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Knowledge Order of the Jersey Court setting aside trusts for mistake in novel circumstances

Private Client analysis: The Royal Court in Jersey held, taking its now-familiar practical approach to mistake cases, that (i) trusts could be set aside for mistake in a case where there were potential but not certain adverse tax consequences, even though the applicant settlor continued to maintain in the context of an HMRC investigation that the adverse tax consequences did not apply; and (ii) trusts could be set aside for mistake where they had previously been terminated and the assets distributed. Written by Robert Christie a partner, and Sonia Shah a senior associate at Bedell Cristin Jersey.

In the matter of the R, S, T and U Trusts [2021] JRC 166

What are the practical implications of the case?

Generally, tax mistake cases involve a situation where the settlor believed that the tax consequences of the trust being settled were 'x' (the 'Expected Consequences'); but in fact they were 'y' (the 'Adverse Consequences'). This case involved grey areas at both ends of this dichotomy. On the one hand, the settlor was aware of the danger of the Adverse Consequences when he settled the trusts; and on the other, he had not conceded, in the context of an HMRC investigation, that the Adverse Consequences did apply – indeed, he maintained that they did not. In these circumstances, the settlor had to demonstrate to the court's satisfaction that a mistake had indeed been made. The case demonstrates that a mistake application of this nuanced kind can nevertheless succeed, depending on the precise facts.

Further, in this case two of the trusts had already been terminated, and the assets distributed to the settlor (who was at all times following the advice he received), before he had made the decision to bring a mistake application. The court held (it is believed for the first time in a reported judgment) that nothing in the Jersey trusts legislation, or the general law of trusts, prevents a court from setting aside a trust on grounds of mistake after it has been terminated.

However, we note by way of commentary that none of this should lead to a conclusion that the Royal Court will exercise its mistake jurisdiction on an unprincipled basis; the recent decision of the Jersey Court of Appeal in Hawksford Trustees Jersey Ltd v P [2021] JCA 201, upholding the Royal Court's decision at first instance, emphasises that while the Royal Court will relieve settlors of the consequences of mistakes in appropriate cases, it is no part of the Royal Court's role to seek to improve the tax position of mistake applicants (eg by retrospectively substituting an alternative scheme).

What was the background?

The key issue in the case was the domicile of the settlor. Having moved abroad in the 1980s and established what he believed was a foreign domicile, he returned to England prior to 2009 (when the trusts were settled) on a temporary basis for the purpose of overseeing his children's education in the England. He was aware, before he settled the trusts, that if he had a UK domicile in 2009, there would be serious adverse IHT consequences in settling the trusts. However, ultimately the advice that he received was that his advisors were satisfied he had maintained his foreign domicile and he was 'safe' in this regard, as opposed to there being a real risk that he was UK-domiciled.

An HMRC investigation into the tax affairs of the settlor began in 2013 and by 2018 it encompassed the trusts. The IHT liability would have been between one third of the value of the trusts, and the whole of the value of the trusts, depending on the incidence of interest and penalties. As mentioned above, the settlor was maintaining in that investigation that he was foreign domiciled (in which case the Adverse Consequences would not apply).

What did the court decide?

In relation to the fact that the settlor was aware of the danger of the Adverse Consequences, the court concluded that he believed the risk they would materialise was negligible, when in fact it was high. The court's approach to the question of what can amount to a mistake (declining to follow the attempts in the English authorities to formulate a mechanistic rule for this question) was that 'It will always be a matter of fact and degree, whether a belief in relation to a risk is so far removed from a realistic assessment of that risk that it can be described as mistaken'. Here, that test was met; this was not a case where the settlor had broadly speaking understood the level of risk, and decided to run it.

In relation to the fact that the settlor advancing the mistake application was maintaining in the HMRC investigation that the Adverse Consequences did not apply, the court concluded that in order for the mistake application to succeed, it was unnecessary to determine that the settlor was UK domiciled in 2009. HMRC had made its position absolutely clear: the settlor was UK domiciled in 2009. The court held that 'If the Settlor had received advice in 2009 as to the likelihood that HMRC would adopt this position… we find that he would not have settled the Trusts.' The court noted that 'for the court to conclude that a mistake has been made, it is sufficient that the mistake has led to a risk of a serious adverse tax consequence, even if it is far from certain whether that risk will actually come to pass'.

In relation to the fact that two trusts had been wound up, the court held that a declaration that a trust was void ab initio did not depend on the continued existence of the trust; so long as rights and liabilities continued to exist, such as the trustees' equitable lien, the court's jurisdiction remained engaged. The exercising of that jurisdiction 'is not futile' since potential tax liabilities subsisted in relation to the trusts. The prior termination of a trust might affect the court's discretion, especially where third parties were affected; but in this case, the assets had been distributed to the settlor, so setting the trusts aside ab initio would create no practical problem.

Case details

- Court: Jersey Royal Court, Samedi Division
- Tribunal: Commissioner Clyde-Smith and Jurats Blampied and Austin-Vautier
- Date of judgment: 10 June 2021

Robert Christie is a partner, and Sonia Shah a senior associate, at Bedell Cristin Jersey.

Article first published on LexisPSL Private Client on 24 August 2021.