Tax Case - Power invalidly exercised

The trustees of an offshore trust in which the settlor and his family were discretionary beneficiaries took advice about avoiding a capital gains tax liability which would arise on the redemption of a loan note in 1998-99. Leading counsel advised that a 'flip flop' scheme should succeed provided that careful attention was paid to timing issues, namely that the borrowing and appointment to new trusts for the family should be completed by 5 April 1998, together with the exclusion of the settlor and other family beneficiaries from the existing trust, and any appointment of the settled property as reduced by the borrowing to a charity should take place after 6 April 1998.

The steps in the scheme then duly went ahead according to plan, except that on 3 April 1998 the trustees exercised the deed of appointment of the settlement funds in favour of the National Society for the Prevention of Cruelty to Children. This was the very appointment which leading counsel advised should not be made before 6 April 1998 because if it were made before that date it would give rise to a capital gains tax liability assessable on the settlor by virtue of the provisions of section 86, Taxation of Chargeable Gains Act 1992. Although the gift was to charity, it was considered that the exemption in section 257, Taxation of Chargeable Gains Act 1992 did not apply in the circumstances of the scheme because consideration was received by the family in connection with the 'gift'.

In order to rectify the mistake, the trustees sought a declaration from the court that the appointment of 3 April 1998 was void. Fortunately, they were successful in this approach. Mr Justice Patten said that when exercising a power of appointment, trustees were bound to have regard to the fiscal consequences of their actions. If it could be shown that the trustees would not have made the appointment if they had properly considered the tax effects of it, then the court was entitled to treat the exercise of the power as having been invalidly made and therefore void ab initio. The position would be different if, even taking into account the tax position, the decision of the trustees would have been the same, but in the present case the court was satisfied that the power would not have been exercised if the Opinion of leading counsel had been properly taken into account at the time. Accordingly the declaration sought by the trustees was given.

This was an unusual case in that the trustees had clear advice about the timing of their proposed appointment and in the events which happened, a muddle seems to have arisen about the timing issue. However, the case will be of interest to other trustees who may have inadvertently overlooked a tax liability which arises as a consequence of their actions and the decision in this case offers a hope that the past can be rewritten to undo a tax position.

(Abacus Trust Co (Isle of Man) Ltd v NSPCC, High Court Chancery Division, 17 July 2001.)

Issue: 3825 / Categories: