In a decision that will be significant for offshore tax planning and trust matters, the England and Wales Court of Appeal has effectively reversed the so-called “Rule in Hastings-Bass” that has developed over the past 20 years, mostly in offshore tax havens like Jersey and the Isle of Man. In Pitt v. Holt, 2011 EWCA Civ 197, the Court of Appeal held that the law took “a seriously wrong turn” 20 years ago, and that Hastings-Bass does not support the “Rule” that has been so often invoked by trustees to unscramble transactions that had unintended tax consequences.

The “Rule” under consideration was allegedly based upon the 1975 English Court of Appeal decision in Re Hastings-Bass. It was conveniently summarized in Sieff v. Fox (2005) as: “Where trustees act under a discretion given to them by the terms of the trust, in circumstances in which they are free to decide whether or not to exercise that discretion, but the effect of the exercise is different from that which they intended, the court will interfere with their action if it is clear that they would not have acted as they did had they not failed to take into account considerations which they ought to have taken into account, or taken into account considerations which they ought not to have taken into account”.

The Rule has been criticized over the years as being the “morning-after pill” or “get out of jail free card” for trustees, who invoke Hastings-Bass to set aside their own decisions that had unintended tax consequences. For most of this time, HM Revenue & Customs has sat on the sidelines while the Rule has been developed and applied. In the past year or so, however, HMRC has intervened in cases in both the UK and offshore jurisdictions seeking to put the brakes on the application of the Rule in Hastings-Bass.  

On March 9, 2011, the Court of Appeal allowed appeals in Pitt v. Holt (2010) and Futter v. Futter (2010) in which lower court judges had applied Hastings-Bass to set aside decisions of trustees that had unwanted tax consequences.

The Court of Appeal performed a thorough review of the cases, and reached the conclusion that the 1975 decision of Hastings-Bass does not support the so-called “Rule” that has developed in the past two decades. The Hastings-Bass case only concerned a trustee’s exercise of the power of advancement. In regards to acts of a trustee that are within their powers but have unintended financial consequences, the Court of Appeal in Pitt v. Holt summarized the “correct” approach as follows:

  • the trustee’s act would be voidable, not void  
  • it would only be voidable if there was a breach of fiduciary duty by the trustee  
  • if it is voidable, it may be set aside upon the application of a beneficiary (not a proceeding commenced by the trustee)  
  • equitable defences and the Court’s discretion would apply.  

Fiscal considerations, such as tax liability, are often among the “relevant” matters that a trustee must take into account when exercising a discretion. However, if a trustee receives professional advice on tax matters, there can be no finding that there was a breach of fiduciary duty.

In the Futter case, the trustees relied upon the tax advice of the law firm Withers. The tax advice turned out to be wrong, but that does not mean that the trustees were in breach of their fiduciary duties. The Court of Appeal held that the decisions of the trustee therefore could not be “voidable”, and the Court could not intervene.

The Pitt case involved a fund established for a brain-injured person. The Court agreed that the same principles apply in the adult guardianship context as in private discretionary trusts. The fiduciary received professional advice that did not take into account tax liabilities. In consequence, the guardian could not be said to be in breach of her fiduciary duty, and the transaction was not voidable.

The Pitt case also raised the issue of whether voluntary payments by an individual could be set aside on the basis of mistake. Courts in offshore jurisdictions such as Jersey have set aside voluntary transactions (such as transfers from a trust fund) that had unintended tax consequences. The Court of Appeal in Pitt v. Holt agreed with the trial judge that the transaction could not be set aside on the basis of mistake, as adverse tax liabilities were merely a “consequence” of the transaction. There was no mistake in regards to the “effect” of the transaction itself.

In both situations (Hastings-Bass and mistake), the Court of Appeal seems to be saying that a trustee should be looking to their professional advisors (or their insurers) for compensation, rather than seeking to set aside the transaction, if there were adverse tax consequences that could have been avoided.

The trustees have filed an appeal of the Pitt v. Holt decision with the UK Supreme Court, and the appeal may not be heard until 2012. In the meantime, courts in offshore jurisdictions will have to decide whether they will follow the Court of Appeal’s decision or continue to apply the Rule in Hastings-Bass.

The Rule in Hastings-Bass has not been applied in Canada. It is doubtful as to whether the Pitt v. Holt decision will affect the rectification procedure that has become so prevalent and useful in domestic tax cases.