Taxing Times: A Briefing Note On AB v CD

On June 30 2016 Her Majesty's First Deemster, Deemster Doyle, delivered a judgment in the case of AB v CD, in which Kevin O'Loughlin and Christopher Arrowsmith of Simcocks acted for the Defendant trustee, CD, and Gillian Christian of Keystone Law and Robert Ham QC acted for the Claimant, AB. This is the first decision in the Isle of Man courts on the Hastings-Bass principle, and on the law relating to relief for equitable mistake following its reformulation by the UK Supreme Court in Pitt v Holt1.

The facts of AB v CD are relatively straightforward, however the judgment has significant implications for professional trustees in the Isle of Man and potentially further afield, and for those who advise them. The main practical implication is that the court found that the trustee was in breach of duty because it failed to take sufficient steps in relation to the taking of tax advice relevant to its decision making process. The court could be regarded as placing an onus on trustees to take and consider, or ensure that there is taken and considered, tax advice on the consequences of trustee decisions.

Setting the jurisprudential scene

The legal position in the Isle of Man, prior to AB v CD, on the two areas of law referred to above was as follows.

In relation to the Hastings-Bass principle, although it was considered that this principle formed part of Isle of Man law, there had been no decisions establishing this. The Hastings- Bass principle refers to the jurisdiction of the court to intervene to set aside a transaction entered into by a trustee (and other fiduciaries) on the grounds of "inadequate deliberation"2 in the exercise of a discretion. The jurisdiction arises where a trustee exercises a discretion, where the effect of the exercise is different from that which the trustee intended, and where it is clear that the trustee would not have acted as it did had it not failed to take into account considerations which it ought to have taken into account, or taken into account considerations which it ought not to have taken into account3. The Court of Appeal in Pitt v Holt decided that, for the court to have jurisdiction to intervene, the inadequate deliberation on the part of the trustees must be sufficiently serious so as to amount to a breach of fiduciary duty, and this was upheld by the Supreme Court on appeal. One practical effect of the Court of Appeal's decision was that, where a trustee takes and acts on apparently competent tax advice, but it transpires the tax advice was incorrect and an unforeseen tax charge arises, the trustee was not in breach of duty and the Hastings-Bass jurisdiction cannot be invoked. AB v CD is the first case in which the Isle of Man court has had an opportunity to consider whether the Hastings-Bass principle forms part of Isle of Man law at all, and if so whether Isle of Man law recognises the requirement introduced in Pitt v Holt for there to be a breach of fiduciary duty on the part of the trustee.

Isle of Man law on the equitable jurisdiction of the court to set aside a transaction on the grounds of mistake ("equitable mistake") has been settled for some years by the decision in Clarkson v Barclays Private Bank and Trust (Isle of Man) Limited4. Applying Ogilvie v Allen5, the Isle of Man court in that case decided that it had such jurisdiction if the mistake was so serious as to render it unjust for the volunteer donee to retain the property irrespective of the precise nature of the mistake, and that the best measure as to whether the mistake was sufficiently serious is if the payment would not have been made "but for" the mistake (in other words the mistake was the cause of the payment). In English law this equitable jurisdiction had been hamstrung by the distinction (seen by some as artificial and difficult to apply) between the "effects" and the "consequences" of the mistake - relief being available for the former, but not the latter - drawn in Gibbon v Mitchell6. That case had categorised a mistake about tax as being a "consequence" for which relief was not available. In Pitt v Holt the Supreme Court decided that Ogilvie v Allen was good law, and reformulated the jurisdiction in terms of injustice or unconscionability, without however approving the "but for" test in Clarkson. The Supreme Court did not endorse the Gibbon v Mitchell distinction, and accepted that a mistake about tax could be sufficient, however expressed some reservations where artificial tax avoidance was involved. AB v CD is the first case in which the Isle of Man courts have had an opportunity to consider whether the decision in Pitt v Holt on equitable mistake is part of Isle of Man law.

Facts of AB v CD

The Claimant was the settlor and primary beneficiary of eight discretionary trusts established under the laws of the Isle of Man in 2012. The Defendant was the trustee of the trusts and in 2012 granted a number of call options, ultimately in favour of the Claimant, over the trust assets. The call options may have given rise to adverse UK CGT consequences for the Claimant and the other beneficiaries, who had become resident in the UK in that year. These consequences could have been avoided by putting in place appropriate nominee agreements, however this was not identified.

The Claimant applied to set aside the call options on the grounds of the principle in Hastings-Bass and on the grounds of equitable mistake. The evidence showed that lawyers assisting the Claimant had corresponded with X, a senior individual intimately connected with the trustee, and X had commented on the need to consider tax consequences of distributions in jurisdictions in which the Claimant was resident, and also the consequences of the ability to exercise the call options. The lawyers had indicated that these comments would be considered and a response sent. However, no response addressing these comments was received, and the call options were granted.

Decision

The court found that X was plainly alive to the fact that careful consideration would need to be given to any adverse tax consequences, that X had raised valid tax points to which a response was not sent, that the trustee did not arrange for tax advice to be obtained but granted the options nevertheless, and that if it had known of the potential adverse tax consequences the trustee would not have granted the call options.

The court set aside the call options on the grounds of both the principle in Hastings-Bass (thus accepting that that principle forms part of Isle of Man law) and on the grounds of equitable mistake. The court commented extensively on the decision of the Supreme Court in Pitt v Holt.

In relation to the rule in Hastings-Bass, and possibly of most practical importance for trustees, the court decided that, if it was necessary in Manx law for a transaction to be set aside to establish a breach of duty on the part of the trustee, such a breach had been established. The court said:

X, intimately connected with the Trustee, raised the tax issue but the Trustee failed to take the point forward. X asked the question but the Trustee did not insist on receiving an answer. The Trustee failed to take tax advice prior to granting the Call Options. The Trustee failed to ensure that tax advice had been taken and did not ask for a copy of any such tax advice that might have been taken. The Trustee obtained no assurance that tax advice had been taken by anyone. The Trustee was aware that the tax question had been asked but no answer had been received. The Trustee chose nevertheless to proceed with the granting of the Call Options. That was a plain breach of duty. In all the circumstances of this case it was not reasonable for the Trustee to take no tax advice and to take no steps to ensure that tax advice had indeed been taken.

The court referred with apparent approval to the decision in Onorati Settlement7 where the Jersey Royal Court had held that the responsibility for deciding on an appointment and considering the tax consequences of any such appointment rested firmly with the trustee. In AB v CD the trustee argued that that whether a trustee should, as part of a decision-making process, obtain tax or other advice depends on what is reasonable in the circumstances, with each case being dependent on its own facts, and that the trustee had acted reasonably in this case. The Court said that it was unpersuaded by these arguments, in the circumstances of this case.

However, the decision may have a wider application and, although arguably fact sensitive, the court might be setting a higher threshold than a "reasonableness" test, and placing an onus on the trustee to positively ensure as part of its decision making process that tax consequences are considered by it. This suggests that the trustee must be advised as to the tax consequences of the proposed decision in relevant jurisdictions.

What does this decision mean for busy practitioners and trustees day to day? In practical terms, the safest approach in future for a trustee who is asked to exercise a discretion is to ensure that it has engaged and received tax advice from tax advisors before making its decision. Otherwise it runs the risk of being found to be in breach of duty, although in hostile litigation against a beneficiary the trustee might be protected by an exoneration or indemnity provision. Such an approach may give rise to additional costs, and commercially there may be a balance to be struck; there may be less costly solutions which might provide an acceptable degree of protection (e.g. insisting on receiving, being able to rely upon and considering a copy of the settlor's or beneficiary's tax advice).

The court expressly stated that it was not deciding whether to follow Pitt v Holt as to the requirement that, for the Hastings-Bass principle to apply, the inadequate deliberation on the part of the trustees must be sufficiently serious so as to amount to a breach of fiduciary duty. The Court said that it "may be a big if" whether it is necessary in Manx law to establish such a breach of duty, that strong arguments against it can be envisaged as a matter of principle and policy, and the court had serious reservations whether a breach of duty is necessary.

This leaves it open to argument, in a future case, that the court should intervene to set aside a transaction entered into by a trustee even though there was no breach of duty on its part (e.g. if it had taken tax advice, which tuned out to have been incorrect).

In relation to the claim to set aside the call options on the grounds of equitable mistake, the court decided that it had been a mistake for the trustee to fail to take professional tax advice, and the tax position having been raised it was a mistake for the trustee to fail to follow that issue forward to a satisfactory conclusion. The court held that the trustee would not have granted the call options but for the mistake as to the possible adverse fiscal consequences, and that the call options should be set aside on this ground also. The court said that if it was necessary in Manx law to establish that it would be unconscionable to refuse relief (as the Supreme Court had held in Pitt v Holt), that this additional requirement was also satisfied in the circumstances of this case. The mistake was sufficiently serious, since it would potentially prevent or reduce capital payments, including the conferment of any benefit, to the Claimant and his family from the trusts without incurring CGT, and that it would be unconscionable for the other party to the call options to retain the benefit of them in the circumstances.

The judgment in AB v CD is also of considerable interest for a number of other reasons. The court made a number of comments on the judgment of Lord Walker in Pitt v Holt. For example, Lord Walker had said, in relation to equitable mistake, that in some cases of artificial tax avoidance the court might think it right to refuse relief, including on the ground that relief should be refused on the grounds of public policy, referring to an "increasingly strong and general recognition that artificial tax avoidance is a social evil which puts an unfair burden on the shoulders of those who do not adopt such measures". Deemster Doyle referred to this as a "UK policy kite", noting difficulties which it has since caused in English cases, and the judgment seems to indicate that the Isle of Man courts might not be inclined to share Lord Walker's views in this respect.

Deemster Doyle also commented on Lord Walker's remark that "... it may be that some offshore trustees come close to seeing their essential duty as unquestioning obedience to the settlor's wishes." Deemster Doyle said that such comments do not reflect the modern offshore trust world which the Isle of Man inhabits, the Deemster noting his belief from experience in private practice and on the judicial bench for over 30 years that the vast majority of trustees in the Isle of Man take their responsibilities very seriously.

Deemster Doyle said of Pitt v Holt that it would be a mistake to assume that Manx law would automatically follow English law especially in respect of a decision which appears largely driven by UK policy and UK tax revenue considerations. The Deemster noted that English precedent is not and has never been binding on the Manx courts, which can draw and have drawn on other sources. The Deemster recognised that certainty in the law is important, and militates in favour of following English decisions, however noted that flexibility is also important. Perhaps tellingly, the Deemster said that sometimes certainty must temporarily be sacrificed until the applicable local Manx law has been settled, whether by a judgment of the Appeal Division or the Privy Council on an appeal from the Isle of Man, or by an Act of Tynwald. The Deemster recognised, of course, that if Pitt v Holt should come to be considered by the Privy Council as the Isle of Man final court of appeal, that the Privy Council consists of some of the same justices who make up the Supreme Court of the United Kingdom. This leaves open the prospect of, potentially, a similarly constituted court, sitting as the Manx highest court of appeal, reflecting on whether public policy in the Isle of Man differs from public policy as expressed by the highest court of appeal in England in Pitt v Holt.

AB v CD is also of interest because of the wide ranging order made by the court designed to protect the confidentiality of the identity of the settlor, the trustee and the beneficiaries. The court has in this and other cases supported the essential requirement for open justice, but has also acknowledged the validity of privacy concerns in cases involving private family trusts. The court said that this is a case where confidentiality is appropriate and the claimant understandably wished to keep the confidentiality "ring" as narrow as possible. The court noted there was a need to protect the confidentiality of the trustee in this case as the identification of the trustee may have led to the identification of the settlor and beneficiaries. This aspect of the case follows on from the court's decision in Delphi Trust Limited8 and both decisions should help avoid trustees and beneficiaries being reluctant, because of risks of publicity, to seek the guidance and intervention of the court in non-hostile cases.

The court in AB v CD referred to the introduction or proposed introduction in other countries of statutory Hastings-Bass and mistake jurisdictions. Representations have been made, including by Simcocks, to the Isle of Man Government in support of similar legislation here. It will be interesting to see whether the judgment in AB v CD influences the Government's approach on this question.

Conclusion

What is exceptionally clear from this judgment is that the Isle of Man court is very aware of the nuances of Manx practice, and the commercial reality of business life, when applying legal principles. It will be of interest to practitioners and their clients worldwide to note that the claim form in this case was issued less than a month before the final hearing, the court gave its decision on the day of that hearing, and the detailed reasons for that decision followed within the month. It is difficult to imagine what other jurisdiction anywhere in the world could have resolved this matter for the parties with any more expedition.

Footnotes

1. Pitt v Holt, Futter v Futter [2013] UKSC 26; [2013] 2 AC 108

2. "Inadequate deliberation" was the expression used by Lord Walker in the Supreme Court in Pitt v Holt

3. As stated in Sieff v Fox [2005] EWHC 1312 (Ch); [2005] 1 WLR 3811; [2005] 3 All ER 693

4. 2005 - 06 MLR 493 (followed in McBurney v McBurney (re Betsam Trust) 2008 MLR 201

5. (1897) 13 TLR 399, CA; sub nom Ogilvie v Allen (1899) 15 TLR 294, HL(E)

6. [1990] 1 WLR 1304; [1990] 3 All ER 338

7. [2013] JRC 182

8. 2014 MLR 51