High Court offers sympathy but no remedy to trustee facing unexpected tax bill

In Mackay v Wesley [2020] EWHC 1215 (Ch), the Claimant, who was instructed by her father to become a trustee of a family trust as part of a tax scheme, failed to obtain from the High Court (1) an order rescinding her appointment as trustee and/or (2) a declaration that she never became a trustee.  The decision underlines the difficulty of “reversing” a multilateral transaction (even in circumstance where the Court’s sympathies are with the claimant), and the need to adduce cogent evidence where such a reversal is sought.


Where HMRC assert that a transaction has given rise to adverse tax consequences, there are usually at least two courses of action to consider.  The first course of action involves accepting that the transaction took place, but challenging HMRC’s view as to how it should be taxed.  This is what happens in a common or garden tax appeal to the First-tier Tribunal (the “Tribunal”).  The second course involves “reversing” the transaction in order to avoid the adverse fiscal consequences.

Although it is possible to follow both courses of action in a single tax appeal, it is not uncommon (and it is frequently advantageous) to bifurcate the challenges, with a tax appeal and High Court claim for relief running concurrently or consecutively.  In Mackay, an appeal and claim were run concurrently.

There are various remedies which may be sought where a litigant seeks to reverse a transaction, and there are various grounds which may be advanced to secure those remedies.  In Mackay, the claimant offered the High Court a panoply of grounds in support of a claim for rescission or declaratory relief.  Unfortunately for the claimant, each ground was dismissed and, accordingly, relief was refused. The Court’s decision is considered in detail below.


The Claimant (Mrs Mackay) was, together with a number of family members including her father (the Defendant, Mr Wesley), a beneficiary of a family trust set up by her grandmother in 1990 with an Isle of Man corporate trustee (the “Settlement”). By 2003, the gross value of the trust fund was approximately £3.6 million and comprised significant unrealised gains. The potential UK CGT liability if the gains were realised was over £1 million.

In 2002, the Isle of Man trustee took advice from PwC in London and decided to use a CGT tax scheme (commonly known as a “Round the World” scheme) to realise the retained gains in a tax efficient manner.

  • “Round the World” schemes were designed to avoid the effect of certain UK legislative provisions which operated to attribute realised gains of a non-UK resident (or dual resident) settlement to a UK domiciled and resident settlor (in so far as that settlor had a (broadly defined) interest in the settlement) (the “Settlement Provisions”).
  • The scheme involved appointing non-UK resident trustees based in a country (1) which did not itself tax capital gains, but (2) which had taxing rights (to the exclusion of the UK) over any capital gains by virtue of the terms of a double tax treaty with the UK.
  • The non-UK trustees realised the relevant gains without incurring a tax liability in the UK (or the jurisdiction in which they were resident). The non-UK trustees would then be replaced by UK resident trustees within the same year of assessment in order to exclude the operation of the Settlement Provisions (which applied only where the trustees remained non-UK resident throughout the relevant year of assessment) and related provisions.

In 2002, pursuant to PwC’s advice, the Isle of Man trustee retired and was replaced by trustees resident in Mauritius (the “Mauritian Trustees”). In 2003, the Mauritian Trustees realised the Settlement’s gains and distributed most of the trust fund to two new Isle of Man trusts. By a deed of retirement and appointment dated 19 March 2003 (the “DORA”), the Mauritian Trustees appointed the Claimant and the Defendant (both resident in the UK) as new trustees of the Settlement (the “UK Trustees”); the Mauritian Trustees retired; and the UK Trustees agreed to provide the Mauritian Trustees with an indemnity.

As regards the Claimant’s participation in the DORA, the Claimant’s evidence (in summary) was that her father had asked her to sign the document.  More particularly, when she was asked to sign the document:

  • she was not afforded any opportunity to read or consider it;
  • she did not receive any legal advice in relation to it; though she appreciated that it “related to certain offshore trusts”;
  • she was under the impression that it related in some way to her (now deceased) mother’s (then) ill health (and that she was to sign the document on her mother’s behalf); and
  • she was subject to considerable pressure from her father to sign it (and did not feel able to refuse him).

As to the pressure from her father (and what the Judge described might be termed “the overbearing nature of her father”), her evidence was that he had always been a forceful character and had “made the important decisions in the family and had dealt with the family’s finances”.  Moreover, the Claimant’s evidence was that, at the time she was asked to sign the DORA, she was in an extremely distressed, shocked and vulnerable state due to a family bereavement and her mother’s ill health.

HMRC challenged the effectiveness of the scheme and assessed the UK Trustees to UK CGT on the gains realised by the Mauritian Trustees. The upshot of HMRC’s contentions, described by the High Court variously as “somewhat surprising”, “unconscionable”, “unjust” and “extraordinary”, was that the Claimant was liable for some £1.6million of UK CGT (her co-trustees now being virtually penniless) “despite having been appointed a trustee of a fund with only some £61,000 in cash in it at the time of her appointment”.  The Claimant appealed to the Tribunal against the assessments and, in parallel, applied to the High Court for an order rescinding her appointment as a trustee and/or a declaration that she never became a trustee.

In the High Court, the Claimant advanced her case on the basis of non est factum, lack of capacity, undue influence, and mistake.


The High Court found against the Claimant on all four grounds.

At the heart of the adverse decision were findings that:

  • the DORA was, in substance, a contract (rather than a unilateral transaction) whereby in consideration of the UK Trustees being appointed, they covenanted to indemnify the Mauritian Trustees (the “Contract Finding”); and
  • even if the appointment of the Claimant as a trustee could be disaggregated from that contract and considered in isolation as a unilateral transaction, it was a transaction effected by the Mauritian Trustees and not the Claimant (the “Appointment Finding”). 

Non est factum

To succeed on a plea of non est factum, a party must establish (in essence) (1) a belief that the document they signed was radically different to the one they intended to sign, and (2) that this belief was induced by some form of misleading explanation or misrepresentation (rather than imprudence or negligence).

In the present case, the High Court found that the Claimant had not misapprehended the nature of the document she had signed: on her own evidence, she appreciated that the document related to certain offshore trusts.  Further, although the Claimant did not realise that by accepting the appointment she risked accepting a large tax liability, that was irrelevant: the doctrine of non est factum is concerned with mistakes as to the nature (or “operative effect”) of a document, not its consequences.  (This is different to the position in relation to “unilateral mistake”, as determined in Pitt v Holt [2013] UKSC 26.)  Moreover, even if the Claimant had made a fundamental mistake, there was no evidence that she had been misled into that mistake.

Insofar as the Claimant advanced her case on the basis that she had lacked the capacity to appreciate that the document related to her appointment as a trustee, the High Court declined to accept her position in the absence of any medical evidence as to her capacity at the time (see further below).

Finally, the High Court held that even if the Claimant has been misled as to the true nature of the document she was signing, this would have been an irrelevance.  This was on the basis of the Appointment Finding: specifically, because the appointment was an act done on the part of the Mauritian Trustees it could not be avoided on the basis of some vitiating factor on the part of the Claimant.  In other words, it would have been necessary for the Mauritian Trustees to plead that they had been misled as to the true nature of the DORA (which, on the facts, clearly was not the case).

Lack of capacity

The High Court reiterated that whilst a unilateral transaction is void where it is entered into without capacity, a contract is voidable at the instance of the incapacitated party only where the other party knew (or ought to have known) of the incapacity.

In accordance with the Contract Finding, the High Court declined to hold that the appointment of the Claimant was void (even if incapacity could be established).  As a result, in order to succeed in having the appointment set aside, the Claimant needed to adduce evidence that the Mauritian Trustees knew of the alleged incapacity.  However, as the Court put it, there was no evidence before it “that the Mauritian Trustees had any inkling of any suggestion of a lack of capacity in the Claimant”.

The High Court did go on to consider and apply sections 2 and 3 of Mental Capacity Act 2005 (which centre on the inability of a person to make a decision in relation to a particular matter due to an impairment of, or an disturbance in the functioning of, the mind or brain).  Although the Court accepted the Claimant’s evidence that, at the time she signed the DORA, she was “consumed by grief and truthfully incapable of making any decisions”, it found that this evidence addressed with insufficient particularity the test in the Mental Capacity Act.  Further, the Court made clear that it would be unwilling to find in favour of the Claimant in the absence of expert medical evidence (which, the Court reiterated, is necessary “in all except very clear cases” of mental incapacity).


In a similar vein to the position in relation to lack of capacity, the Court confirmed that it is much easier to set aside a transaction (on grounds of mistake) where it is unilateral.  Specifically (and as set out in Pitt v Holt) a voluntary disposition can be set aside whenever there is a causative mistake so grave that it would be unconscionable to refuse relief.  Where rescission is sought of a contract, the common law regime is much narrower and requires (relevantly) evidence that there was a common mistake (shared by the parties) which (1) makes the contract impossible to perform or (2) makes the contract’s subject matter “essentially and radically different form the subject matter which the parties believed to exist”.

Again, in accordance with the Contract Finding, the Court declined to approach the Claimant’s appointment as a unilateral transaction on the part of the Claimant.   As to whether there had been any mistake on the part of the Mauritian Trustees, again, the Court found itself without the necessary evidence (albeit, on the facts, it seems unlikely that the Claimant would have been able to adduce evidence of a mistake on the part of the Mauritian Trustees even if she had turned her mind to it).

Moreover, in the Court’s view, there had been no mistaken belief on the part of the Claimant (which could have formed the basis of a claim for unilateral mistake): rather, there had been “causative ignorance”.  In the Court’s view, the tacit assumption by the Claimant that her father “would not ask her to sign documents which would put her in danger” was too wide and vague to constitute a relevant mistake as to the effect or consequence of signing the DORA.  (Contrast this with an erroneous representation from the Claimant’s father, or one of the professional advisers, that engendered a conscious and specific belief on the part of the Claimant that no adverse tax consequences would ensue.)

Undue influence

Citing the principle of “presumed” undue influence as set out by Lord Nicholls in Royal Bank of Scotland Plc v Etridge (No.2) [2001] UKHL 44, the High Court found that a prima facie case was made out.  Namely, that the Claimant placed trust and confidence in her father, the Defendant, in relation to the management of her financial affairs; and that the transaction whereby the Claimant became a trustee “calls for an explanation”.

On that basis, had the transaction been a simple bilateral transaction between the Claimant and her father, the Court would have “no hesitation” in setting aside the transaction.  However, in line with the Appointment Finding, the Court found that the transaction was one effected by the Mauritian Trustees and wholly untainted by undue influence. 


The decision highlights that claimants (and their advisers) should take great care in formulating applications for equitable relief and ensuring that the necessary evidence, from the right parties, is before the Court.  It also highlights the benefit, if possible, to identify and challenge a unilateral disposition rather than a multilateral transaction.

In the light of the High Court’s finding that the appointment of the Claimant was a unilateral act on the part of the Mauritian Trustees (untainted by mistake or undue influence), the Claimant applied (in her application for permission to appeal) to amend her application to seek, in the alternative, the setting aside of her acceptance of trusteeship and a declaration that she was at liberty to disclaim the trusteeship. Unfortunately for the Claimant, permission to amend, and permission to appeal, was refused by the High Court.  In particular, having regard to the importance of finality in litigation and the overriding objective, permission to amend was refused on the basis that the amendments proposed were ineffective or insufficiently precise, and that (among other things) further evidence would need to be admitted at a very late stage of the claim.

Nick Clayton
Nick Clayton
+44 20 7466 6409
Dawen Gao
Dawen Gao
Senior Associate
+44 20 7466 2595

Tax Treaty Interpretation: The Limits of Fiction

In Fowler v HMRC [2020] UKSC 22, the Supreme Court determined that a statutory fiction created by a deeming provision of UK tax law did not affect how the terms of a bilateral tax treaty should be applied. In particular, the Supreme Court held that although the UK deeming provision in question applied to treat the (employed) taxpayer in question as if they were carrying on a trade, it did not change the fact that, for the purposes of the treaty, the taxpayer derived “income from an employment” (and hence that the employment income article of the treaty was engaged).


Mr Fowler was a qualified diver, resident in South Africa at all relevant times (including for the purposes of the double taxation treaty between the UK and South Africa, the “Treaty”).

During the 2011/12 and 2012/13 tax years, Mr Fowler undertook diving engagements in the waters of the UK continental shelf.

It was common ground as between Mr Fowler and HMRC that if Mr Fowler was self-employed in the relevant tax years, then his diving income would only be taxable (if at all) in South Africa. However, the parties were not in agreement as to whether:

  • Mr Fowler was in fact self-employed (as Mr Fowler contended); or
  • if Mr Fowler was in fact an employee, his income was taxable in the UK.

That second issue was litigated as a preliminary issue (on the assumption that Mr Fowler was an employee).


Section 6(5) (as amended) of the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”) provides that employment income is not charged to tax under Part 2 of ITEPA if it is charged to tax as trading income by virtue of section 15 of the Income Tax (Trading and Other Income) Act 2005 (“ITTOIA”).

Section 15(2) ITTOIA specifies that, for certain diving activities performed by an employed diver, the performance of those activities is treated for income tax purposes as the carrying on of a trade in the UK rather than as an employment generating employment income subject to tax under Part 2 ITEPA.

Section 6 of the Taxation (International and Other Provisions) Act 2010 provides that “[d]ouble taxation arrangements have effect in relation to income tax … so far as the arrangements provide” for certain specified outcomes.

Article 3(1) of the Treaty contains a number of definitions, some exclusive and some non-exclusive. Article 3(2) states that a term not defined in the Treaty will, unless the context otherwise requires, have the meaning that it has under the law of the State that is seeking to apply the Treaty, with the meaning of the relevant term under the State’s tax law having preference over any meaning given to the relevant term under other laws of the relevant State.

Article 7 of the Treaty is entitled “Business Profits”. Article 7(1) of the Treaty provides that the profits of an enterprise of the UK or South Africa (being the “Contracting States” to the Treaty) are taxable only in the Contracting State where the enterprise is established unless the enterprise carries on business in the other Contracting State through a permanent establishment situated in that other Contracting State.

Article 14 of the Treaty is entitled “Income from Employment”. Article 14(1) of the Treaty states that (subject to certain exceptions which were not relevant in this case) salaries, wages and other similar remuneration derived by a resident of a Contracting State from a particular employment are only to be taxed in that State unless the employment is carried out in the other Contracting State. If the employment is carried out in the other Contracting State, any remuneration derived from that employment may also be taxed in that other State. If both South Africa and the UK sought to tax the same amount of employment income in the circumstances contemplated by Article 14(1), the provisions of the “elimination of double taxation” article of the Treaty would be engaged.

Earlier decisions

The First-tier Tribunal (“F-tT”)1 held that section 15(2) ITTOIA treated Mr Fowler’s income as being derived from the carrying on of a trade in the UK “for income tax purposes”. The F-tT held that this statutory fiction extended to determining how the Treaty applied in circumstances where the UK was seeking to levy income tax. As a result, the F-tT considered that the effect of the UK deeming provision was that Mr Fowler’s income (derived from his diving activities in the years in question) constituted profits within Article 7(1) of the Treaty (rather than employment income within Article 14(1) of the Treaty). In consequence, it was taxable exclusively in South Africa.

The Upper Tribunal2 came to the opposite conclusion. It did so on the basis that section 15(2) ITTOIA does not supplant the meaning of “employment” under ITEPA, but only the meaning of “employment income”. As such, for the purposes of the Treaty the term “employment” takes its ordinary meaning (as supplied by ITEPA). The result, on the facts, was that Article 14(1) of the Treaty was engaged. In consequence, the UK was entitled to impose income tax on Mr Fowler’s income from the relevant diving engagements.

The Court of Appeal3, in a majority decision, reversed the decision of the Upper Tribunal. It referred to the Court of Appeal’s statement in Marshall v Kerr4 (in the leading judgment of Peter Gibson J) that, when construing a deeming provision, “because one must treat as real that which is only deemed to be so, one must treat as real the consequences and incidents inevitably flowing from or accompanying that deemed state of affairs, unless prohibited from doing so.” It followed from this that the effect of the deeming provision in section 15(2) ITTOIA also extended to the application of the Treaty, such that the profits from Mr Fowler’s deemed trade fell within the scope of Article 7(1) of the Treaty and were therefore taxable only in South Africa.

Supreme Court decision

In a unanimous decision, the Supreme Court overturned the decision of the Court of Appeal. In essence, the Supreme Court approached the matter by considering (a) as a matter of Treaty interpretation, the extent to which the Treaty permits domestic deeming provisions to affect the meaning of terms in the Treaty and (b) as a matter of domestic law, the extent to which the relevant deeming provision was intended to alter the meaning of terms relevant to the Treaty.

Lord Briggs (with whom Lord Hodge, Lady Black, Lady Arden and Lord Hamblen agreed) commenced his analysis by observing that “[n]othing in the Treaty requires articles 7 and 14 to be applied to the fictional, deemed world which may be created by UK income tax legislation. Rather they are to be applied to the real world, unless the effect of article 3(2) is that a deeming provision alters the meaning which relevant terms of the Treaty would otherwise have.”

In support of this statement, Lord Briggs referred to the OECD Commentary accompanying the OECD Model Tax Convention. The relevant paragraphs of the OECD Commentary indicate that, under a double taxation agreement, deeming provisions in the domestic law of a Contracting State do not require employment services to be treated as services provided by an enterprise (or vice versa) for the purposes of a double taxation agreement where:

  1. this is not required by the context of the relevant double taxation agreement; or
  2. there are no “objective criteria” which would permit a formal contractual relationship of a particular kind to be characterised as another type of relationship.

Lord Briggs also cited Lord Reed’s judgment in the Supreme Court decision in HMRC v Anson5, where the following observation was made:

As Robert Walker J observed at first instance in Memec [1996] STC 1336 at 1349, 71 TC 77 at 93, a treaty should be construed in a manner which is ‘international, not exclusively English’.

That approach reflects the fact that a treaty is a text agreed upon by negotiation between the contracting governments.”

This principle underscored that applying the Treaty to the fictional scenario created by section 15(2) ITTOIA “would be contrary to the requirement to treat the Treaty as a bilateral international agreement”.

Lord Briggs’ analysis then turned to the question of whether the deeming provision in section 15(2) ITTOIA was intended to alter the meaning given to key terms in the Treaty (namely, “profits”, “enterprise of a Contracting State”, “salaries, wages and other similar remuneration” and “employment”). According to Lord Briggs, no such intention could be discerned from the language of section 15(2). Instead, that section merely “erects a fiction which, applying those terms in their usual meaning, leads to a different way of recovering income tax from qualifying divers.

The same conclusion also followed from a consideration of the purpose of the deeming provision in section 15(2) ITTOIA. Relying upon the finding made by the F-tT, Lord Briggs held that the purpose of this provision was narrow: to permit divers to benefit from a more generous regime for the deduction of expenses, rather than to resolve any confusion as to whether such divers were or were not employees. At the time when the provision (which was subsequently rewritten to section 15(2) ITTOIA) was introduced, the class of employed divers falling within that section tended to incur their own costs, and were therefore considered to deserve the more generous expenses treatment prescribed in statute for the self-employed, in contrast to that prescribed for employees.

Earlier in his judgment, Lord Briggs had indicated that a statutory fiction should have effect only as far as the intended purpose of the relevant deeming provision. He also indicated that a court should, in the absence of a clear statutory requirement, be reluctant to apply a deeming provision in a way that produces an anomalous result. As such, when properly considered, the effect of section 15(2) ITTOIA was limited in Lord Briggs’ view to its purposes of securing computational benefits for a prescribed class of (employed) taxpayers and did not extend to altering the meaning of terms used within the Treaty. It could not be applied in such a way so as to render “a qualifying diver immune from UK taxation”.

As a result, Lord Briggs determined the preliminary issue in terms that if Mr Fowler was an employed diver during the relevant tax years, his income from diving engagements in the waters of the UK continental shelf would be taxable in the UK.


The unanimous decision of the Supreme Court brings clarity to an issue of treaty interpretation which saw conflicting judgments from the F-tT and the majority of the Court of Appeal on the one hand and the Upper Tribunal and the minority of the Court of Appeal on the other.

In the context of a double taxation treaty, the Supreme Court’s decision confirms that the interaction between a deeming provision under domestic law and the relevant articles of the double taxation treaty will be determined by (a) whether the deeming provision, construed purposively, is sufficiently broad in scope to alter the manner in which the double taxation treaty is applied (and the definition of terms used within it) and (b) whether, on a proper reading, the treaty permits the deeming provision to have such an effect. It is to be hoped that in most cases there will be a tolerably clear answer to this question. In certain situations, however, the purpose of a particular deeming provision may prove difficult to discern, such that the effect of the relevant deeming provision will remain unclear.

Turning to the international dimension, the Supreme Court’s decision once again confirms that interpreting double taxation treaties requires something more than determining the meaning of relevant terms under domestic law. A proper interpretation may require a consideration of the bilateral context which generated the relevant treaty and may also take into account the obligations imposed, and the interpretative methods prescribed, by the Vienna Convention on the Law of Treaties as well as any guidance contained in relevant parts of the OECD Commentary.

As a final observation, Fowler may point to the potential pitfalls of opting to have an issue in an appeal to the F-tT determined as a preliminary issue. As Fowler demonstrates, where an issue is complex or difficult to determine, it can take a number of years and multiple appeals before a preliminary issue is determined. Even then, other issues in the case may still need to be resolved after the preliminary issue has been decided. In this case, for example, the question of whether Mr Fowler was in fact employed during the relevant tax years has yet to be determined. Each tax appeal turns on its own facts, and it would not be correct to second guess the decisions taken in other appeals. It may be, however, that if other taxpayers are faced with appeals where two separate issues could each be determinative of the appeal, opting to have only one of those issues heard as a preliminary issue may only be desirable if there are compelling reasons to do so.

[1]       [2016] UKFTT 0234 (TC)

[2]       [2017] UKUT 0219 (TCC)

[3]       [2018] EWCA Civ 2544

[4]       (1993) 67 TC 56

[5]       [2015] STC 1777


Nick Clayton
Nick Clayton
+44 20 7466 6409
Steven Wenham
Steven Wenham
+44 20 7466 2444

APAC Monthly Private Wealth Legal Developments – May 2020

Welcome to Herbert Smith Freehills’ new monthly private wealth industry updates in Asia.

Every month we survey ten Asian jurisdictions for legal developments concerning trust and estate planning which are of interest to the private wealth industry, and provide a succinct summary in a table format. The jurisdictions covered in the update are Hong Kong, Singapore, China, Taiwan, Japan, India, Malaysia, Indonesia, Thailand and the Philippines. We hope that these updates will prove to be a useful resource to keep private clients, business people, and lawyers abreast of legal updates in the region. Continue reading


We asked trust companies questions about the most significant risk and compliance issues they face. The respondents identified tax compliance issues as the fourth most significant challenge.

The survey mapped which specific tax compliance issues trust companies struggled with the most. A fairly even share of the vote for most pressing issue (15-17%) was taken by each of (1) managing tax compliance issues arising from the daily operation of existing structures; (2) identifying and dealing with tax compliance issues arising from new structures, or (3) inheriting non-compliant structures as the most pressing issue. However, the front-runners emerged as keeping up with legislative changes in tax law (24%) and the management of historic (and potentially contentious) tax issues arising in relation to existing structures (28%).

What do you find most challenging about tax compliance?

This is perhaps to be expected given current trends in tax compliance and transparency, resulting in the surfacing of historic tax issues.  Transparency is, of course, here to stay, and this year (2020) sees the introduction of the following regimes:

  • Reporting of cross border arrangements (pursuant to sixth EU directive on administrative cooperation, “DAC 6”).  As most readers will be aware, DAC 6 requires intermediaries (that is, anyone who designs, markets, manages, organises or makes available for implementation) to report cross-border arrangements which bear certain hallmarks.
  • Augmentation of trust registration requirements (pursuant to the fifth EU money laundering directive, “5MLD”).  Among other things, 5MLD requires registration of all UK express trusts and non-UK express trusts which acquire UK real estate or enter into a business relationship with a regulated person in the UK (including registration of controlling interests in non-EEA entities).

Based on experience, particularly that which emerged from the “requirement to correct” process in the UK (“RTC”), many of the historic tax issues arising for trust companies were caused by (i) reluctance on the part of clients to provide full disclosure of relevant facts and analysis (particularly in relation to domicile status) and (ii) difficulty in keeping up to speed with tax rule changes (which, in our survey, registered as the second biggest challenge for trust companies).  In relation to the RTC, we are now seeing HMRC starting to assess and enforce the significant penalties promised in that legislation of up to 300%.

  • As regards the marshalling of facts, certainly post-implementation of CRS and the RTC, we have seen trust companies revisiting their terms and conditions and new business intake processes in an effort to reconsider (i) what information is required; (ii) how that information is verified; and (iii) how tax risks are allocated between the parties.
  • As regards legislative change, in order to assist the reader with issue spotting and horizon scanning from a UK perspective, we set out below some of the most relevant recent and future developments relating to UK trust taxation (and a link to our briefing on the recent Budget can be found [insert hyperlink to briefing]).

It is also now known that HMRC are considering approximately 30 cases in relation to the (relatively) new strict liability corporate criminal offence of failing to prevent the facilitation of tax evasion (the “CCO”).  In summary, that offence is committed where an associated person of a corporate/partnership (whether or not UK resident) facilitates another person to evade tax (whether foreign or UK), and the relevant corporate/partnership cannot demonstrate that it had in place “reasonable prevention procedures”.

Given this increase in enforcement activity, it is more important than ever that businesses ensure they have conducted an appropriate risk assessment; implemented appropriate policies and procedures to address any risks identified; and ensured staff and associates (particularly those within populations identified as being high risk) have received adequate training.  HMRC’s actions make clear that they are taking seriously the new regime, and are serious about targeting advisors and service providers as well as non-compliant taxpayers themselves.

What would be most helpful in handling the tax compliance issues in your organisation?

Recent changes

  • Remittance basis. Since tax year 2017/18, the remittance basis of taxation has been unavailable to (i) any individual after they have been UK resident for 15 out of 20 years; and (ii) any individual who was born in the UK with a domicile of origin within the UK. (See our blog here for the latest on the UK’s statutory residence test in light of Covid-19.)   In each case, such an individual is now “deemed domiciled” within the UK for income and capital gains tax purposes (the deemed domicile rules for inheritance tax purposes have also been changed, and are subtly different).  As such, they will be taxed on an arising basis on benefits received from UK trusts (as well as on personal income and gains), and any trusts established by them will be within the scope of UK inheritance tax.
  • Trust protection and tainting.  In parallel with the deemed domicile changes, rules were implemented to ensure that non-UK trusts (established prior to the settlor acquiring deemed domicile status) can still be used as tax efficient roll up vehicles within the UK provided that (broadly) (i) the wealth remains in the trust, and (ii) no property is added to the trust by the settlor.
  • Anti-recycling rules etc.  From tax year 2018/19, rules prevent the avoidance of tax by routing trust payments to UK resident beneficiaries via non-UK residents.  These rules will not generally apply where the payment to the UK resident is made more than 3 years after the original distribution.  At the same time, rules were enacted to (i) tax settlors where certain trust payments are received by close family members and (ii) to prevent income and gains being “washed-out” by distributions to non-UK resident beneficiaries (prior to distributions to UK resident beneficiaries).
  • IHT relating to UK real estate.  From April 2017, interests held by non-UK trusts in certain companies and partnerships have been within the scope of UK inheritance tax if and to the extent the value of those interests derives from UK residential property (or, in certain cases, the proceeds of disposal of the same).  Complex rules also apply to create charges where monies are used to finance or the secure the purchase of such property.
  • CGT relating to UK real estate.  From April 2019, complex rules apply to ensure that non-UK residents are chargeable to capital gains tax on the disposal of both directly held and indirectly held interests in UK real estate (in the latter case, only where the holding is substantial, and the relevant entity is property rich).

Future changes

  • Trust taxation.  The UK Government launched a wide ranging consultation on the reform of trust taxation.  Although the consultation period closed almost a year ago, the Government’s response is still awaited, so the likely scope of any reforms remains unclear.  A Government response to a review it commissioned of the UK’s inheritance tax regime is also awaited (the review, conducted by the UK’s Office of Tax Simplification, concluded that wide ranging simplification was advisable).
  • Compliance.  Prior to re-election in December 2019, the UK Conservative Party published a manifesto pledging (among other things) new increased sanctions for tax avoidance and evasion law; a “beefed-up anti-tax evasion unit in HMRC”; and consolidation of the UK’s existing anti-avoidance and evasion measures and powers.  The development and deployed of these pledges is still a work in progress.

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Nick Clayton
Nick Clayton
+44 20 7466 6409
Richard Norridge
Richard Norridge
+44 20 7466 2686

Rapid resolution of domicile disputes: be careful what you wish for

In Henkes v HMRC [2020] UKFTT 7645 (“Henkes”), the First-tier (Tax) Tribunal (“the Tribunal”) held that (a) it could (and would) determine the taxpayer’s domicile status when determining an application for the closure of a domicile enquiry and (b) its determination of that issue would be binding in any substantive appeal against a subsequent tax assessment.  Unfortunately for the taxpayer, however, the Tribunal agreed with HMRC that the taxpayer had acquired a domicile of choice within the UK. Continue reading

Trusts gains of foreign residents

In summary

A recent Federal Court decision has put a major stumbling block in the path of non-resident beneficiaries of Australian discretionary trusts. The ongoing use of discretionary trusts for asset protection, flexibility and succession planning is now in jeopardy because of the unnecessary tax cost they create.

In detail 

It has long been a tenet of Australian tax folklore, confirmed in the High Court’s decision in the Charles case in the 1950s, that the interposition of a trust between an income source and a beneficiary does not change character or source or timing for tax purposes.  This follows as the logical corollary of the position at equity that a trust is just, ‘a relationship over identified property.’  When the Board of Taxation looked at the treatment of investment trusts, it took this treatment as axiomatic: ‘the tax outcomes for investors in a CIV should be broadly consistent with the tax outcomes of direct investment’ (the major exception being losses). And when Parliament enacted the Investment Manager Regime and the AMIT rules, it was pursuing that same approach; the pivotal section in the AMIT rules simply says that tax shall, ‘treat the member as having derived [each] determined member component … in the member’s own right …’

So the appropriate tax policy seems clear, and long-standing, and uncontentious: the tax position of a beneficiary is to be determined as if they had earned the income themselves, and the policy is no different whether the trust is a small privately-owned family trust or a large widely-held managed investment trust.  All of which makes the recent Federal Court decision in the Greensill case rather disappointing.  Counsel for the taxpayer had put this very argument, that ‘there existed a policy objective of not taxing foreign beneficiaries of resident trusts in respect of CGT events in relation to CGT assets which were not taxable Australian property …’ but the argument was rejected.

And so we have another case where the ATO has decided to pursue a position which challenges settled policy and accepted practice, and wins the case because the drafting miscarries. But while the result is unwelcome, it is not unexpected; the ATO now has a decision to support some elements of its thinking in TD 2019/D6 and 2019/D7, and before that in ATO ID 2007/60. Our comments on those 2 TDs are available here.


The case involved capital gains realised during the 2015, 2016 and 2017 tax years by a resident company on the sale of shares in another Australian resident company. The company held those shares as trustee of a discretionary trust and in each year resolved ‘to distribute 100% of any capital gain from [the sale of the shares] that has been added to the capital of the trust to Alexander Greensill.’  Greensill was a tax resident of the UK.  It was accepted that the shares being sold were not taxable Australian property and that, ‘s. 855-10(1) would have applied [ie, Mr Greensill would have had no Australian tax liability] if Mr Greensill rather than the trust had owned and disposed of the shares …’

A second smaller transaction involved the transfer to Greensill in specie of shares in the same Australian resident company. Again, it was accepted that the shares being transferred to him were not taxable Australian property.

The ATO issued assessments to the trustee company under s. 98 claiming tax on a deemed amount: the amount included under s. 115-215(3) when calculating the capital gains of beneficiaries.

The reasoning

So far as the share sales were concerned, case turned on the intersection of four sets of provisions: Div 6E which removes capital gains from the ‘net income’ of a trust estate, Div 115-C which deals with the capital gains made by trustees, Div 855 which exempts non-residents from CGT unless the CGT event is happening to ‘taxable Australian property,’ and the portion of Div 6 dealing with the collection of tax owed by non-residents from resident trustees.

It was not surprising that the trustee disputed the tax liability since Greensill was a non-resident, two CGT events were happening (CGT event A1 and CGT event E5), and those events were happening to assets that were not taxable Australian property.  But it was not seriously disputed that the tax, if any, would have to be paid by the trustee because s. 115-220 requires the trustee for a non-resident beneficiary to, ‘increase the amount … in respect of which you are actually liable to be assessed (and pay tax) under s. 98 … in respect of [a non-resident] beneficiary… if the … capital gain was reduced … [by] twice the amount mentioned in subsection 115-225(1) in relation to the beneficiary.’

The taxpayer’s principal argument was that when the trustee sold the shares, s. 855-10 was enlivened: it provides that a foreign resident is to ‘disregard a *capital gain or *capital loss from a *CGT event if … the CGT event happens in relation to a *CGT asset that is not *taxable Australian property.’  This propositions follows from the idea that a trust is simply a relationship: Greensill should be viewed as making the capital gain, and because he was a non-resident, the gain was disregarded by s. 855-10.

But Thawley J ruled that, ‘s. 855-10 has no relevant application to the present facts’ citing several reasons: in his view, the capital gain was made by the trust and ‘the trust was not a foreign resident’; the amount being taxed to the trustee was ‘not a capital gain and [so] cannot fall within s. 855-10’; and the amount attributed to Greensill under Subdiv 115-C was ‘not a “capital gain … from a CGT event” within the meaning of s 855-10.’ His reasoning is summed up this way:

… a capital gain which is attributed to a beneficiary, because of a CGT event happening to a CGT asset owned by a trust, was not intended to fall within the phrase “a capital gain … from a CGT event”.  The capital gain deemed to have been made by a beneficiary under s. 115-215 of the ITAA 1997 is not a “capital gain … from a CGT event” within s 855-10.  Section 855-10 would have applied if Mr Greensill rather than the trust had owned and disposed of the shares, but it does not operate to disregard the capital gains of the trust attributed to Mr Greensill under Subdiv 115-C.

Thawley J did note that capital gains made by a beneficiary of a fixed trust (rather than a discretionary trust) might be disregarded because of s. 855-40. Section 855-40 applies to a capital gain ‘you make in respect of your interest in a fixed trust’ where, amongst other matters, the gain ‘is attributable to a CGT event happening to a CGT asset of a trust.’ The language of this section is clearer as to the manner in which it is to apply to capital gains made by a trust to which a non-resident beneficiary is entitled.

The analysis of the tax consequences of the share distributions in specie was less detailed, but involved the same approach. The taxpayer argued that this transaction triggered CGT event E5 because the beneficiary became absolutely entitled to shares which had been assets of the trust. His Honour was prepared to accept that under s. 104-75(5), Greensill made a capital gain, ‘from a CGT event’ and this gain was disregarded under s. 855-10.  But under s. 104-75(3), the trustee also made a capital gain (the amount by which the market value of the shares transferred exceeded their cost base) and this amount also fell to be dealt with under s. 115-215(3) with the same result: a capital gain is attributed to Greensill, it is not ‘from a CGT event’ although ‘it is attributable to a CGT event’, and so s. 855-10 is not available.

The mechanics of capital gains and (non-AMIT) trusts, post 2011

The background to these provisions is in the ATO’s challenge in the late 2000’s to the streaming of franking credits and capital gains via trusts, and the rebuke by the Government in May 2011, announcing it would legislate to confirm the practice. Unfortunately, these so-called ‘interim’ provisions were drafted hastily – indeed, the Second Reading speech to the Bill alluded to, ‘the short time frame involved in developing these amendments’ and the ‘scope for unintended consequences.’  The drafter adopted the expedient route of removing capital gains from Div 6 entirely so that their treatment fell exclusively within Div 115-C.  The EM to the 2011 amendments took the position that, ‘for trusts that have capital gains or franked distributions but do not stream them to specific beneficiaries, the amendments apply but they will generally produce the same outcome as the current law’ but this is only accurate in a general sense.  If the capital gains of trusts had remained within Div 6, or if the CGT measures had been written under other circumstances, or using different drafting devices, this dispute might never have happened.

The provisions in Div 115-C being discussed involve a drafting device used to reverse the effect of another drafting choice — to deliver CGT discount at the trust level. The calculation of capital gains from transactions effected by a trustee (other than a bare trustee) is done at the trustee level so that capital losses suffered by the trustee can be applied against capital gains.  This calculation also incorporates CGT discount. This was always a somewhat problematic choice, given that not all beneficiaries are meant to enjoy CGT discount, and not all beneficiaries are meant enjoy the full 50% discount delivered to trustees by s. 115-100.  Moreover, capital losses are meant to deplete undiscounted gains, not the (smaller) gain remaining after CGT discount has been claimed.  Consequently the decision to deliver discount to the trustee has to be reversed elsewhere.

This post-loss, post-discount figure has to be reported by, and taxed to, someone but Div 6E has the effect that the net capital gain is excluded from the net income of the trust estate for the purposes of ss. 97 and 98.  In other words, while Div 6 allocates liability to pay tax on interest and rent and depreciation recapture and CFC attributions and TOFA amounts and most other amounts earned from assets held on trust, it does not allocate responsibility to pay tax on net capital gains made from assets held on trust.  This is confirmed in the Guide to Div 6 which says, ‘Division 6E modifies the operation of this Division for the purpose of excluding amounts relevant to capital gains … from the calculations of assessable amounts under sections 97, 98 …’ Allocating the tax liability on capital gains is now done exclusively by s. 115-215(3) and it represents an important change made in 2011 to the mechanics of taxing trust capital gains: prior to 2011, capital gains flowed through Div 6, that effect was then reversed (by a deduction), and Div 115-C then operated; after 2011, capital gains bypass Div 6 altogether, and Div 115-C operates exclusively.

The effect of s. 115-215(3) is to treat the beneficiary of the trust estate as if they had, ‘a capital gain equal to twice the amount mentioned in subsection 115‑225(1)’ [ie, the post-loss, post-discount capital gain]. This treatment happens ‘for the purposes of Div 102’ and the section includes the helpful deeming that if the trustee had qualified for a discount, ‘Division 102 also applies to you as if your capital gain were a *discount capital gain …’  It also includes a deeming that you have this capital gain ‘despite s. 102-20’ (the section which provides you can only make a *capital gain ‘if a *CGT event happens’).  Having included this putative figure as an undiscounted capital gain of the beneficiary, the beneficiary can now apply their own personal capital losses against the undiscounted gain, and then re-instate the CGT discount if eligible.

So the amount upon which the trustee was being assessed was an entirely concocted figure; it was conceived by the drafter as the best design to achieve a number of steps (i) trust capital losses were applied by the trustee, (ii) CGT discount was reversed, (iii) personal losses were applied by the beneficiary against an undiscounted amount, but (iv) CGT discount could be reinstated in the hands of the right kinds of beneficiaries.

So the drafting accomplishes much, but it does not address one critical feature — it fails to address explicitly any jurisdictional issues of residence and source.  The approach of the judge is, in effect, to treat this figure as an amorphous item of gain, without source, and assessable without reference to the residence of the owner.  If capital gains had still been routed through Div 6 or if all statutory income had to be run through the prism of s. 6-10, the jurisdictional arguments would have been different and arguably clearer, though that is by no means certain. They would certainly have been more prominent.

While there are elements of the reasoning and some statements in the judgment that can (and may well) be challenged in any appeal, the lesson of the decision as it stands is to demonstrate another example of defective drafting; it fails to achieve ‘tax outcomes for investors … broadly consistent with the tax outcomes of direct investment’ which in this context means it does not accomplish the ‘policy objective of not taxing foreign beneficiaries of resident trusts in respect of CGT events in relation to CGT assets which were not taxable Australian property …’

When the interim measures were enacted in 2011, the Minister promised, ‘the operation of these amendments will be closely monitored and if unintended consequences are identified, the government will act to remedy those consequences retrospectively.’ Hopefully, the current government will honour that promise.

This article was first published on Greenwoods & Herbert Smith Freehills Website.

Authors: Cameron Blackwood, Andrew White and Graeme Cooper

APAC Monthly Private Wealth Legal Developments – December 2019

Welcome to Herbert Smith Freehills’ new monthly private wealth industry updates in Asia.

Every month we survey ten Asian jurisdictions for legal developments concerning trust and estate planning which are of interest to the private wealth industry, and provide a succinct summary in a table format. The jurisdictions covered in the update are Hong Kong, Singapore, China, Taiwan, Japan, India, Malaysia, Indonesia, Thailand and the Philippines. We hope that these updates will prove to be a useful resource to keep private clients, business people, and lawyers abreast of legal updates in the region. Continue reading

APAC Monthly Private Wealth Legal Developments – November 2019

Welcome to Herbert Smith Freehills’ new monthly private wealth industry updates in Asia.

Every month we survey ten Asian jurisdictions for legal developments concerning trust and estate planning which are of interest to the private wealth industry, and provide a succinct summary in a table format.  The jurisdictions covered in the update are Hong Kong, Singapore, China, Taiwan, Japan, India, Malaysia, Indonesia, Thailand and the Philippines. We hope that these updates will prove to be a useful resource to keep private clients, business people, and lawyers abreast of legal updates in the region. Continue reading