In the matter of the Representation of IFM Corporate Trustees Limited  JRC 160: An interesting case concerning the rectification of a Trust.
On 31st July 2015, the Royal Court gave judgment in In the matter of the Representation of IFM Corporate Trustees Limited  JRC 160 making an order for the rectification of a Trust. In so doing, the Court raised an interesting issue as to whether it should exercise its discretion to rectify a trust if its assistance was sought to rectify a mistake relating to an "aggressive tax avoidance" scheme.
IFM (the "Trustee") was trustee of an employer financed retirement benefit scheme (the "Trust"). The Trust was established upon the acquisition of an employment business by the Settlor. The business of the Settlor was to second its staff to third parties, primarily in the UK, and the Settlor ceased its trade on 31st March 2014 Consequently the Trust was no longer active.
The Trust was intended to motivate and incentivise the employees of the Settlor, which employed approximately 2000 employees all of whom were intended to form part of the class of beneficiaries under the Trust.
The previous owner of the Settlor's business had carried out a similar business and put in place a similar structure for rewarding employees as was put in place by the Settlor. It was clear that both the Settlor and the Trustee intended that the employees should be rewarded in the way in which employees of the previous business had been rewarded.
The arrangements between the Settlor, its employees and the Trust were as follows:
- The Settlor paid employees the UK national minimum wage as a salary;
- This payment was made independently of the Trust;
- In addition to the salary, the Settlor also made discretionary loans to employees by way of reward for their services;
- These loans were made at the sole discretion of the Settlor, and were not made by the Trustee;
- At the end of each month, the Settlor transferred the right to repayment of the discretionary loans to the Trust;
- At the same time the Settlor would make a cash contribution to the Trust; and
- Discretionary loans, loan rights and cash contributions were all generally contributed to the Trust on a monthly basis.
The loan rights and contributions, once settled into trust, were handled in the following way:-
- The loan rights were held on the trusts of one sub-fund (the "Initial Sub-Fund"), which had only two main beneficiaries, including the First Respondent to the proceedings (a specified employee) and the Second Respondent (the "Missing Beneficiary"). The cash contributions were held on the trusts of other sub-funds (the "Subsequent Sub-Funds") which had a large number of main beneficiaries.
- Following the appointment of the loan rights and cash contributions, the Trustee entered into an instrument of transposition by which the loan rights and the cash contributions would be transposed so that the Initial Sub-Fund held all the cash contributions and the Subsequent Sub-Funds held the loan rights (on the repayment of a discretionary loan by an employee, the Trustee could potentially benefit employees who were beneficiaries of the Subsequent Sub-Fund). The Settlor motivated its employees in this way so that various tax advantages in the UK might be secured.
The terms of the Trust included a definition of the expression "beneficiaries" which the Court stated "extended to any specified employee, the spouse for the time being and widow of any specified employee, the children or remoter issue, and parent or remoter ancestor of any specified employee and the spouse of issue and ancestors who were the spouse of such a person immediately before their death. What was missing from the Trust was language which would have added other classes of beneficiaries, namely:-
"(i) Any child or remoter issue of any grandparent of any specified employee.
(ii) The spouses of all persons described in paragraph 1 above.
(iii) Any person who was the spouse of a person described in paragraph 1 above immediately before his death."
In relation to the Initial Sub-Fund, the problem arose because the third schedule to the Trust which set out the beneficiaries did not include paragraphs (i) – (iii) above. The Trustee therefore sought rectification of the trust instrument to introduce those potential objects as beneficiaries of the Trust. This would allow the Second Respondent to the proceedings to benefit from the Initial Sub-Fund.
The test for rectification is well established and is as follows:-
"(i) The court must be satisfied that as a result of a genuine mistake the trust deed does not carry out the true intentions of the parties and the settlor in particular;
(ii) There must be full and frank disclosure; and
(iii) There should be no other practical remedy."
Application of the Test
Genuine mistake and no other practical remedy
The evidence indicated that it was the Settlor's intention that the Missing Beneficiary was to be a beneficiary of the Trust and was one of the people whom it was anticipated the Trustee would be likely to benefit. Although there were some 2000 named beneficiaries of the Trust itself, the Initial Sub-Fund defined beneficiaries by reference to named individuals and accordingly the beneficiaries of any of the Subsequent Sub-Funds would be unaffected by any rectification of the Initial Sub-Fund. The Trustee and Settlor were agreed that a mistake had been made at the time of the creation of the Initial Sub-Fund, the only person likely to benefit from that Sub-Fund did not oppose the rectification on the grounds of mistake and there was no other practical remedy for enabling benefit to be paid from the Sub-Fund to the Missing Beneficiary. The Court accepted that the trust instrument did not reflect the intentions of the Settlor and the Trustee and that rectification was the only practical remedy.
Full and Frank Disclosure
On the issue of full and frank disclosure, the Court was concerned that there was little mention of the tax position in the UK in the papers provided to it and that this particular scheme might have fallen into the category of "aggressive tax avoidance". Following argument, the Court understood that this was a DOTAS scheme – a regime allowing HMRC to keep up to date with what types of tax avoidance schemes are in circulation and that HMRC were aware of the scheme generally, the scheme promoter having been required to disclose the main elements to HMRC who were then able to monitor the scheme's use and if necessary legislate to terminate it. The Court therefore accepted that full and frank disclosure had ultimately been made.
Important observations of the Court
The Court observed that if this particular scheme was "aggressive tax avoidance", it might have been a relevant factor in the exercise of its discretion, such as to potentially to lead to the refusal to exercise discretion in favour of the Trustee in respect of its application for rectification.
William Bailhache QC, Bailiff, observed:
"This Court recognises that there are strong ethical arguments why tax payers should recognise their obligations to the state in which they live, making their fair and appropriate contribution towards the outgoings which any modern state has in the provision of services for the benefit of the community ... On the other hand, it has long been the case that, as a matter of law, a citizen is entitled to retain his property unless by appropriate legislation, the state takes it away, or makes it chargeable to tax. That is the basis of the distinction between tax evasion, which is unlawful, and tax avoidance, which is not. To organise one's affairs so as to minimise tax has often been seen as a fundamental freedom, enabling the individual to live his life in accordance with the rules which the state sets down, of which taxation is but one...
"... What seems to us perhaps to be open to argument is whether, in an area which involves the exercise of a judicial discretion in cases where the court's assistance is being sought for a mistake which has been made, there is room for the argument that the discretion ought not to be exercised if on the facts of a particular case, the scheme in question is lawful but appears to be so contrived and artificial that it leaves the Court with distaste if, in effect, it is required to endorse it".
Whether the nature of a lawful tax avoidance scheme (aggressive as it may be) is a relevant factor going to the exercise of the Court's discretion when considering the granting of an equitable remedy did not need to be decided in this case as the Court accepted, in the circumstances, that it was not such a scheme. The matter is therefore for argument on another day. However, what is clear is that trustees must be mindful of both their obligations to the Court to make full and frank disclosure on applications of this kind and to be aware that the argument as to whether the remedy of rectification will be available in relation to aggressive tax avoidance schemes is likely to be a live issue in such applications in the future.