Jersey: Creditor's Remorse: In The Matter Of The E Settlement [2018]JRC143

Last Updated: 29 August 2018
Article by Robert Dobbyn and Carla Plater

Introduction

Not for the first time in recent years, the Royal Court of Jersey has shown itself willing to assist a trustee by setting aside a previous decision of that trustee, drawing on the law of mistake and also the Hastings-Bass principle.

This will be familiar ground to regular readers of our briefings, so this note does not go into great detail on the relevant statutory provisions.1

Background

In the present case, the action in question was a decision by the trustee to call for, and then accept, the payment of interest due to it under £18 million of loan notes. The default position, absent such a demand, was that interest accrued over time (and was compounded semi-annually) but was not required to be paid until the end of the term.

This state of affairs arose out of a fairly typical (historically at least - perhaps less so now) UK property-holding structure, where the trustee previously owned shares in a BVI company and that company in turn was the owner of a London property. The property was subsequently carved out of the trust by way of a share sale of the BVI company; the loan notes represented a later restructuring and formalisation of the purchase price, which had originally been left outstanding.

The trustee's interest demand in 2016 was a logical one. The trust had two beneficiaries: the settlor's son, who was an adult, and the son's own son, who was a minor. The trust's assets were substantial but illiquid, making it increasingly difficult for the trustee to fund its regular payments towards the maintenance and education of the settlor's grandson. Accordingly, the trustee made a formal demand for payment of interest on the loan notes in the sum of £2,285,111.83. This sum was duly paid by the debtor to the trustee.

Of significance is the fact that the debtor was a company incorporated in England and Wales. Unfortunately, as the trustee was subsequently advised, this meant that the payment of interest gave rise to a liability to income tax in the UK of just over £1 million. This could have been avoided relatively easily; had the trustee established a wholly-owned non-UK resident company, and then assigned the loan notes to that company prior to the interest demand, there would have been no income tax liability on the trustee or on the assignee company upon payment of the interest. Arrangements could then have been safely made to distribute the funds up to the trustee and then out for the benefit of the settlor's grandson.

The court was not asked to apportion blame between the trustee and its tax advisers as to why this result had not been anticipated prior to the decision to call in the interest. But to summarise their respective positions briefly: the tax advisers asserted that their previous review of the trust's affairs in 2015 (on which the trustee relied) had been correct not to show any UK source income or tax liability at that date because interest on the loan notes had only been accrued at that date; the trustee, on the other hand, argued that it should have been alerted by the tax advisers to the fact that actual payment of the interest would amount to UK source income and would therefore lead to a charge to UK tax.

Either way, the Royal Court accepted the trustee's assertion that, had the trustee been alerted to the correct tax position, it would have followed the course referred to above and assigned the loan notes to a wholly owned non-UK resident company (such as a Jersey company) before claiming payment of any interest. This simple step would have resulted in no charge to UK income tax on the payment of interest on the loan notes.

The law and the findings

As mentioned above, readers are referred to our earlier briefings for a more extensive summary of Articles 47G and 47H of the Trusts (Jersey) Law 1984. This case is a straightforward application of the same provisions, and resulted again in the granting of relief on both grounds, leading ultimately to a declaration that the interest received was therefore held by the trustee on bare trust for the debtor company. Thus, in relation to A47G, dealing with the law of mistake:

  1. the trustee made a mistake as to the consequences of its decision to make the interest demand: it believed that there would be no UK tax consequences as a result of its decision, whereas in fact payment of accrued interest led to a charge to UK income tax at 45% on the interest paid;
  2. the trustee would not have exercised the power to demand payment of interest if it had not made that mistake: in order to obtain income for the maintenance and education payments, it would first have assigned the loan notes to a wholly owned non-UK company and that company could have made the interest demand without any charge to UK tax; and
  3. the inadvertent UK tax liability of just over £1 million, to the detriment of the beneficiaries of the trust, was of sufficiently serious a character as to render it just for the court to declare the decision to demand interest void from the time of its exercise.

And in relation to Article 47H, being the statutory enactment of the rule in Hastings-Bass2: the trustee failed to take into account a relevant consideration, namely the fact that demanding payment of interest would give rise to a substantial tax charge, and it would not have exercised the power in that way but for its failure to take that relevant consideration into account.

Comment

Much of this will come as little surprise to anyone who has visited this territory before. Of note though is the reiteration, by the court, of its view from a previous occasion3 on the desirability (or not) of withholding relief where the effect would otherwise be to leave it to the parties to litigate amongst each other. As it is a comforting and constructive statement, it is set out below.

"More generally, we are not attracted by the proposition that beneficiaries should be left to a remedy of bringing litigation against trustees or professional advisors. The beneficiaries are usually not at fault and have already incurred loss by reason of unnecessary tax charges. To force them to incur further expense in what may be uncertain litigation when the law allows for the avoidance of a decision made in breach of the trustees' duties seems unnecessary, undesirable and unjust."

This quote was originally deployed in the context of the rule in Hastings-Bass, but the Royal Court confirmed in the present case that the sentiment was equally applicable to decisions made by a trustee due to mistake.

Footnotes

1 Readers who wish to understand the relevant statutory framework in Articles 47G and 47H of the Trusts (Jersey) Law 1984 could therefore also look at "In the matter of the L Trust: a textbook mistake/Hastings-Bass application with a little extra on the side" (published December 2017). Setting aside decisions of a settlor (rather than a trustee) is considered in our briefing note on In the matter of the M Trust [2017] JRC 198 (published January 2018).

2 As it was understood to be prior to the decision of the Supreme Court in Pitt v Holt [2013] UKSC 26

3 Re Onorati Settlement [2013](2) JLR 324, para 44

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