 11 will continue to provide an alternative basis for relief. It may be that applicants and the Court will to continue to rely on Article 11 in view of the substantial body of case law decided under it.
Please note that this briefing is only intended to provide a very general overview of the matters to which it relates. It is not intended as legal advice and should not be relied on as such.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
