O n 9 March 2011, the English Court of Appeal delivered judgment in the twinned appeals of Pitt v Holt and Futter v Futter.¹ The Court of Appeal rejected entirely what has become known as ‘the rule in Re Hastings-Bass’ and clarified the equitable jurisdiction in England to remedy the ill effects of erroneous tax advice. The leading judgment of Lloyd LJ contains a rigorous analysis of the principles underpinning, and a full assessment of the cases that have applied, ‘the rule’ and the doctrine of mistake.

These principles are of great significance in the offshore world as they provide a basis for trustees (and tax advisors) to set aside transactions resulting in unintended tax consequences. The legal principles detailed in the conjoined appeals challenge this practice and raise the question as to whether it ought to be permitted to continue. Although the decision is potentially subject to an appeal to the Supreme Court and it is open to other jurisdictions to take an alternative approach, the judgment is of great interest because, at the very least, it may well signify the end of the era of ‘get out of jail free cards’ for trustees and tax advisors where transactions have been entered on the basis of erroneous tax advice.

To recap, the ‘rule’ refers to the court’s (purported) power to set aside a trustee’s exercise of discretion or power when its effect is otherwise than intended and the trustee would not have acted as he did having either ignored relevant considerations or considered irrelevant matters.

Over the last two decades or so, it has ordinarily been a failure to consider the actual (and adverse) fiscal implications of a transaction that has given cause for trustees to ask the court to exercise its equitable jurisdiction to set aside decisions based on erroneous tax advice. Revisiting these decisions has been beneficial to trustees and tax advisors as it has enabled them to avoid liability for their errors.

Pitt v Holt concerned a claim to set aside a transfer to trust of the proceeds of a structured settlement claim made pursuant to professional advice and under which Mr Pitt was entitled to a lump sum and monthly payments in respect of serious injuries that had been occasioned to him in a road accident. Post settlement, it was realised that the transfer into trust attracted inheritance tax in the same manner as any transfer into any discretionary trust. It was claimed that the settlement into trust was voidable under the principles espoused in Re Hastings-Bass² or otherwise on the ground of mistake. The trial judge ordered that the transactions be set aside under the Hastings-Bass rule but held that he would not have set aside the transactions on the basis of mistake. The Court of Appeal rejected both claims.

Futter v Futter concerned a more typical claim in this area arising from the exercise of powers of enlargement and advancement by offshore trustees acting under professional tax advice from London lawyers with the object of avoiding a charge to capital gains tax on stockpiled gains. The trial judge ordered that the transactions be set aside under ‘the rule’ such that he did not need to consider the argument that the same were also vitiated on the ground of mistake. Again, the Court of Appeal rejected both claims.

Lloyd LJ’s judgment emphatically confirms that, as a matter of English law, the decision in Re Hastings-Bass has been misunderstood and misapplied since at least 1990. The misunderstanding was found to have grown from Warner J’s misinterpretation of ‘the rule’ in Mettoy Pension Trustees Limited v Evans [1990] 1 WLR 1587, which had subsequently been followed in numerous other cases. The judgments of Lloyd LJ and Mummery LJ allow two clear principles to emerge from the shadow of what had become known as ‘the rule’.

First, a purported exercise of power will be void and ineffective where there is a fraud on the power or the exercise is beyond power. Secondly, an exercise of power will be voidable where the trustee has disregarded relevant considerations or has had regard to irrelevant considerations. The exercise is voidable at the instance of the beneficiaries on the basis that the same constituted a breach of fiduciary duty by the trustee. The trustee will not be permitted to make the application. Where the power is exercised for fiscal advantage, the trustee will not be liable if advice has been taken from an appropriately qualified and competent tax advisor. There the remedy will likely lie against the tax advisor.

It is far from clear that the decision will be followed in other offshore jurisdictions. At least insofar as Jersey is concerned (and likely elsewhere), there are strong arguments for and against following the recent decision in this respect.

Each of the seven reported cases in Jersey³ has referred to and followed Re Hastings-Bass. Further, all bar one⁴ of those cases referred to and applied the three stage test⁵ espoused in Mettoy (the case in which the Court of Appeal considered corrupted equitable principles by the judicial invention of ‘the rule’). It is therefore arguable that if the English decisions are plainly wrong in principle then it is wrong for them to be followed in the future. Additionally, it is arguable that the absence of adversarial argument (from the HMRC or another interested party) in each of these cases has prevented the court from finding against the existence of ‘the rule’.

However, against this it must be remembered that, first, the Jersey court is not bound to follow any decision of any foreign court and, secondly, the Jersey court will not depart from its earlier decisions unless persuaded that its earlier decision was wrongly decided. While it is now plainly arguable that these earlier decisions should be ignored as unsafe as they were based on a misunderstanding of relevant principles, the existence and content of the preceding case law cannot be ignored. There are at least two good reasons why ‘the rule’ could not be followed in Jersey (and elsewhere).

First, despite its name, ‘the rule’ did not originate from the case of Re Hastings-Bass but, as was noted by Birt, Deputy Bailiff (as he then was) in In the Matter of the Green GLG Trust,⁶ ‘the rule’ existed prior to that case and this much was ‘entirely consistent with precedent and principle’.⁷

Secondly, irrespective of argument as to the origin of ‘the rule’, as it is arguable that it is consistent with principle (if not now English precedent), public policy considerations might allow a different path to be followed. In four⁸ of the seven cases the Jersey court has, as a matter of public policy, rejected the idea of encouraging the trustee to suffer the tax consequences arising from erroneous advice and pursue its remedies against the tax advisors. For obvious reasons, public policy considerations onshore are different to those offshore and provide cogent reason for maintaining ‘the rule’ offshore rather than encouraging the proliferation of adversarial litigation.

The English Court of Appeal restated the rule for setting aside voluntary transactions on the basis of mistake. To invoke the court’s equitable jurisdiction, it was held that the donor must be mistaken as to the legal effect (as compared with the consequence) of the disposition or an existing fact that is fundamental to the transaction and the mistake must be so serious in its character as to render it unjust for the recipient to retain the benefit of the gift. It was also specifically held that the creation of unforeseen tax liabilities is a consequence (not an effect) that will be insufficient to enliven the jurisdiction.

This statement as to the English law position is quite apposite given the relatively recent collection of decisions in Jersey⁹ and Guernsey¹⁰ on point, some of which have required the application of English law because the trusts involved were governed by English law. While the recent decision of the English Court of Appeal will clearly assist in determining the question of mistake in relation to English law trusts, it might not have a significant bearing on the same question in relation to Jersey law trusts. The Jersey cases referred to have made clear that making a distinction between the effects and consequences of a transaction is unattractive to dealing with matters of this nature. Instead, the test is whether the mistake of law or fact is such that the settlor would not have entered into the transaction ‘but for’ the mistake in question. Given this recently settled law on point, it is unlikely that the recent decision will have any bearing on this matter.

In England, losses suffered because of erroneous tax advice can now only be resolved by litigation between those adversely affected and their trustees and/or tax advisors. There is scope for offshore jurisdictions to take a different path and it will be interesting to see how the recent judgment is treated in light of offshore policy considerations. It will also be interesting to see whether the recent judgment inspires HMRC to intervene for the first time in a Hastings-Bass application in Jersey, given that it has recently done so in Guernsey.¹¹