The Court considers whether a power of appointment was made validly in Abacus Trust Company (Isle of Man) Limited and another v National Society for the Prevention of Cruelty to Children.
Trustees of a non-resident trust carried out a capital gains tax avoidance scheme on the advice of counsel. This involved the transfer of borrowed funds to a new settlement and a subsequent appointment of funds in the existing settlement to a charity.
The Court considers whether a power of appointment was made validly in Abacus Trust Company (Isle of Man) Limited and another v National Society for the Prevention of Cruelty to Children.
Trustees of a non-resident trust carried out a capital gains tax avoidance scheme on the advice of counsel. This involved the transfer of borrowed funds to a new settlement and a subsequent appointment of funds in the existing settlement to a charity.
The implementation of the scheme was found to be defective. The trustee and protector of the trust applied to the Court for a declaration that the deed of appointment in favour of the charity was void ab initio for failure by the trustee to take into account the interests of the beneficiaries and the consequences of its decision. The declarations sought by the claimants in the action were granted by the Court.
The background and facts
Mr Christopher Oakley was involved in a management buyout of Ingersol Publications Limited, a United Kingdom company which published a number of newspapers and other publications in the Midlands and other parts of the country. Mr Oakley had at all material times been both resident and ordinarily resident and domiciled in the United Kingdom for the purposes of United Kingdom capital gains tax.
As part of the management buyout arrangements, a new company called Demiblend Limited was used to acquire the issued share capital of Ingersol Publications Limited. At the same time Mr Oakley established the Jaylands Trust and provided out of his own resources the sum of £90 to Abacus Trust Company (Isle of Man) Limited as the initial capital of the non-resident settlement.
Subsequently, Abacus established in the Isle of Man a company limited by guarantee called Jaylands Investments Limited. Abacus then paid Jaylands the sum of £90 provided by the settlor and Jaylands then subscribed for 900 10p shares (later subdivided into 9,000 1p shares) in Demiblend. The remaining shares in Demiblend were acquired by the other investors with the result that Jaylands Investments Limited came to own 15 per cent of the management ordinary equity of Demiblend and 1.3 per cent of the entire ordinary equity of the company. Demiblend then acquired the entire issued capital of Ingersol Publications Limited from its various shareholders and changed the name of that company to Midland Independent Newspapers Limited.
Subsequently, Midland Independent Newspapers Limited obtained a stock exchange listing and as a result of this flotation the value of the trustee's interest in Jaylands Investments Limited increased significantly in value. Three years later, Mirror Group Plc made a public offer for the entire issued share capital of Midland Independent Newspapers Limited; as part of this Jaylands Investments Limited accepted a loan note issued on 28 November 1997 by Mirror Group Plc in the amount of £2.7 million in consideration for the transfer of its shares in Midland Independent Newspapers Limited. The loan note had a maturity date of 15 July 1998 and for purposes of capital gains tax a disposal would occur when the loan note was redeemed or on an earlier sale.
The beneficiaries of the Jaylands Trust included the settlor and his wife together with various discretionary beneficiaries such as their children, remoter issue and also within the class of discretionary objects was any charity within the meaning of what was then section 45(1), Charities Act 1960. The settlement created life interests in income in favour of the settlor and his wife. After their deaths the income was to be held on discretionary trust for the benefit of the specified class of discretionary objects subject to a gift over of capital and income upon trust for the settlor's great grandchildren, then living, and in default upon trust for the NSPCC at the conclusion of the trust period which was defined as a period of eighty years commencing with the date of the settlement. The trustees were given an overriding power of appointment exercisable during the trust period with consent of the protector for the benefit of any one or more of the discretionary objects so defined. The settlement also contained an express power enabling the trustees to exclude any individual or corporate body from benefit under the settlement.
The appellant trust company instructed solicitors to advise on a suitable form of tax planning to deal with the imminent charge to capital gains tax that would arise when the loan note matured later in 1998. The trustees, who were neither resident nor ordinarily resident in the United Kingdom in the relevant year of assessment, were not liable to capital gains tax in respect of the chargeable gains accruing during that year. However, any gains which accrued in the relevant year of assessment were treated by section 87(4), Taxation of Chargeable Gains Act 1992 as accruing to the beneficiaries of the settlement who received capital payments from the trustees in that year or in any earlier year.
That régime had been amended by what is now section 86, which provides that in the case of a qualifying settlement (i.e. a settlement created on or after 19 March 1991) chargeable gains arising by virtue of disposals of any settled property originating from the settlor shall be treated as accruing to the settlor in the year of assessment in which they arise if in that same year the trustees are not resident or ordinarily resident in the United Kingdom during any part of that year, the settlor is domiciled and is either resident or ordinarily resident in the United Kingdom during any part of that year, and that at any time during the year the settlor retains an interest in the settlement.
At February 1998 the residence requirements in relation to both the settlor and the trustees were fulfilled and the settlor did retain an interest in the settlement both on account of his own life interest and also on account of the interest conferred upon his spouse, his children and their spouses. If nothing was done, Mr Oakley would become liable to capital gains tax on the gains which would crystallise when the loan note matured on 15 July 1998.
The solution proposed by their solicitors was a form of tax planning known as the 'flip flop' scheme. The essential elements of this were that two United Kingdom resident settlements would be established to mirror the 85/15 division of funds within the Jaylands trust that was created by an earlier appointment made on 29 October 1991. The beneficiaries under the two new trusts would be the settlor and his wife together with other members of his family.
The Abacus Trust would then borrow a sum of money from a bank charged on the shares in Jaylands Investments Limited which would correspond to the value of the trust assets. These monies would then be appointed on an 85/15 basis to the two new settlements, thereby removing any value from the existing trust fund. Abacus would also exercise its powers under the Jaylands Trust to exclude as beneficiaries the settlor and his wife together with any other persons falling within the categories of defined persons specified in paragraph 2(3) of Schedule 5 to the Taxation of Chargeable Gains Act 1992.
Provided these steps were completed by 5 April 1998, section 86, Taxation of Chargeable Gains Act 1992 would not apply to the gain that would accrue upon the maturity of the loan note in July 1998. Funds released on that occasion could then be used to repay the loan from Coutts Bank. The balance after payment of any costs would be available for distribution to the remaining beneficiary in the form of the NSPCC or some other charity. There would be no capital payment from the settlement out of the proceeds of the loan note so as to attract a charge upon the beneficiaries under section 87, Taxation of Chargeable Gains Act 1992, and the earlier transfer to the new trust of the money borrowed from the bank would not itself create any chargeable gain.
The advice given gave a clear warning that under no circumstances should there be either a disposal of the loan note or the shares in Jaylands Investments Limited in the same year that Mr Oakley and his family continued to be beneficiaries under the Jaylands Trust. To achieve this, two things were necessary. The creation of two new trusts and the exercise of the power of exclusion had to take place before 6 April 1998, and any appointment of the Jaylands Investments Limited shares to the charity had to occur after that date.
However, in the event, the solicitors acting failed to take fully into account counsel's opinion and suggested that a deed of appointment in favour of the NSPCC should be executed on Friday 3 April 1998. The effect of this action was that the conditions specified in section 86, Taxation of Chargeable Gains Act 1992 were satisfied for the tax year 1997-98 with the result that Mr Oakley became liable to capital gains tax in a sum of approximately £1.2 million calculated on a chargeable gain of approximately £3 million.
Accordingly, the trustee and the protector of the trust applied to the High Court for a declaration that the deed of appointment in favour of the NSPCC was void ab initio for failure by the trustees of taking into account the interest of the beneficiaries and the consequences of this decision. The NSPCC contended that an appointment could not be avoided for failure of the trustee to take into account the fiscal consequences of its decision and that, the settlor and family having been excluded as beneficiaries, the trustee was no longer required to consider their interest in making the appointment in favour of the NSPCC.
(Nicholas Warren QC for the claimants; Thomas Dumont for the NSPCC.)
The Chancery Division judgment
The matter came before Mr Justice Patten, who dealt with the facts in some detail. It was clear that the making of the appointment on 3 April 1998 was ill advised and a breach of duty on the part of the claimant, even if the only interest which he had had to consider was those of charity.
The judge then went on to consider the validity of the appointment. It was clear that the decision to execute the deed of appointment on 3 April 1998 resulted from a failure to follow the advice given to the trustees by counsel, in fact the counsel appearing for the company in this case. Had the trustees applied their minds to that advice at the relevant time, the deed of appointment would not have been executed on that day.
Mr Justice Patten had been invited to apply to the making of this appointment what had come to be known as the principle in Re Hastings-Bass (deceased), Hastings v Commissioners of Inland Revenue [1974] STC 221. In that case, the Court of Appeal declined to set aside the exercise of a statutory power of advancement under section 32, Trustee Act 1925 in the form of a transfer of funds between two family settlements.
Another relevant case was Mettoy Pension Trustees Limited v Evans [1991] WLR 1587, where the judge had to consider the decision in Re Hastings-Bass in relation to a deed of appointment of trustees under a pension scheme. In Mettoy Mr Justice Warner set out questions which had to be answered as follows:
'In a case such as this, where it is claimed that the rule in Hastings-Bass applies, three questions arise: (1) What were the trustees under a duty to consider? (2) Did they fail to consider it? (3) If so, what would they have done if they had considered it?'
The judge considered that it was the first of those questions which led to the real argument before him in the current case. There was no doubt that the trustees understood correctly what the legal effect would be of executing the appointment in favour of the NSPCC. What they had failed to take into account were the fiscal consequences of making the appointment on 3 April 1998.
Mr Justice Patten also considered a recent unreported decision by Mr Justice Jonathan Parker in Green v Cobham in which non-resident trustees decided to distribute some retained profits by various appointments under a will trust in favour of the testator's grandchildren. Following the execution of the deed of appointment, which created two accumulation and maintenance settlements in addition to the subsisting will trust, there were ten trustees who failed to be treated as a single and continuing body of persons for the purposes of determining the residence of the trust.
Unfortunately, just after the appointment of trustees, of whom six were non-resident, one of the non-resident trustees retired from practice and the effect of his retirement was to terminate the non-resident status not only of the trust created by the deed of appointment but also of the will trust itself.
The capital gains tax consequences of this were described by the learned judge as catastrophic and the evidence was that the accrued gains amounted to some £35 million.
A challenge was therefore made in Green v Cobham to the validity of the 1990 deed of appointment on the grounds that the trustees of the will trust failed to give any proper thought to the capital gains tax consequences of those dispositions, in particular in relation to the choice of trustees given the provisions of section 69(1), Taxation of Chargeable Gains Act 1992 and to the impending retirement of one of the non-resident trustees. Had those matters been fully appreciated and taken into account, the 1990 deed of appointment would not have been executed in the form in which it was.
The conclusion of the case was that the judge accepted that the Hastings-Bass principle applied and that the application of that principle required that the Court should interfere by declaring the 1990 deed to be an invalid exercise of a trustee's power of appointment, and consequently it was void in its entirety.
On the basis of the facts and the case law outlined, Mr Justice Patten was satisfied that Abacus, through its directors, failed to take relevant matters into account in the form of counsel's advice when considering whether to execute the deed of appointment in favour of the NSPCC made on 3 April 1988. Since that was highly material to their decision, for the reasons explained, and given that the appointment would not have been made had the advice been taken into account, it followed that the exercise of the power of appointment made on that day was invalid and of no effect.
The decision
The declarations sought by the claimants were made.
(Reported at [2001] STC 1344.)
Commentary by John T Newth FCA, FTII, FIIT, ATT
This is a classic case for students of capital gains tax planning, and particularly for those involved in sophisticated arrangements such as the 'flip flop' scheme. However, a cautionary note must be interposed regarding the decision. The Inland Revenue was invited by the claimants to agree that the deed of appointment should be treated as null and void for all purposes of United Kingdom tax, but it declined to give any such undertaking. The department also refused to agree to be bound by the decision of the High Court on the current claim or to be joined as parties for the purposes of making any submissions. The claimants, the NSPCC and Mr Oakley, therefore have to address the consequences of the decision by Mr Justice Patten.
Clearly, this case is a cautionary tale for those involved in sophisticated tax planning. There is already existing case law which sets out the warnings, such as Roome and another v Edwards [1981] STC 96, where the consequences were dire. The decisions in Bond v Pickford [1983] STC 517 and Swires v Renton [1991] STC 490 were more favourable to the taxpayers, but the facts in the current case show clearly what can happen even if a minor part of the scheme goes wrong.
The writer well remembers a case of his own which took place soon after capital gains tax had been introduced. An elderly client established a discretionary settlement which benefited, among others, her grandson. The grandson was a navy pilot and was killed in an air crash, predeceasing his grandmother. The effect of this was that the trust ceased to exist and the settlor became liable to capital gains tax on the chargeable gains of all the shares involved.
The other issue which has not come to light is whether a professional negligence claim will be made by the Oakley family against the firm of solicitors which administered the scheme. Even if the tax liability is cancelled, substantial legal and other costs must have been incurred.
The Hastings-Bass principle which was applied in this case has many interesting facets and is still evolving. It is hoped to examine it in more detail in a forthcoming article in Taxation.
