In re R - The Waking Of Leviathan

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The former Bailiff of Jersey, Sir Philip Bailhache has recently delivered a judgment in In re R [2011] JRC 117 which declines to follow the English Court of Appeal’s test for mistake established in Pitt v Holt .
Jersey Tax
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The former Bailiff of Jersey, Sir Philip Bailhache has recently delivered a judgment in In re R [2011] JRC 117 which declines to follow the English Court of Appeal's test for mistake established in Pitt v Holt1. The judgment has significant implications for the future of mistake applications for settlors trying to avoid adverse tax consequences from negligent tax advice. The judgment may also mean that HMRC are afforded only a pyrrhic victory from the decision in Pitt v Holt.

The facts

The facts of R were not unusual in mistake applications. On the basis of tax advice the settlor had transferred to B Limited, a Jersey company, shares in a French company. B Limited in its capacity as trustee settled the shares on trust. The beneficiaries were the settlor's children and grandchildren and any future issue. At the time of the transfer the settlor was domiciled in England and as a result significant IHT arose in the sum of £1,943,689. Rather unusually the IHT charge was not what the mistake application was about. This was paid by the settlor and an action taken against the negligent tax advisors which was compromised. Further tax charges however were due to any distributions made to the beneficiaries who were US residents. No consideration had been given to these tax implications at the time of the transfer of shares. The implications were again significant, with a tax charge imposed of up to 100% of the value of the distribution.

The settlor gave evidence that but for the misleading and/or inadequate tax and legal advice she had received she would not have transferred the assets into the trust. She took advice from English Counsel in 2001 who at that stage advised no application could be made to rescind the transactions. In 2007 the settlor created a New Trust in which the equity of the first trust was settled. This transfer didn't give rise to any additional tax implications but both trusts remained within the IHT net, meaning that a 10 year anniversary charge would apply.

This application sought a declaration that the transfers into trust and the New Trusts were voidable.

HMRC's notification and attendance

The Royal Court gave some thought to whether in fact HMRC should be notified and convened to the application. This was based upon the Guernsey court's decision in HMRC v Gresh2 – even though that involved a Hastings Bass application. Importantly, the Court concluded that HMRC did not need to be notified or convened to the application.

The decision

Jersey law was applied as being the law of the place of the enrichment, in line with conflict of laws principles. The Jersey Royal Court took some time considering whether they should apply the English Court of Appeal's decision in Pitt v Holt.

Lloyd LJ had delivered a tour de force in Pitt which reigned in the equitable jurisdiction of Hastings Bass. Commentators and practitioners in this area had long been expecting the Court of Appeal to do so. Once that had been established, there was little rationale in keeping a wider equitable jurisdiction for cases of mistake as to tax consequences by a settlor. Lloyd LJ doubted that the test in Ogilvie v Littleboy3 meant that a settlor could bring an application for mistake as to fiscal consequences. In considering the Manx cases of Re Betsam Trust4 and Clarkson5 and the Jersey authority of Re A trust6 Lloyd LJ concluded that these decisions gave wholly inadequate effect to the gravity of the test posted by Lindley LJ in Ogilvie and ignored the distinction drawn by Millet J in Gibbon v Mitchell7 drawn between effect and consequences. Accordingly, he concluded that those cases did not represent the English law.

Ogilvie v Littleboy was of course binding precedent at the time Gibbon v Mitchell came to be determined. It was not cited in Gibbon simply because it had been lost and remained in the 'shadows' prior to it being cited in Sieff v Foxx8 in Lloyd LJ's other well known judgment in this area. Hence, Millet LJ's distinction between effect and consequences did not necessarily have to be applied as being consistent with Ogilvie because Millet LJ had never in fact considered the effect of Lindley LJ's formulation and if the two could not be reconciled, Ogilvie was binding.

The Jersey Royal Court declined to follow Lloyd LJ's formulation of the mistake test and rather followed Commissioner Clyde-Smith's test established in Re A as applied by the current Bailiff, Birt in Re Lochmore9.

Commissioner Bailhache decided that the Court could not properly say that the test propounded in Re A was wrong in law or for reasons of policy. There were several reasons for so doing. The test in Re A did not ignore the distinction between effects and consequences but rather concluded that the Ogilvie formulation was to be preferred. Secondly, that the criticism that the A Trust test did not give an adequate effect to the gravity of Lindley LJ's test was misconceived because of the stringent application of the questions first applied by the Jersey Royal Court in Re A and further refined by Birt, Bailiff in Re Lochmore. These were in fact, high hurdles for the applicant to meet. Thirdly, that the Jersey Royal Court saw no need to strive to protect the interests of the HMRC stating that "in our view Leviathan can look after itself".

One case which was cited before Commissioner Clyde-Smith in Re A, that of Ogden v Trustees of the RHS Griffiths 2003 Settlement [2008] EWHC 118 (Ch) [2009] 2 WLR 394 was not expressly cited in Re R but was referred to. Ogden had involved a rather unusual mistake namely, that the transferor was mistaken as to his health. At the time he made the transfers in question he had been terminally ill, a fact which was not known to him until after the transfers had been made. The transfers were therefore liable for IHT charges. Lewinson J at first instance found that this could lead to a voidable declaration stating; "I do not read the formulation by Millett J as limiting the overall scope of the equitable jurisdiction to relieve against the consequences of mistake. He said that a voluntary deed will be set aside if the court is satisfied that the disponer did not intend the transaction to have the effect which it did. He did not say that a voluntary deed will only be set aside if the court is satisfied that the donor did not intend the transaction to have the effect which it did. The formula of principle by Lindley LJ [ie that in Ogilvie v Littleboy as relied upon in Clarkson] and approved by the House of Lords is not so limited" (Lewinson J at page 401 of the judgment)

Lloyd LJ in Pitt v Holt had to reconcile this judgment with the Gibbon v Mitchell formulation of the mistake test which caused him some difficulty. A mistake as to your health is not a mistake as to the effect of the transaction. It is a mistake of fact which in this case led to a mistaken consequence – that of a fiscal penalty. Lloyd LJ therefore defined this as a mistake of fact which justified the mistake application because it was "basic to the transaction". In reconciling this decision the English Court of Appeal had already widened the test beyond the rather awkward distinction between 'effect' and 'consequences'. Ogden forced Lloyd LJ to find a test that either mistakes as to effects or a mistake of fact which is basic to the transaction will suffice. Once this test was relied upon there was little justification (in the Jersey Royal Court's opinion) to distinguish between a mistake of fact and a mistake of law which is similarly basic to the transaction.

Conclusion

Jersey has gone its own way in relation to the law on mistake applications. Time will tell whether Jersey follows England in relation to a Hastings Bass application. For HMRC the decision of Re R has significant implications. They will now need to consider whether to recognise the decision of the Jersey Royal Court under the provisions of s150 of the Inheritance Act if for example IHT is involved. It is also likely that HMRC will become more aggressive in seeking to be joined to any application by a settlor for a voidable declaration in Jersey. Leviathan will indeed have been woken but what action it now takes remains to be seen.

The author of this article was the junior Advocate for the successful Representor in Re A

Footnotes

1. [2011] EWCA Civ 197

2. (2009-10) GLR 239

3. Ogilvie v Allen (1889)15 TLR 294

4. [2009] WTLR 1489

5. [2007] WTLR 1703

6. [2009] JLR 447

7. [1990] 1 WLR 1304

8. [2005] 1 WLR 3811

9. In re the Lochmore Trust [2010] JRC 068

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