In its September 2016 decision in In the Matter of the D, E and F Trusts, the Royal Court applied Jersey's 2013 statutory mistake provisions for the first time in order to set aside transfers of shares to three Jersey trusts, which had been made a number of years after the trusts were established and in circumstances where the mistake in question gave rise to contingent, rather than crystallised, tax liability. The court also clarified that, notwithstanding the fact that foreign law governed the transfers to the trusts, Jersey's firewall provisions required the question of the validity of the transfers to be determined under Jersey law.
The application concerned the 2011 transfer of shares in Luxembourg companies (which in turn held substantial shareholdings in a public company) by a settlor to be held on three Jersey law trusts: the D Trust, E Trust and F Trust. The trusts had originally been established in 2009 with the settlement of a nominal cash sum, but were amended in 2011. The trusts were settled to benefit the settlor during his lifetime and his family thereafter, but also to achieve certain US tax objectives, the most relevant being to ensure that:
- any distributions to the settlor's two sons were not subject to US tax; and
- no part of the assets held by the trusts would be subject to US estate tax on the death of the settlor (who was a Swiss resident) or either of his sons (who were both US residents).
The 2011 amendments to the trusts were effected to mitigate against a potential change in Swiss estate tax law, which would have exposed the settlor's assets (including the valuable shareholdings subsequently transferred to the trusts) to a substantial Swiss estate tax charge. However, on making the amendments, it was also important for the trusts to continue to achieve the original US tax objectives. The provisions of US and Swiss law required different principal features for the trusts, although none of these were mutually exclusive. The settlor obtained advice on the proposed amendments in order to adopt changes that would address the competing risks of US tax liability and the potential Swiss tax liability.
The amended trusts were stated to comprise completed gifts to the settlor's sons and, in the event of their deaths before the expiry of the trusts, to their children. Each trust had three trustees (respectively called the family, administrative and independent trustee, the latter of which held dispositive powers). The settlor's sons were the family trustee of the D Trust and E Trust, respectively, and together the family trustees of the F Trust. The sons were also protectors.
The amendments to the trusts introduced an unintended provision that gave rise to a potentially significant US tax liability – it granted each of the sons in their respective capacities as protectors of the trusts the power to remove the independent trustee and appoint themselves or a person related or subordinate to them as the independent trustee. For the purposes of US tax law, the power as drafted (which had been addressed in an early draft by the US lawyers but was not identified in the final draft) amounted to a general power of appointment over the trust assets in favour of the sons. As a consequence, if the sons were to die before the expiry of the trusts, the value of the respective trust assets would be deemed to fall within their estates for US estate tax purposes and could attract US estate tax at a rate of up to 40%.
Ultimately, the applicable Swiss tax law was not changed and therefore the Swiss tax risk fell away. However, some years later, the settlor's advisers identified the risk of the US estate tax charge by reference to the power of appointment. The trust instruments could not be adopted in an effective way for US tax purposes to remedy the issue. Therefore, the settlor applied to have the transfers set aside and declared void on the grounds of mistake pursuant to Article 47E of the Trusts (Jersey) Law 1984, with the effect that the shares would be declared to have been held at all times on bare trust by the trustees for the settlor.
The decision confirms that where an application based on mistake does not seek to set aside the trust, but rather to set aside the disposition of assets onto the trust – particularly if such transfers took place some time after the establishment of the trust – the application can squarely be brought under Article 47E of the law. The more typical remedy sought where the establishment of a trust and corresponding settlement of assets causes a tax issue is to set aside the trust under Article 11 of the law.
The court applied the three questions reflected in the 2013 amendments to the law:
- Was there a mistake on the part of the settlor?
- Would the settlor not have made the transfers but for the mistake?
- Was the mistake of so serious a character as to render it just for the court to make a declaration?
The court did not hesitate in answering the first two questions affirmatively based on the error in drafting the trusts instruments at the time of the amendment (noting the US tax advice subsequently received) and the settlor's affidavit evidence that he would not have made the transfers had he known of the tax implications. The third question was a more difficult one. While mistake applications are typically brought in respect of mistakes which gave rise to an existing tax liability, in this case, the tax liability was entirely contingent on either of the settlor's sons dying before the expiry of the trusts (in 2041). The Royal Court concluded that such a contingent risk could be seen as a consequence which renders the mistake so serious as to justify the transfers being set aside. Its reasoning included the following:
- Notwithstanding its contingent nature, the magnitude of the potential liability was heavily in favour of granting the relief. In particular, the tax liability may have led to the settlor's sons' respective families having to divest themselves of the shares (the original company having been created by the settlor's father).
- It was the settlor's clear intention that his assets go to the beneficiaries of the trusts and none of the beneficiaries were likely to suffer if the transfers were set aside.
- The settlor was not a US taxpayer.
- The trusts were not artificial schemes but merely intended to achieve tax-efficient estate planning, which gave the settlor no interim advantage.
Conflicts of law
The Royal Court also reviewed the scope and application of the firewall provisions set out in Article 9 of the law. The agreements effecting the transfers were governed by Swiss law, save to the extent that Luxembourg law was compulsory. The application was premised on the argument that Article 9 required that Jersey law be applied to the question of the validity of the transfers.
The court agreed with the arguments advanced on behalf of the settlor in this regard and also that the consequence of any order to invalidate the transfers under Jersey law would merely result in the trustee, as transferee, holding the asset on a different trust, namely as bare trustee for the transferor. On the facts, there was no evidence that a Jersey court order setting aside the transfer could be used as a basis to rectify the share registers of the Luxembourg companies.
The decision provides a useful confirmation of the court's approach to mistake applications brought to address subsequent transfers into Jersey trusts. It also provides much welcomed clarity on the application of Article 9 where different laws apply to the transferred assets (in this case, the shares in a foreign company). For trustees and settlors, the decision helpfully underlines the court's willingness, in appropriate circumstances, to consider it just to set aside transfers made on the basis of a mistake and which give rise to contingent, as opposed to crystallised, liabilities.
Further, at the convening hearing commencing the application, the court accepted that the application need not be notified to the potentially relevant tax authority for the following reasons:
- No tax liability had crystallised in respect of the transfers, and would only crystallise in the event of the settlor's sons dying before the expiry of the trusts (which was unlikely given the sons' ages).
- Any future tax liability would not be a burden on the settlor (not being a US resident), but would be a burden on his sons' estates. This approach was fact specific as typically – and particularly where the setting aside of a transfer due to mistake avoids a crystallised tax liability – the court will order the relevant tax authority to be notified.
For further information on this topic please contact Nigel Sanders or Leon Hurd at Ogier by telephone (+44 1534 514 000) or email (email@example.com or firstname.lastname@example.org). The Ogier website can be accessed at www.ogier.com.
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