The familiar adage "if it looks too good to be true, it probably is too good to be true" has certainly applied to a number of tax mitigation schemes over the years. In a recent Jersey case another attractive and apparently effective tax mitigation arrangement had proved to be a fiscal disaster. Not only that, but the case has highlighted that HMRC appears to be becoming more inclined to intervene in relation to applications to set aside schemes with unforeseen tax consequences. Moreover, although the Royal Court determined by "a small margin" to set aside the transactions it perhaps, rather surprisingly, expressed reservations as to the Courts coming to "the rescue of foreign tax payers who, anxious to avoid paying their contribution towards the outgoings of their own jurisdiction's government, and thus meet their own obligations as citizens of that jurisdiction, make schemes of this nature."
In In the matter of the S Trust and the T Trust  JRC259, two unconnected married couples had taken up similar inheritance tax mitigation schemes recommended to them by a particular financial advisor. After an initial asset contribution of £20, a more significant sum was subsequently transferred into the trust for investment by each couple from borrowings secured on their principal asset, their houses. The financial advisor told the couple that this was an effective inheritance tax mitigation scheme permitting them to pass on their main capital asset, their house, to their children free of inheritance tax.
Unfortunately for each couple, it transpired that, in the words of the Court, "Far from being an effective scheme for avoiding inheritance tax liabilities, the scheme...was a fiscal disaster" giving rise to immediate and delayed tax charges. The trust property would also be treated as being part of their estates for inheritance tax purposes.
The couples applied to the Royal Court to set aside the transfers on the grounds of mistake.
Issues and decision
The Royal Court found that the couples had been mistaken as to the tax consequences of the transfers – which was a relevant mistake for the purposes of the application. The Royal Court rejected the submissions of HMRC relying on Pitt v Holt and Futter v Futter  UKSC 26 essentially to the effect that a mistake as to tax consequences was not sufficient. The Royal Court emphasised that in these cases, whilst any decision of the Supreme Court was given the utmost respect, it was operating from 'a different juridical root'.
The Court revisited the relevant test and the relationship between Article 11 (seemingly aimed at the validity of a trust as a whole) and Article 47E (seemingly aimed at dispositions to a trust) of the Trusts (Jersey) Law 1984 reviewing the earlier case of In the Representation of the Robinson Annuity Investment Trust  JRC133. As the Court said in Robinson, "In many cases the two are inextricably linked, because without any trust property there can be no trust. Furthermore, in many if not most cases the transfer of property will occur at much the same time as the creation of the trust and the same mistake will be operating on the mind of the Settlor both in relation to the creation of the trust and the transfer of the property to it." The Court (in the Re S and T case) found that despite the distance in time between the establishment of the trusts and the transfers of assets, the two were actually inextricably linked – one would not have been done without the other, and the same mistake was therefore operative.
The significance of the Court applying Article 11 or Article 47 lay in the third limb of the test. This has been set out in case law for Article 11 (see In re the Lochmore Trust  JRC068): is the mistake so serious as to render it unjust on the part of the donee to retain the property? (the judicial test). It is set out in the statute itself for Article 47 cases: is the mistake so serious as to render it just for the Court to make a declaration under the Article? (the statutory test).
Although this has been considered a distinction without a difference, the court here found that the present case raised new factual circumstances such that a potential difference was that with the judicial test, the court was measuring justice by reference to the position of the donee – is it just for the donee to retain the property in the circumstances of the mistake? With the statutory test, the court must look at whether it is just to make a declaration that a disposition of property is voidable because of a mistake made by the donor. The Court said "These are very fine margins, and whilst we agree that in most cases the result of the statutory and judicial tests will be the same, we are not sure that there will not be some factual circumstances which might make the distinction between the two tests relevant."
However, in this case any difference in the tests was not material. The real stumbling block was whether it should exercise its discretion at all. Not only did the Court pronounce its disapproval of the motivation behind the tax scheme, but it noted the absence of any financial consequences adverse to the beneficiaries given the indemnity received as a result of the settlement of proceedings the couples had brought against their advisers before the English High Court. Ultimately, it was only "by a small margin" that the Court decided that it would exercise its discretion to set aside the transfers as the family had suffered enough.
This case highlights a number of points:
(i) that Jersey maintains its unique statutory position in relation to mistake;
(ii) that HMRC took a more active interest demonstrating HMRC's recent approach to offshore tax avoidance schemes; and
(iii) that the Royal Court may find it unattractive to come to the rescue of overseas taxpayers where tax mitigation schemes do not work as intended. Whilst here the Court found in favour of the couples, this may not always be the case.
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