TQR December 2022

TRUSTS ON TOUR

Welcome to the final issue of the Trust Quarterly Review for 2022. The geographical coverage is as diverse as the underlying subject matter: we are travelling from the British Virgin Islands to England and Wales, via Germany, Israel and New Zealand.

Simon Hurry, Kellyann Ozouf and Matt Gilley kick off this issue with an overview of the very significant judgment of the UK Privy Council on the insolvency of trusts. This was an appeal from the respective Jersey and Guernsey Courts of Appeal, relating to Jersey-law-governed trusts. The authors focus on the Jersey appeal. The legal and practical implications are highly significant and go to the heart of a trustee’s ability to adequately recover under its indemnity from a trust fund while in office and after retirement.

Daniel Paserman TEP, Inbar Barak-Bilu TEP and Yoad Cohavy follow with a review of the Supreme Court of Israel’s judgment in Samuel Galis v Director of Land Appreciation Tax Tel-Aviv Although a number of open questions remain, the case primarily considers whether transfer of Israeli real estate to a trust is subject to local taxes. There is much complexity, but the authors conclude that the case leaves open the use of trusts over Israeli real estate in the context of succession planning. We move on to the extremely sensitive and (caveat lector) upsetting, but important, decisions of the New Zealand Court of Appeal and the High Court of New Zealand. John Brown TEP asks: can equity provide a remedy for adult children of an abusive parent who transfers assets to a trust

before death? As the author notes, the article includes details regarding the sexual and physical abuse of children. Reader discretion is advised.

One of the great enduring problems for tax and succession lawyers alike is how different types of entity or legal relationship are treated in a foreign jurisdiction, where they have no domestic existence or equivalent. Jörgchristian Klette and Daniel Schüttpelz discuss the particular problem of the taxation of trusts in Germany and how trusts must be analysed for legal and tax purposes in light of a 2021 decision of the German Federal Fiscal Court.

Christopher McKenzie TEP then provides an update on recent innovations in British Virgin Islands trusts and estate law, including provisions relating to the variation of trusts; firewall provisions; allowing the flawed exercise of a fiduciary power to be set aside; and updating local reserved powers provisions.

We finish with Miranda Allardice’s review of The Family Court Practice 2022 (Red Book), edited by the Right Honourable Lady Black of Derwent and others. As the reviewer notes, it is important for private client lawyers to understand the core principles of family law, not least where matrimonial principles and trusts clash. The book is broad: in the words of the reviewer, ‘[t]his brief review will illustrate the breadth of its remit and value as the first port of call for a synopsis of the relevant law’.

We wish our readers the very best for the upcoming festive season, and a peaceful end to the year.

THE EDITORS

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DOUBLE-EDGED SWORD

An overview of the UK Privy Council’s landmark judgment on the ‘insolvency’ of trusts

BY SIMON HURRY, KELLYANN OZOUF AND MATT GILLEY

ABSTRACT

• On 13 October 2022, the UK Privy Council handed down one of the most significant decisions of the past decade for the trusts industry in common-law jurisdictions. The decisions related to an appeal from the Jersey Court of Appeal and the Guernsey Court of Appeal, respectively. Both concerned trusts governed by Jersey law and so the two matters were heard together. This article focuses on the facts underlying the Jersey appeal and the practical considerations that trustees and their creditors might now usefully have regard to.

• The authors recognise that those who practice in or around the trusts industry are likely to have already heard about this matter. The various judgments are lengthy, complex and already the subject of considerable publication. However, a very brief summary of the salient background leading up to the Privy Council’s decision is set out below, adopting the misnomer of ‘insolvent trust’ for convenience.

BACKGROUND

The respondent to the Jersey appeal was Equity Trust (Jersey) Ltd (ETJL), which was the original sole trustee of the Ironzar II Trust (the ZII Trust) and the Ironzar III Trust. ETJL entered into a deed of removal and appointment (DORA) with its successor, Volaw Corporate Trustee Ltd (Volaw) as trustee of the ZII Trust.

The liquidators of Angelmist Ltd, a company within the ZII Trust structure, brought proceedings for breach of fiduciary duty against two of its former directors, who had been employees of ETJL at the relevant time. ETJL was made a defendant to the claim on the basis that it was vicariously liable (the Angelmist Claim). The Angelmist Claim, together with interest, totalled approximately GBP53 million.

ETJL gave notice to Volaw that it intended to rely upon the indemnities in the DORA. This prompted Volaw to apply to the Royal Court of Jersey (the Royal Court) to wind up the ZII Trust as its debts exceeded its assets. The ZII Trust was placed into a bespoke insolvency process (the first of its kind in Jersey). The Angelmist Claim was eventually settled for GBP16.5 million, with each party bearing their own costs; in ETJL’s case, approximately

GBP2.4 million. This resulted in ETJL seeking to recover approximately GBP18.9 million from the assets of the ZII Trust, pursuant to its indemnity (the ETJL Claim).

FIRST INSTANCE

The Royal Court was asked to determine, inter alia, whether the payment of the ETJL Claim should be made in priority to ETJL’s own creditors and subsequent trustees and their creditors (Volaw having retired and being replaced by Geneva Trust Company SA, GTC). The issue of priority was significant in that if ETJL had priority then it would recover all of the assets of the ZII Trust, which had been assessed at approximately GBP6 million, leaving ETJL with a loss of GBP12 million, against receiving approximately GBP330,000 if it had to share the assets of the ZII Trust pari passu with the claims of subsequent trustees and other trust creditors (being creditors with a claim to the trust assets by way of subrogation through a trustee).

A number of assumptions were made in order for the Royal Court to consider this important issue, not least of all that the ETJL Claim was the subject of indemnification from the assets of the ZII Trust; an issue that has yet to be determined.

The Royal Court held that, as between former and successor trustees (and their respective creditors claiming through them by way of subrogation), the claims against the trust assets ranked pari passu (i.e., rateably and on an equal footing), largely for reasons of fairness. The Royal Court also held that a former trustee claiming under its right of indemnity was not entitled to claim the costs of proving its claim in the winding up of an insolvent trust.

APPEAL

The outcome did not suit ETJL and it appealed.

The Jersey Court of Appeal (the Jersey Appeal Court) sided with ETJL by reversing the Royal Court’s decision. It held that:

• a trustee has a single right of indemnity and lien that arises as an incident of it taking office and covers all liabilities that a trustee may properly incur in its office; and

• as between successive trustees, a former trustee’s right of indemnity and lien ranks ahead of a successor trustee’s right of indemnity and lien

on a ‘first‑in‑time’ basis (i.e., the first trustee has priority over the second, if appointed later).

The Jersey Appeal Court noted that the ranking of the claims of trust creditors inter se and the ranking of the claims of a trustee and its trust creditors were no longer live issues and, therefore, do not fall to be decided (although, some obiter conclusions were expressed by Logan Martin JA). The Privy Council did not pick up the baton on these issues.

The Jersey Appeal Court also reversed the recoverable costs point, holding that a former trustee claiming under its right of indemnity was entitled to claim the costs of proving its claim in the winding up of an insolvent trust.

THE PRIVY COUNCIL Trust creditor Simon Halabi, in his capacity as executor of the estate of the late Intisar Nouri, appealed the Jersey Appeal Court’s decision to the Privy Council (having been granted unconditional leave to do so in respect of the priority issue and the status of a trustee’s lien in Jersey law).

Relevantly, prior to the Privy Council hearing the appeal, the Royal Court blessed a decision of GTC to enter into a compromise of breach of trust litigation against a former trustee. The Royal Court noted that the settlement had secured ‘comfortably more’ than enough funds for the trust to meet the ETJL Claim, on the assumption that the Jersey Appeal Court’s decision on the priority issue was upheld. In contrast, if the Jersey Appeal Court’s decision was overturned the distribution available to other claims to the trust assets would more than double.

‘The Jersey Appeal Court noted that the ranking of the claims of trust creditors inter se and the ranking of the claims of a trustee and its trust creditors were no longer live issues and, therefore, do not fall to be decided’

Consequently, it remained firmly in the interests of those other than ETJL for the appeal to the Privy Council to be heard.

The Privy Council sat for three days to hear the appeal from the decisions from the Jersey Appeal Court and the Guernsey Court of Appeal, respectively, and distilled the issues to be decided as follows:

1. Does a trustee’s right of indemnity confer on the trustee a proprietary interest in the trust assets?

2. If so, does the proprietary interest of a trustee survive the transfer of the trust assets to a successor trustee?

3. If so, does a former trustee’s proprietary interest in the trust take priority over the equivalent interests of successor trustees?

4. Does a trustee’s indemnity extend to the costs of proving its claim against the trust if the trust is ‘insolvent’, in the sense that the trustees’ claims to indemnity exceed the value of the trust fund?

The decision (which spans 97 pages) was not quick to produce, with the Privy Council considering matters for over 15 months, which might have been contributed to by the tension between the Privy Council on the contentious and central issue 3. However, it was worth waiting for.

Before dealing with the conclusions reached in respect of these issues, it is worth noting that the Privy Council, against the submissions made in support of the appeal, concluded that the relevant principles of English and Welsh law1 are fully applicable in the case of trusts governed by Jersey law and not inconsistent with, or modified by, Jersey customary law or legislation.

ISSUE 1

Answer: Yes (unanimous decision). The Privy Council noted that the English courts had not explicitly addressed this question. However, it concluded that the analysis in the authorities (many of which were Australian) that the right confers or constitutes a charge or lien over trust property, enforceable by a court of equity, leads ‘inevitably to the conclusion that it does create a proprietary interest in favour of the trustee’.

It is clear that a trustee is entitled to apply, or to seek an order of the court to apply, trust assets in

1 Instances of English and Welsh will be referred to as ‘English’ for the remainder of this article.

its possession in payment of amounts due under its right of indemnity and that a trustee is or may be entitled to retain sufficient assets or require security before a transfer to a new trustee. These rights are not inconsistent with the concept of a charge over, or proprietary interest in, the trust assets.

ISSUE 2

Answer: Yes (unanimous decision). The priority interest in the trust assets continues after the transfer of the trust assets to a successor trustee.

ISSUE 3

Answer: No (4:3 split). This issue resulted in three separate and carefully reasoned judgments. The majority view is set out in the judgment of Lord Briggs, with whom Lord Reed and Lady Rose agreed. Lady Arden was also in agreement, albeit for slightly different reasons. Lord Richards and Sir Nicholas Patten delivered the dissenting judgment of the minority, with Lord Stephens agreeing.

The starting point is Lord Briggs’ observation that there was a dearth of authority on the point, ‘anywhere in the common law world’. As set out above, if the first‑in‑time principle was upheld, a former trustee would have priority recourse to the trust assets over a successor trustee.

However, the unique nature of the trustee’s lien, distinguishable from other types of equitable interest and not being deemed security per se for the payment of a debt enabled the majority to depart from the usual first‑in‑time rule. In coming to this conclusion, the Privy Council compared a number of other scenarios where competing claims are made to assets insufficient to meet them all in full. These alternative scenarios included directors in a company insolvency (who are treated as unsecured creditors and rank pari passu between themselves), and liquidators and administrators (who enjoy priority over other classes of creditors in a liquidation, but have no priority inter se).

From a practical perspective, ranking trustees’ claims on a ‘first in time’ basis could cause unjustified prejudice (where one of two joint trustees was appointed moments after the other, for example) and subject creditors to settlement of their claims on the basis of the date of appointment of the trustee with whom they contracted.

Lord Briggs, originally in favour of the first in time outcome, concluded that ‘the impressive arguments, coupled with lengthy ensuing debate and reflection, have caused me to change my mind’, swinging the vote to 4:3 in favour of pari passu.

Ultimately, the majority decision rested, comfortingly, on considerations of justice, fairness, equity and common sense, while acknowledging that the pari passu rule will not always work perfectly in every case; the rule being described, in some cases, as doing no more than rough justice. However, the majority recognised that there is an inherent justice in equal division or equal sharing in common misfortune (if that is the outcome).

ISSUE 4

Answer: Yes (unanimous). The Privy Council held that the indemnity extends to the costs of proving the trustee’s claim against the trust assets, there being no basis for suggesting otherwise given the survival of the indemnity after the retirement of the trustee.

The Privy Council, consistent with its stated position vis‑à‑vis the laws of Jersey, held that there was no analogy to be drawn from the bankruptcy process under regime in the Bankruptcy (Désastre) (Jersey) Law 1990 as it does not apply to trusts and a former trustee is not proving a claim as a creditor but establishing the quantum of its proprietary interest in the fund.

PRACTICAL OBSERVATIONS TRUSTEES

In light of the Privy Council’s decision, trustees will or should now carefully consider their position when they are:

• being appointed as the first and original trustee of a structure where the structure will be what we call ‘asset rich, cash poor’;

• being asked to provide trustee services to an existing trust in place of a retiring trustee;

• retiring as trustee; and

• entering into transactions incurring a liability for the structure, whether as an original trustee or a successor trustee.

Liquidity should (if not already) be a particular focus and concern of trustees in all the scenarios above, but particularly because the duty of trustees switches in favour of the creditors of the trust

when cash‑flow insolvent. Difficulties also arise for trustees when charging fees for administering a trust that is cash‑flow insolvent, unless with creditor or court agreement to do so.

Trustees entering into a DORA should no longer expect a ‘cheap’ standard STEP ‘10/10’ form of DORA.2 DORAs are likely to become tailored to each trust and potentially heavily negotiated, given the risks on retiring trustees and incoming trustees.

Trustees will need to move away from the expectation that a DORA will cost GBP750. The costs will increase to reflect the bespoke and tailored advice that will be required to ensure adequate protection for the trustee (irrespective of whether it is an outgoing or an incoming trustee).

The authors anticipate a possible reversal on the now somewhat antiquated ‘direct chain indemnities’ on the change of trustees and there will inevitably be a much deeper and more thorough dive into the accounts of a structure prior to incoming trustees accepting new trusteeships, rather than that detailed review following acceptance of a trusteeship.

Trustees should now give proper consideration as to whether:

• liabilities can and/or should be paid in full before handing over the trusteeship;

• liabilities be novated to the incoming trustee;

• third‑party lending agreements be terminated prior to handing over the trust or, in the absence of that as it may not always be in the best interests of the beneficiaries of the trust, the retiring trustee expressly being released by the third‑party lender from all of its obligations under such agreement

2 This is in reference to STEP’s jurisdiction-specific guidelines as set out in its 2017 publication, A Practical Guide to the Transfer of Trusteeships, by Richard Williams TEP, Arabella Saker and Toby Graham TEP.

INSOLVENT TRUSTS SIMON HURRY, KELLYANN OZOUF AND MATT

‘DORAs are likely to become tailored to each trust and potentially heavily negotiated, given the risks on retiring trustees and incoming trustees’

and the incoming trustee stepping into its shoes in all respects;

• a retention be sought if there are anticipated liabilities and/or claims that can be quantified;

• in the absence of a retention being agreed on the resignation of a trustee, one might foresee trustees negotiating an undertaking that an incoming trustee ringfence an amount equal to the anticipated claim and any anticipated costs associated with such claim (if they can be met from the trust fund and do not arise from the former trustee’s own fraud, gross negligence or wilful misconduct);

• restrictions be placed on an incoming trustee as to incurring any liability that it will not be able to repay in full, taking into account all existing liabilities of the trustee at the point of that new liability being incurred and any professional fees to be incurred, including the trustee fees; and

• an undertaking be provided by an incoming trustee that it will ringfence an amount equal to any liability or claim that a retired trustee notifies it of within any agreed period specified within a DORA and that the incoming trustee will not, once on notice, act in any way that would prejudice the retired trustee’s ability to be able to enforce its indemnity under the DORA in full. These are our initial observations of the potential considerations for trustees in light of the Privy Council’s decision, but these may be expanded on in due course.

THOSE TAKING SECURITY

The Privy Council held that, as a matter of Jersey law, the lien conferred by the right of indemnity is not a form of security on the basis that there is no personal obligation to secure.3

It was further held that a trustee, in respect of its right of indemnity, is not a creditor because it has no personal claim against anyone but instead it has a proprietary interest in the trust assets.4 As mentioned, the Privy Council unfortunately declined to consider the issue of priority between trustees and trust creditors; it not being an issue that was considered by or argued before the Jersey Appeal Court nor it being advanced as a ground of appeal. The Privy Council considered this 3 at para.216 4 at para.185

question of priority to be potentially important, not straightforward and an issue that should only be considered by the Privy Council after full argument and, save in exceptional circumstances, only after it has been considered fully by the courts below.5 However, it was made clear that the lien conferred by the right of indemnity gives the trustees ‘clear priority over the beneficial interests of the beneficiaries’.

Lenders to Jersey trustees should ensure that any such rights afforded to trustees by reason of their appointment as fiduciaries are expressly waived in favour of the rights of the lenders generally and transaction security provided to secure that third‑party debt. Such a waiver should continue to be made by the trustees both in their own personal capacity, given that the interest survives the transfer of trust assets to a successor trustee, and in their capacity as trustee of the relevant trust. Careful consideration should be given to any such language to ensure that such a waiver is clear and unambiguous.

CONCLUSION

The Privy Council’s decision goes to the heart of trust administration not only in Jersey but also in common‑law jurisdictions across the world; a trustee’s ability to legitimately and adequately recover under its indemnity from trust assets while in situ and after retirement being a key consideration.

The result is, in some ways, double‑edged. Trustees now have clarity that they do have a proprietary interest in the trust property, irrespective of whether they have retired in favour of another trustee. However, given that this interest ranks pari passu with former and successor trustees in an insolvent situation, there is a clear emphasis on a detailed exploration of the trustee’s potential exposure upon retirement in tandem with ensuring that adequate assets are suitably ringfenced to provide for the same.6

SIMON HURRY, KELLYANN OZOUF AND MATT GILLEY ARE PARTNERS AT COLLAS CRILL, JERSEY

5 at para.44

6

Collas Crill, together with leading counsel Shân Warnock Smith KC TEP and Clare Stanley KC, acted for the successful appellant in the Jersey Appeal, Simon Halabi (in his capacity as executor of the estate of the late Intisar Nouri).

CLOSING CHAPTER

The consequences of a recent Supreme Court of Israel ruling for the taxation of trusts that hold Israeli real estate

BY DANIEL PASERMAN, INBAR BARAK-BILU AND YOAD COHAVY

ABSTRACT

• On 30 June 2022, the Supreme Court of Israel’s judgment in Samuel Galis v Director of Land Appreciation Tax Tel‑Aviv was published.1 The judgment reached a decision on one of the most significant questions that has remained open since the legislating of the trusts chapter (the Chapter) of the Israeli Income Tax Ordinance in 2006. The Chapter concerns whether the contribution of Israeli real estate by a settlor to a trust is subject to real estate taxes in Israel, including betterment (capital gains) tax for the settlor and purchase tax for the trustee.

• Also, the Chapter left uncertain as to whether the distribution of Israeli real estate by a trustee to a beneficiary is subject to real estate taxes in Israel.

• The authors will first address the relevant legal framework, before delving into the depths of the judgment. 1

Historically, trusts are not commonplace in Israel. Although the Israeli Trust Law 5739‑1979 (the Trust Law) was enacted in 1979, it broadly applies to all fiduciary relationships and not necessarily to a trust in the classic sense of the term. In his book, Shlomo Kerem writes:

‘The Trust Law is intended to serve as a framework legislation for any legal framework whose content is a trust. It makes no difference what legal form the framework takes – whether it is a voluntary trust or a trust regulated by law. Therefore, the Trust Law is a kind of normative standard for any trust. It is consistent with the requirements of such a standard, because it provides instructions for the Trustee’s modi operandi, both appropriate and permitted. It also formalizes a system of remedies and other means of protection for the trust assets.’2

2 Shlomo Kerem, The Trust Law, 5739‑1979, 28, 4th edn (2004)

In an article, Professor Adam Hofri‑Winogradow describes how, at the time it was enacted, the Trust Law was exceptional among the trust regimes around the world:

‘In contrast to the overwhelming majority of these regimes, the Law permits the creation of a trust without the ownership of the assets subject to the trust being transferred to the trustee; it did not limit the period of the trust; it created two different trust regimes, the application of one of which is dependent on the manner of the creation of the trust; and it determined an omission norm whereby the beneficiary’s right pursuant to one of these regimes is non‑assignable, non‑pledgeable and non‑attachable.’3

In the relatively young Israel of those days, there was no long‑standing tradition of using trusts. In the late 1990s, as a result of the cancellation of the Currency Control Law 5738‑1978 and the granting of permission to Israeli residents to hold funds outside of Israel (according to the Currency Control Permit 5758‑1998), wealthy families began to set up foreign trusts that were mainly used to hold funds outside of Israel. At that time, it was not clear:

• how trusts and foreign trusts (a fortiori) should be taxed, either as a corporation or as an individual;

• whether a trust’s assets and income should be attributed to the settlor or beneficiaries, or whether the trustee should be taxed; and

• whether there is significance to the place of the effective management of the trust, and so on. Many people took advantage of the lack of clarity and adopted the position that those trusts that held assets outside of Israel and were managed by foreign‑resident trustees were not liable to tax in Israel. Consequently, a considerable amount of wealth was channelled overseas.

The Israel Tax Authority (the ITA) took its time in responding and, due to the complexity of the matter, the entire issue of the taxation of trusts was not handled in the framework of the comprehensive reform in international taxation

3 Adam Hofri‑Winogradow, ‘Trust Law in Israel: From Obstacles to Gems?’, Mishpatim, 45, 49 (November 2015)

that was implemented in 2003 (amendment 132 of the Income Tax Ordinance (the ITO), 2002). It was determined that a special, separate committee be set up, which would examine and settle the taxation treatment of trusts only.

A report by the Yisraeli Committee for the Taxation of Trusts (the Committee), published in July 2003, stated that the institution of trust was not commonplace in Israel for reasons such as differences in cultural background, partial legislative regulation with respect to the establishment of foreign trusts and a lack of regulation of the taxation of trusts. Nevertheless, the report did state that the need had arisen for a comprehensive arrangement for the taxation of trusts, following the accumulation of wealth of families in Israel, the lifting of the control on foreign currency and exposure to the vehicle of trusts abroad. The Committee published its recommendations in 2003 but these were not adopted verbatim and an additional committee was set up in 2005: the joint committee of the State Income Administration and the ITA. Consequently, amendment 147 to the ITO was finally enacted, effective from 1 January 2006, which added a special chapter (the Chapter) dedicated to regulating the taxation of trusts in Israeli law.4 The Chapter is comprehensive and determines, as a rule, that the trust/trustee is a taxpayer in and of itself/themselves, who is taxed as an individual. Further, the residence of the trust and its tax implications are derived from the fiscal residence of the settlor and of the beneficiaries.

In passing the comprehensive Chapter, the tax advantages of using foreign trusts came to an end and, since then, trusts have been used as a legitimate and acceptable instrument in all matters pertaining to intergenerational transfers and succession planning. Yet, notwithstanding the passage of the Chapter, there is one key subject that has not been regulated: the issues of the taxation of the contribution to and distribution from a trust of Israeli real estate.

For our purposes, the Chapter (4B of the ITO) forms part of Part E of the ITO, which discusses the taxation of capital assets. Further, in chapter 4B, s.75C of the ITO, an ‘asset’ is defined, for the purposes of the Chapter, as ‘any property, whether

4 Amendment no.147 to the ITO, 2005

DANIEL PASERMAN, INBAR BARAK-BILU AND YOAD COHAVY

real estate or chattels, and any right or benefit, vested or contingent, and all whether in Israel or abroad’.

In other words, the definition of an asset in the Chapter is extremely broad and includes any property whatsoever, including real estate in Israel or abroad.

That said, as distinct from the Chapter, the ITO does not, in principle, apply to the taxation of the purchase and sale of real estate in Israel. For historical reasons, there is another, separate law: the Land Taxation (Appreciation and Purchase) Law, 5723‑1963 (the 1963 Law), which applies to any sale and purchase of real estate in Israel. Accordingly, s.88 of the ITO, which regulates the taxation of capital gains, determines that Part E does not apply to the sale of real estate in Israel (as opposed to real estate abroad, in which case, Part E applies). Therefore, with respect to the taxation of Israeli real estate, although the taxation of current income is regulated under the ITO, purchases and sales are regulated under the 1963 Law.

Therefore, it transpires that there is, apparently, a contradiction between the two provisions. Although Part E excludes from its application real estate in Israel, the section covering definitions in the Chapter (which is, as previously mentioned, part of Part E) also pertains to real estate in Israel. The lack of clarity is even further exacerbated as there are provisions in the Chapter that determine that upon the existence of certain circumstances, a contribution to a trust will not be deemed to be a sale for the purposes of Part E of the ITO. It should also be noted that the provision pertains solely to Part E and it does not specifically pertain to the 1963 Law. Practitioners, therefore, find themselves contending with an unclear law that is the subject of controversy between taxpayers and the ITA. Although taxpayers have claimed that the contribution to a trust of real estate in Israel does not constitute a ‘sale’ (upon the satisfaction of the conditions set forth in the Chapter), the ITA has clung to the position that such a contribution does indeed constitute a sale for all intents and purposes, especially for the purposes of the 1963 Law, and such a transaction is therefore subject to real estate taxation.

This dispute has remained unresolved ever since the passage of the Chapter in 2006, and even

in the subsequent legislative amendments5 the legislature has not taken the trouble to resolve the lack of clarity. Consequently, throughout this period, the prevalent fact in practice was that, in the absence of well‑regulated provisions in the law, the contribution of Israeli real estate to a trust or the distribution thereof from a trust is exposed to betterment tax and purchase tax. Further, the ITA published a tax ruling in 2012 in which it was determined that the contribution of Israeli real estate to an Israeli trust in which the settlor is also the beneficiary during their lifetime and, 6 thereafter, their heirs became the beneficiaries does not constitute the sale of a right in real estate. Nevertheless, in 2016, the ITA published a circular regarding the taxation of trusts,7 in which it was determined that the contribution of an asset to a trust constitutes a tax event pursuant to the 1963 Law.

In 2019, this principled dispute finally made its way to the courts in Galis.

SAMUEL GALIS v DIRECTOR OF LAND APPRECIATION TAX TEL‑AVIV

In the Supreme Court of Israel (the Supreme Court) case of Samuel Galis v Director of Land Appreciation Tax Tel‑Aviv, 8 a Canadian‑resident couple contributed Israeli residential apartments

5 Including amendment no.165 in 2008, and amendment no.197 in 2013.

6 Taxation Ruling by Agreement No. 3324/12, regarding ‘establishment of a private trust (Hekdesh)’

7 Income Tax Circular on the Taxation of Trusts, 3/2016 (9 August 2016)

8 Civil Appeal 7610/19

TRUST TAXATION IN ISRAEL DANIEL PASERMAN, INBAR BARAK-BILU AND YOAD COHAVY

‘Although Part E excludes from its application real estate in Israel, the section covering definitions in the Chapter (which is, as previously mentioned, part of Part E) also pertains to real estate in Israel’

to an Israeli trust (or, to be more precise, to an Israeli trust holding company). The beneficiary of the trust was the Israeli‑resident granddaughter of the settlors; however, at the settlors’ request, she was not aware that she was a beneficiary of the trust and, pursuant to the trust deed, she could have been removed from the trust or other beneficiaries could have been added with her. The trust was a classic irrevocable trust pursuant to common law, where the trustee and the protector (both of whom were Israeli residents) were given extremely broad powers and the settlors’ wishes were set forth, inter alia, in a non‑binding letter of wishes.

The settlors of the trust divested their assets and agreed that they would not retain control of the assets after the transfer thereof to the trustee, provided that they would have the right to contact the trustee and present their wishes with respect to the management of the trust.

The trustee was entitled, at his discretion and subject to approval from the protector, to distribute the trust assets to the beneficiary at any time.

Although the trustee should have considered the settlors’ wishes, they were not required to do so. The trustee would then be subject to certain approvals from the protector, appointed by the settlors of the trust. Numerous powers were conferred on the protector, including appointing or removing the trustee, giving the trustee instructions and the ability to add or remove beneficiaries, according to the settlors’ wishes.

The couple and the trustee claimed that the contribution of the Israeli real estate to the trust was not subject to real estate taxes in Israel, whereas the ITA rejected this position.

In the Tel Aviv District Court (the Court) Appeal Committee’s judgment of July 2019,9 the taxpayers’ position was accepted and it was ruled that the contribution in this case was not subject to real estate taxes in Israel. Although the decision was unanimous, the panel had differences of opinions in the reasons it provided for the decision.

In a well‑reasoned judgment by one of the members of the Appeal Committee, the relationship between the Chapter and the 1963 Law was comprehensively discussed. The Court

Appeal Committee (Tel Aviv District Court) 49026 07 17

reviewed the legislative proceedings in the Israeli parliament (Knesset). It ruled that the fact that the law does not contain a specific reference to the question of the contribution of Israeli real estate to a trust does not constitute a negative arrangement.

The Court decided that, in view of the aspiration to create legislative harmony, the lacuna must be filled in accordance with the purposes of the legislation and the Chapter. The Court concluded that the contribution should not be deemed a sale for the purposes of the provisions of the 1963 Law. One of the panel members ruled that in the present case there had been no ‘sale’ because, effectively, the control over the rights in the asset remained held by the settlors and only the return on the real estate had been assigned to the granddaughter (the beneficiary).

The ITA appealed to the Supreme Court, which allowed the appeal.

In the judgment, the Supreme Court analysed the relationship between the Chapter of the ITO, which formalises the tax treatment that applies to trusts throughout their stages of life, commencing from the establishment of the trust and ending with the distribution of the trust assets and the dissolution of the trust; and the 1963 Law, which governs the taxation of real estate situated in Israel. The Supreme Court concluded that Part E of the ITO formalises the taxation of capital gains that are subject to tax under the ITO but it does not apply to the sale of real estate in Israel, the taxation of which is formalised in the 1963 Law and in the regulations enacted thereunder.

According to the Supreme Court’s approach, this is not a gap or lacuna but rather an informed and clear choice by the legislator to leave unchanged the historical division between the taxation of the appreciation arising from the sale of Israeli real estate under the 1963 Law and the taxation of capital gains under the ITO (including the taxation of appreciation arising from the sale of real estate outside of Israel).

Therefore, the contribution of Israeli real estate to a trust will be subject to the provisions of the 1963 Law only. The provision of the Chapter that determines that a contribution (without consideration) to an Israeli‑resident trust is not a taxable event does not apply to the contribution of Israeli real estate. This does not nullify the

IN ISRAEL DANIEL PASERMAN, INBAR BARAK-BILU AND YOAD COHAVY

application of the Chapter to the ordinary income from the real estate generated by the trust (for example, rental income from the real estate).

Once the Supreme Court had decided that the contribution of Israeli real estate (without consideration) to a trust must be examined through the prism of the 1963 Law, it was required to examine the contribution in the present case from the perspective of the 1963 Law. Given that the matter concerns a contribution to an irrevocable trust, the Supreme Court ruled that this case involves a ‘sale’ pursuant to the 1963 Law and that this sale is not exempt from betterment tax for the transferors (the settlors) or from purchase tax for the purchaser (the trust).

At the same time, the Supreme Court noted that had there been a specific, final and informed beneficiary of the trust on the date of the contribution of the real estate to the trustee and if the trust had reported as required by the 1963 Law, then there would have been no impediment to applying the provisions of s.69 of the 1963 Law. This provision determines the treatment of a ‘nominee’ that holds Israeli real estate, whereby a tax event occurs at the time of the contribution to the nominee (called ‘trustee’ in the 1963 Law) in accordance with the identity of the settlor and the beneficiary, but no additional tax occurs at the time of the distribution to the beneficiary.

However, in Galis, the granddaughter was not the final beneficiary and she had not even been aware that she was a beneficiary of the trust from the outset and, therefore, the provisions of this section did not apply. The Supreme Court further emphasised that this unique arrangement in the 1963 Law may apply not only with respect to a nominee relationship but also with respect to a trusteeship relationship, as occurred in Galis. Nevertheless, the Supreme Court did not expressly address the tax implications at the time of the distribution of the real estate to the beneficiaries in cases in which the provisions of s.69 had not been satisfied; nor did it address the potential for double taxation, which could be entailed therein.

Further, the Supreme Court stated in an obiter dictum that if the contribution had been to a revocable trust, if the settlor had kept the control for themselves (including through the protector), or if the beneficiary had been the settlor himself

only, then it is possible that this would not even have been viewed as a ‘sale’, which creates a taxable event.

The Supreme Court’s decision, therefore, clarifies that a contribution to a trust of Israeli real estate will be subject to the provisions of the 1963 Law (and not the ITO). However, perhaps it is possible under certain circumstances to create a revocable trust in which the settlor is the sole beneficiary during their lifetime, and only after their death do the descendants become beneficiaries and the trust become irrevocable. It is possible to argue that under these circumstances, there is no ‘sale’ at the time of the contribution to the trust and, at the time of death, the inheritance provisions in the 1963 Law would be applied. However, as aforementioned, none of these subjects or implications were explicitly discussed in the Supreme Court’s judgment and, therefore, this should be further clarified.

As can be seen, there remain open questions in this regard. At any rate, the Supreme Court actually does leave an opening for making use of trusts with respect to real estate in Israel in the context of succession planning and an intergenerational transfer, naturally, in the appropriate circumstances, and in accordance with the procedural provisions as set forth in the law.10

DANIEL PASERMAN TEP IS HEAD OF TAX AND INBAR BARAK‑BILU TEP AND YOAD COHAVY ARE PARTNERS AT GORNITZKY, ISRAEL

10 It is interesting to note that after the publication of the Supreme Court’s judgment, the ITA published a new Tax Ruling (Taxation Ruling by Agreement No. 3399/22, regarding ‘Transfer of an apartment to a trust’). This ruling discusses the transfer of the registration of residential apartments in Israel, owned by an Israeli couple, into the name of an Israeli attorney, who would serve as the ‘trustee’, who would manage the apartments for the benefit of the couple and who would hold the apartments for them. The ‘trustee’ is not authorised to perform any action in or transfer of the apartments, and they do not have the authority to exercise their discretion, other than an action for the benefit of the couple, and after obtaining an express instruction, in writing, from the couple. The full responsibility for the apartments remains with the couple.

In the Tax Ruling, it was determined that the contribution of the apartments to the trust by the couple, who are the settlors and the beneficiaries, would not create a tax event in Israel. In practice, this matter concerns a ‘nominee relationship’ and not a ‘trustee relationship’, and the material ownership of the apartments was and remained held by the couple.

It was further clarified in the Tax Ruling that a trust deed that allows the change, replacement or addition of beneficiaries does not constitute a trust pursuant to the 1963 Law and, therefore, in the event of a transfer to such a trust, as well as a transfer from such a trust to a beneficiary, any such transfer will be deemed to be a sale and s.69 of the 1963 Law will not apply in these cases.

ISRAEL DANIEL PASERMAN, INBAR BARAK-BILU AND YOAD

ABUSE OF TRUST

Equity as a remedy for adult children of a parent who uses a trust to defeat New Zealand estate claims

BY JOHN BROWN

ABSTRACT

• This article considers decisions of the High Court of New Zealand (the High Court) and the New Zealand Court of Appeal (the Court of Appeal) relating to the transfer of assets by a father to a trust for third parties to defeat a claim against his estate by his now adult children whom he seriously abused in their childhoods, leaving them damaged for life. Did the father breach a fiduciary duty to his children and was there an ongoing duty to them? The decisions raise a number of novel issues, including:

• Are fiduciary duties limited to matters concerning property or can they have a wider application?

• Does an action for breach of fiduciary duty lie against a father who seriously physically abused his sons and sexually abused his daughter, causing ongoing damage in their adult lives?

• Could the transfer by the father of his assets to a trust for third parties shortly before death with the expressed intention of defeating any claims by his now adult children against his estate constitute a breach of fiduciary duty to his children?

• These issues were considered by the High Court in A, B and C v D and E Ltd , which found for the adult children, and on appeal by the Court of Appeal in D and E Ltd v A, B and C, which by majority found for the trustees. The children have filed leave to appeal to the New Zealand Supreme Court.

• This article includes details regarding the sexual and physical abuse of children. Reader discretion is advised.

BACKGROUND

In the New Zealand Court of Appeal (the Court of Appeal) case of A, B and C v D and E Ltd, 1 the plaintiffs were given the fictitious names of Alice, Barry and Cliff (A, B and C, respectively), the three living adult children of Z (Robert).

The defendants, D and E Ltd, were the surviving trustees of the Z Trust (the Trust), which Robert settled in December 2014 for the benefit of himself and third parties with an expressed intention of alienating most of his assets, so they did not form part of his estate in order to ‘prevent[s] any of his family getting any of his [assets]’. Robert was a trustee of the Trust. The trust assets were worth approximately NZD700,000 and comprised a house and shares gifted in December 2014 and January 2016, respectively. Robert died in April 2016.

It was accepted in the High Court of New Zealand (the High Court) and the Court of Appeal that the plaintiffs and their mother were repeatedly physically, mentally and emotionally abused, and were threatened with firearms. It was also accepted that Alice, from the age of seven, was repeatedly raped and sexually abused by her father. These incidents occurred in the 1960s and 1970s, with their parents’ marriage ending in 1983. Robert established a new relationship for a time with a woman with children and grandchildren from another relationship, who were also made beneficiaries of the Trust. The plaintiffs or their children were mentioned in some of Robert’s wills, but no provision was made for them in his final will of November 2015.

The plaintiffs said they were each estranged from Robert as adults because of his abusive behaviour and they had little contact with him. The effects of this abuse have continued during the plaintiffs’ adult lives. Alice disclosed the abuse to a doctor in 1982 and wrote to Robert in 1992 telling him about its effect on her life and the suffering this had caused. She received no response. Alice was diagnosed with post‑traumatic stress disorder and major depressive disorder. Barry and Cliff gave similar evidence of physical and emotional abuse and its long‑term effects on them. The abuse left them emotionally and psychologically vulnerable, and educationally and financially deprived.

[2021] NZHC 2997, (2021) 5 NZTR 31‑022, (HC)

The plaintiffs’ evidence was that they were operating under a disability as a result of their father’s abuse. They argued that the continued disability they suffered meant the fiduciary relationship between them and their father continued into their adulthood. The High Court judgment provides some of the harrowing details of the abuse suffered.

LEGISLATIVE BACKGROUND: ABOLITION OF GIFT DUTY

An unintended consequence of the abolition of gift duty in New Zealand from 1 October 2011 was that a person could more easily gift away assets on their deathbed, 2 so as to defeat legitimate family claimants to their estate under the Family Protection Act 1955 (the Act). Previously, when gift duty was in force, the gift of a house and shares to the trustees, as in this case, would have incurred total duty of at least NZD170,000 that would have been due by the trustees.3 This would have been a strong disincentive to make such gifts, given New Zealand had no death duty.

A special report by the Policy and Strategy area of Inland Revenue (previously the Policy Advice Division) discloses that none of the government ministries consulted opposed gift duty abolition,4 relying on an earlier review:

‘As the review progressed, a strong case for outright abolition emerged. Some of the concerns which existed in 1992 have been addressed or reduced by the strengthening of existing legislative provisions. Remaining areas of concern were scrutinised in consultation with the Treasury, the Ministry of Economic Development, Ministry of Justice, Ministry of Health, New Zealand Police, the Ministry of Social Development, and Housing New Zealand Corporation. None of these agencies opposed gift duty abolition and several have said they will make administrative changes to support its abolition’.5

2 Taxation (Tax Administration and Remedial Matters) Act 2011, s.245

3 Gifts in excess of NZD27,000 were taxed on a graduated scale reaching a maximum rate of 25 per cent at NZD72,000, gift duty at that point being NZD5,250). The total assets gifted were about NZD700,000, of which the shares were worth about NZD46,000, gifted 13 months after the establishment of the Trust.

4 Gift Duty Abolition, Inland Revenue Policy Advice Division, 1 September 2011

5 Page 2

In addition, in answer to an FAQ, at page 5:

‘Ministry of Justice officials do not consider changes to the Property (Relationships) Act, Family Protection Act and the Law Reform (Testamentary Promises) Act are required. The underlying philosophy of these Acts is that individuals are generally free to deal with their own property as they wish – any entitlement one person may have to the property of another does not arise until the actual event of separation or death … The Ministry of Justice will monitor any impacts of gift duty abolition to inform the government‑wide post‑implementation review.’

The underlying philosophy of the Act was to ensure that where adequate provision had not been made for a very limited class of persons related to the deceased, those people could claim against the deceased’s estate rather than be a burden on the state. The legislation referred to in the special report did not include ‘the underlying philosophy that individuals are free to deal with their property as they wish’.

It would appear that the effect of the abolition of gift duty on the operation of the Act was either overlooked or not considered by government officials as it related to circumstances such as the present case. Other parties that might be vulnerable following the abolition of gift duty, such as creditors or the Ministry of Social Development,6 had their own statutory or regulatory protection. 7

Consequently, assets may now be transferred to a trust to frustrate claims under the Act, which has no anti‑avoidance provision. It should also be mentioned, by way of comparison, that under s.4 of the Act, the court’s jurisdiction is limited to circumstances where a deceased has failed to make ‘adequate provision’ for the claimant. It is thought that the comparable English and Welsh legislation, which enacts a standard of ‘reasonable provision’, requires more generous treatment. Generally, the New Zealand statute has been interpreted by the

6 The Insolvency Act 2006, ss.204 and 205, the Companies Act 1993, s.292, and the Property Law Act 2007, subpart 6, contained provisions to provide for the claw‑back of dispositions for creditors.

7 The Ministry of Social Development (formerly Social Welfare) introduced extensive regulations dealing with gifting by an applicant or spouse/de facto partner prior to an application for a rest‑home subsidy.

courts conservatively, to give greater recognition to a testator’s wishes.8

In terms of alternative legal remedies, the Accident Compensation Act 1972 (the 1972 Act)9 introduced a bar to civil claims for personal injury. However, it did not prevent a plaintiff from suing for exemplary damages (except in respect of criminal proceedings before 1998)10 where they were the victim of an assault or for breach of fiduciary duty giving rise to physical and emotional harm, such as in a doctor/patient relationship. In the present case, a claim in tort had long expired under the then Limitation Act 1950 (the 1950 Act).

HIGH COURT DECISION

In the substantive High Court proceeding, Justice Gwyn held that:11

• Robert’s relationship with his children was inherently fiduciary when they were in his care. The abuse Robert inflicted on each of his children was a breach of the fiduciary duty he owed them. Once his children became adults, Robert ceased to have an inherently fiduciary relationship with them.

• Robert’s earlier breaches of the fiduciary duties he owed to the plaintiffs left them emotionally and psychologically vulnerable, and educationally and financially deprived. The consequence of his breaches was enforced incompetence and non‑autonomy.

• This was not a case about testamentary freedom but property rights and the ability to deal with property during one’s lifetime, subject only to pre‑existing legal constraints. The plaintiffs’ vulnerability was a direct consequence of Robert’s own actions. Their abuse, particularly that suffered by Alice, was egregious. To find a fiduciary relationship between Robert and the children as adults would not give rise to a floodgate of litigation (as the trustees asserted).

• At the time he gifted the property to the Trust, Robert owed each of the plaintiffs a duty to

8 In the trend‑setting decision of Williams v Aucutt [2000] 2 NZLR 479 (CA), the testatrix in her will left an estate of NZD1 million to two daughters 95:5. The High Court changed that to 75:25. The Court of Appeal reduced that award to 90:10.

9 Commencing 1 April 1974 and continued by the accident compensation legislation.

10 Collins J discusses this at [62]. If criminal proceedings had been initiated against Robert, then prior to the passing of the Accident Insurance Act 1998 exemplary damages could not have been sought.

11 A, B and C v D and E Ltd [2021] NZHC 2997, (2021) 5 NZTR 31‑022

recognise them as members of his family and provide for them from his wealth. This arose from the vulnerability his earlier breach of fiduciary duties had caused them. The transfer was in breach of the fiduciary duties Robert owed his children.

• The trustees were liable for knowingly receiving the property gifted by Robert because his knowledge as trustee was imputed to the other trustees of the Trust.12

• The assets of the Trust were held on a constructive trust for Robert’s estate.

In a subsequent supplementary judgment, A, B and C v D and E Ltd,13 Gwyn J held that:

• the constructive trust imposed on the trustees was an institutional constructive trust effective from the date of receipt of the property;

• the interim distributions to the Trust beneficiaries were made after the institutional constructive trust came into existence and could not stand; and

• the defendant trustees were not entitled to indemnity costs from the trust fund. The trustees appealed.

COURT OF APPEAL OVERVIEW

In D and E Ltd v A, B and C,14 Justice Collins, writing the principal judgment, dissented in part by dismissing the trustees’ appeal in respect of Alice but agreed with President of the Court of Appeal Stephen Kós and Justice Gilbert in allowing the appeal in respect of the sons. Kós P and Gilbert J found for the trustees in regard to Alice, so allowing their appeal in full.

While Collins J and Kós P agreed on the issue of fiduciary duty while children are minors, Kós P disagreed as regards any continuing duty. He also disagreed with Collins J in regard to the nature of the remedy in a situation such as the present. Collins J argued for rescission of the transfer of the father’s assets to the trust, whereas Kós P maintained that the remedy for breach of fiduciary duty, by way of sexual or other physical abuse, would be equitable compensation. Gilbert J on the issue of fiduciary duty argued for the traditional, limited approach.

12 Regal Castings Ltd v Lightbody [2008] NZSC 87, (2008) 2 NZTR 18‑018, [2009] 2 NZLR 433

13 [2022] NZHC 172, (2022) 5 NZTR 32‑001]

14 [2022] NZCA 430, (2022) 5 NZTR 32‑012 (CA)

The trustees’ appeal from the High Court was therefore allowed, effectively dismissing the claims by the adult children.

FIDUCIARY DUTY IN THE HIGH COURT AND THE COURT OF APPEAL Fiduciary duty in the High Court

In the High Court, Gwyn J noted that there were two broad circumstances in which the courts would categorise a relationship as fiduciary: those recognised by law as inherently fiduciary (such as solicitor/client relationships) and those where the law imposed fiduciary obligations because the particular circumstances justified doing so, namely ‘where one party is reasonably entitled to repose and does repose trust and confidence in the other, either generally or in a particular transaction ...’.15 The High Court also noted that a significant, recent development in this area was the recognition of fiduciary duties in circumstances of physical and sexual abuse and a move away from tying fiduciary protection to economic interests. Gwyn J referred to the Canadian Supreme Court decision of M (K) v M (H)16 and a New Zealand case that also supported this approach.17 Robert’s relationship with the plaintiffs, as their parent and caregiver while they were children, was inherently fiduciary, here limited to the requirement to refrain from sexually or physically assaulting the plaintiffs.

The High Court concluded that although Robert’s relationship with the plaintiffs as children was inherently fiduciary, the relationship of an adult child to their parent is generally of a non‑fiduciary kind unless there were aspects that engaged fiduciary obligations within the second Chirnside category.18 Gwyn J then referred to Judge Wilson’s formulation in Frame v Smith and the three general characteristics of a fiduciary relationship,19 namely:

• the fiduciary has scope for the exercise of some discretion or power;

• the fiduciary can unilaterally exercise that power

15 Estate Realties Ltd v Wignall [1991] 3 NZLR 482 (CA) at 492

16 M (K) v M (H) [1992] 3 SCR 6 at [61], [62]

17 B v R (1996) 10 PRNZ 73 (HC)

18 Chirnside v Fay [2006] NZSC 68; [2007] 1 NZLR 433 (SC). The Supreme Court held a fiduciary duty might exist where there is an inherently fiduciary relationship between the parties, or when particular aspects of a relationship that is not inherently fiduciary nonetheless justify it being classified as such. See below ‘Fiduciary duty in the Court of Appeal’.

19 Frame v Smith [1987] 2 SCR 99 at [60]

or discretion so as to affect the beneficiaries’ legal or practical interests; and

• the beneficiary is peculiarly vulnerable to or at the mercy of the fiduciary holding the discretion or power.

The High Court pointed out that the key feature of vulnerability was fundamental to all fiduciary relationships. Gwyn J concluded that there was no reason, in principle, why fiduciary principles should not be extended to cover a relationship and circumstances that have not, to date, been recognised as fiduciary. This was not a case about testamentary freedom but property rights and the ability to deal with property during one’s lifetime, subject only to pre‑existing legal constraints. The plaintiffs’ vulnerability was a direct consequence of Robert’s own actions.

Fiduciary duty in the Court of Appeal In the principal judgment, Collins J set out observations regarding fiduciary duties in New Zealand:20

• Fiduciary duties are assumed responsibilities and may be inferred where the relationship is one of assumed trust, confidence and loyalty.

• A relationship may give rise to fiduciary duties:

• when there is an inherently fiduciary relationship between the parties; or

• when particular aspects of a relationship not inherently fiduciary nonetheless justify it being

20 Referring to Dold v Murphy [2020] NZCA 313 (CA) at [51]‑[59], which drew on three Supreme Court decisions, Chirnside v Fay [2006] NZSC 68, [2007] 1 NZLR 433; Paper Reclaim Ltd v Aotearoa International Ltd [2007] NZSC 26, [2007] 3 NZLR 169; and Amaltal Corp Ltd v Maruha Corp [2007] NZSC 40, [2007] 3 NZLR 192.

classified as such (Chirnside v Fay)21 and which in either situation is marked by the entitlement of one party to place trust and confidence in the other.

• Some relationships are inherently fiduciary in nature, such as solicitor/client and trustee/beneficiary relationships, whereas in other cases a fiduciary relationship is only likely to be inferred when the legal relationship involves:

• conferral of powers that may be used to affect the proprietary rights of the beneficiary;

• the apparent assumption of a representative or protective responsibility by the alleged fiduciary for the beneficiary; and

• the implied subordination of the alleged fiduciary’s own self‑interest.

In regard to ‘vulnerability’, Gilbert J considered this to be vulnerability to an abuse of fiduciary power:

‘They were only “vulnerable” and “at his mercy” in terms of any atonement for his offending because of their freely informed decision not to pursue any remedy against him until after his death.’22

Kós P disagreed with Gilbert J on this point, noting that although vulnerability was expressly stated in the Canadian formulation, it was:

‘… inherent in its New Zealand counterpart. It is not to be over‑emphasised, however; it refers to vulnerability arising from the relationship itself, rather than existing apart from it. For instance, in many principal/agent relationships, the principal will be the far stronger party economically; the principal’s vulnerability arises from the act of empowering the agent to manage its affairs’. 23

FIDUCIARY DUTIES IN A FAMILY CONTEXT

Collins J discussed fiduciary duties in a family context, in particular the relationship between parent and child, which had been recognised as fiduciary in Canada and New Zealand. Hallmarks included the actual or implied trust and confidence a child has in a parent and a duty not to act contrary

21 SC CIV 7/2004 [6 September 2006] 22 at [145] 23 at [154]

‘Gwyn J concluded that there was no reason, in principle, why fiduciary principles should not be extended to cover a relationship and circumstances that have not, to date, been recognised as fiduciary’

to the child’s interest. A breach of fiduciary duty was recognised in the situation of sexual abuse by a father of his daughter as a child in the Canadian decision of M (K) v M (H) 24 Those principles were applied in New Zealand in B v R.25 Robert’s relationship with each of his children while living in his home was inherently fiduciary and breached by his proven physical abuse of Barry and Cliff and proven sexual abuse of Alice.

Kós P agreed with Collins J that the relationship between the children and their father was inherently fiduciary in nature for so long as they lived with or were cared for by him:

‘The relationship between parent and child is –or should be regarded as – inherently fiduciary in nature, at least for so long as the parent undertakes care of the child. It is difficult to imagine a context in which greater trust and confidence is reposed. That the relationship is not primarily economic does not alter that reality or analysis.’26

Kós P reasoned further:

‘That a fiduciary duty should be recognised in a parent/child context is supportable by reference to cases involving more conventional fiduciary relationships: doctor and patient and priest and penitent. I refer to these cases because they have two points in parallel with the present appeal. First, the relationship is often purely personal in nature, rather than proprietary. Secondly, the nature of the abuse at issue in a claim for breach of duty may be similar in nature, being sexual or other physical abuse.’27

It was noted that it had long been accepted that a doctor is in a fiduciary relationship with a patient when dealing with their property, citing Dent v Bennett and Mitchell v Homfray.28 Kós P continued:

‘A more contested issue is whether the doctor‑patient fiduciary relationship

24 [1992] 3 SCR 6

25 (1996) 10 PRNZ 73 (HC)

26 at [153]

27 at [156]

28 Dent v Bennett (1835) 7 Sim 539, 58 ER 944 (Ch); Mitchell v Homfray (1881) 8 QBD 587 (CA)

extends beyond these proprietary grounds. The proposition that it does has been effectively rejected in England and Wales in Sidaway v Board of Governors of the Bethlem Royal Hospital (HL)29 and in Australia in Breen v Williams (HCA).’30

In concluding, Kós P considered that the duty in a family context should be cast in negative terms:

‘[A]s I see it, the fiduciary duty is to refrain from acts that fundamentally violate the relationship of trust inherent in a parent‑child relationship. Foremost within a duty expressed in such terms is to refrain from sexually and physically abusing the child.’31

In the present case, the judge’s findings on sexual and other physical abuse by the father were unchallenged and there was no reason to doubt those findings. Gilbert J made no comment or disagreed regarding such a fiduciary duty.32

CAN FIDUCIARY DUTIES TO THE CHILD EXTEND BEYOND CHILDHOOD?

Collins J noted that in some circumstances, the inherent fiduciary relationship between parent and child may continue after a child becomes an adult: for example, a child with severe disabilities who is dependent on their parents for care and support, with the continuous relationship being inherently fiduciary. Kós P may have left this door open in stating the duty ended ‘when the responsibilities of parental care ended’. In the present case, this was ‘on the children leaving home’.33 It might be argued, however, that where the physical and emotional abuse is so serious that the children are forced to leave home, should this factor end the fiduciary duty? It also leaves open the question of ongoing damage already caused.

Another issue relates to the absence of subsequent contact between Robert and his children, which was the basis on which the majority rejected a duty in favour of Alice.

29 [1985] AC 871 (HL) at 884 30 (1996) 186 CLR 71 (HCA) at 93 31 at [161] 32 See discussion below. 33 at [166]

Collins J picks this point up:34

‘The majority have used the absence of contact between Robert and Alice to reason that Robert could not have owed fiduciary duties to Alice. I do not, however, consider the absence of contact between Alice and Robert to be a barrier to Alice’s expectation that Robert would provide for her. The absence of contact between Alice and Robert was the direct consequence of Robert’s abuse. Alice could not have been expected to continue contact with Robert, but Alice could expect Robert to provide her with the support that she needed as a result of the abuse. It would, in any event, be perverse if Robert could avoid being held to be a fiduciary by relying on his earlier breaches of fiduciary duty.’

A FIDUCIARY DUTY IN NOVEL CIRCUMSTANCES

Collins J, like Gwyn J, acknowledged that to find a fiduciary duty would be to recognise a fiduciary relationship in novel circumstances but noted ‘the categories of fiduciary relationships are not closed, and it is a strength of equity that it can respond flexibly to the needs of justice’. Collins J also pointed out:

‘It is not an adequate response to argue that finding a fiduciary duty in this case is unprincipled and outcome driven. Rather, it is an example of equity responding to an unprecedented situation by applying the established indicia of a fiduciary relationship. In the exceptional circumstances of this case, the needs of justice require the recognition of a fiduciary relationship between Robert and Alice … that continued throughout Robert’s life … Robert’s transfer of his principal assets to the Trust to deprive Alice of any

meaningful claim against his estate was in breach of this fiduciary duty.’35

In regard to the sons, Collins J allowed the trustees’ appeal. He considered that they did not have the requisite trust in Robert when he transferred his principal assets to the Trust. The judge found Barry and Cliff ceased to rely on their father once they left home. In contrast, Alice’s life was ruined by the nature of the abuse inflicted, which caused profound and enduring psychological trauma throughout her life, and her situation was comparable to that of an adult child with disabilities. The judge expressed the view that the sons made good their lives after many long years battling their childhood disabilities. However, the evidence and the High Court judgment might be thought to paint a more sombre picture of their disabilities in adulthood.

REMEDY

The Court of Appeal disagreed with the High Court as regards remedy. Collins J considered that a claim in knowing receipt gave rise to a personal rather than proprietary remedy such as a constructive trust. The judge did not view this as fatal to Alice because the equitable principles governing rescission were available where property has been transferred in breach of a transferor’s fiduciary obligations. The transfer may be rescinded, with the trustees and beneficiaries receiving the property as volunteers.

Kós P maintained that the usual remedy for a fiduciary’s breach of duty, by way of sexual or other physical abuse, must be equitable compensation, referring to the Canadian case of Norberg v Wynrib 36 In that case, a doctor had sexually abused his patient by procuring sexual favours in exchange for drugs. The remedy of equitable compensation

35 at [103]‑[104] 36 [1992] 2 SCR 226

‘Collins J, like Gwyn J, acknowledged that to find a fiduciary duty would be to recognise a fiduciary relationship in novel circumstances but noted “the categories of fiduciary relationships are not closed”’

had also been applied in priest/penitent cases involving sexual abuse that were not time‑barred.

Kós P agreed with Gilbert J that the transfer to the Trust was not in breach of fiduciary duty and could not be rescinded. The residual personal claim for equitable compensation could not be converted to (and preserved by) a continuing proprietary claim to the father’s property. That Alice suffered enduring vulnerability and disadvantage did not sound in a new or sustained fiduciary duty to make proprietary provision during the many years they no longer lived together. This would amount to overreach and convert a purely personal claim into a proprietary one where proprietary remedies had no place.

A CONSERVATIVE JUDGMENT?

It is the author’s respectful view that Gilbert J appears to chart a more conservative course, against a backdrop of earlier Supreme Court and Court of Appeal judgments over the past 15 years, which have indicated a cautiously wider approach to fiduciary duties. The judge did not offer comment on whether there was a fiduciary relationship between Robert and the respondents while they were children nor whether he owed a fiduciary duty not to physically or sexually abuse them. It was noted that no such fiduciary relationship or duty had been recognised in Australia or England and Wales. The judge argued that the respondents could have successfully pursued claims against Robert in tort for assault and battery and for breach of fiduciary duty because those causes of action arose prior to 1 April 1974, which is when the accident compensation legislation came into force. A further argument against finding for the children was that they continued to have no contact with Robert.

Gilbert J considered that there was no fiduciary relationship between Robert and his adult children at the time he gifted his assets to the Trust, referring to the central, distinguishing obligation of a fiduciary, to act with undivided loyalty to the beneficiary, being absent. However, that is only one limb of fiduciary duty arising in the situation of a solicitor/client or trustee/beneficiary relationship and not the one that arises in this case.

Gilbert J argued that the respondents had no proprietary claim to Robert’s assets and that the fiduciary duty proposed by Collins J in regard to Alice in her adult life:

‘is not only novel but unprincipled … such an approach opens up the possibility of a vast expansion of the circumstances in which claims for breach of fiduciary duty can be advanced, without a sound foundation in principle’.37

Gilbert J argued there was no authority given for the proposition that parents owe their children lifelong fiduciary duties of any kind. Both Collins and Gwyn JJ note the exceptional circumstances of this case. In allowing the appeal in full, Gilbert J concluded, ‘I cannot agree that equity can supply the remedy sought in this case following Robert’s death.’38

CONCLUSION

That the children had no ongoing contact with their father was not surprising given the abuse suffered for an extended period at such a vulnerable age. One would think that in early adulthood they were focused on trying to hold their lives together rather than contemplate litigation against their abusive father. There appears to be some confusion around the significance of the lack of contact. Not having contact may be disentitling conduct under a claim under the Act but has limited relevance to fiduciary duty.

With regard to the failure to take up a claim in tort, it is suggested that this is largely illusory. Although the other two children were born in the early 1960s, Cliff was born in 1971. Claims in tort were barred three years later by the 1972 Act. The effect of this and the 1950 Act left little of a window within which to achieve a just remedy. Given the damage suffered by the children, it must be questionable whether this was a realistic expectation in the circumstances of the case.

In what appears to be a government department oversight, with the abolition of gift duty, the New Zealand Parliament’s statutory intention and provision under the Act has, in the present case, been negated. Breach of fiduciary duty, as held in the High Court, is a potential solution and Collins J’s judgment provides the remedy.

JOHN BROWN TEP IS A NEW ZEALAND BARRISTER LIVING IN FRANCE

37 at [122] 38 at [121]

TAXING GERMAN BENEFICIARIES

The taxation of trusts in Germany: an update

BY JÖRGCHRISTIAN KLETTE AND DANIEL SCHÜTTPELZ

INTRODUCTION

ABSTRACT

• Trusts are not legally recognised in Germany and, consequently, face a degree of legal and tax uncertainty. Each trust must be classified on a case‑by‑case basis as either tax transparent or non‑transparent.

• A non‑transparent trust’s distribution to a German tax‑resident beneficiary risked double taxation with German income tax and gift tax. However, on 25 June 2021,1 the highest German tax court ruled that trust distributions made in accordance with the trust deed are not subject to gift tax if the beneficiary has no legal right to the distributions. Whether such right exists has to be determined under the law applicable to the trust.

• The decision could allow for further structuring options for trusts with German beneficiaries. The German add‑back taxation rules will restrict this to trusts with certain kinds of assets.

1 German Federal Fiscal Court, decision of 25 June 2021, II R 31/19, BStBl. 2022 vol.II, p.481

The authors first gave an overview of Germany’s legal treatment and taxation of trusts in the September 2020 edition of the Trust Quarterly Review. 2 At the time, a German Federal Fiscal Court (the Court) decision had provided clarity on the gift tax treatment of distributions from foreign (non‑German) foundations to German beneficiaries. In the decision of 25 June 2021, the Court applied the same principles to trusts.

THE TREATMENT OF A TRUST IN THE GERMAN LEGAL SYSTEM

Although some countries of Continental Europe recognise trusts and have even enacted trust laws, it is not a traditional instrument of the civil‑law system of Europe. The Continental European law tradition has developed other legal forms to achieve similar results as with a trust; in particular, certain structures in inheritance law (e.g., bequests, usufructs, etc.) and foundations. However, the legal basis of these structures is not comparable with a trust. Therefore, the German

2 J Klette and D Schüttpelz, ‘Trusts with German Beneficiaries’, Trust Quarterly Review, Vol18 Iss3 (September 2020)

civil‑law system has to find its own answer to the question of how to treat a trust. This answer remains quite unsatisfactory: since the German civil‑law system does not acknowledge the trust, it does not exist as such. Any trust arrangement has to be reinterpreted as the native German legal institution that comes closest to the intended effect of the trust in the individual case. In particular, this can be:

• the institute of pre‑ and post‑inheritance;

• a usufruct;

• a suspended or temporary inheritance; or

• the permanent execution of the will.

Since the trust is not acknowledged by the civil‑law system in Germany, it cannot be entered into a public register, such as the commercial register or the land register, with the result that its ability to acquire assets in Germany is limited.

LEGAL TYPE COMPARISON OF A TRUST

For German income, inheritance and gift tax purposes, the trust, like other foreign legal forms, must be classified based on a comparison with native German legal forms or instruments, according to a so‑called legal type comparison (Rechtstypenvergleich), in order to make it manageable for the German tax system. In particular, a trust may be treated as an independent property fund (selbständige Vermögensmasse) similar to a corporate entity (non‑transparent or opaque) or as a partnership or fiduciary arrangement (transparent). Specific legal regulations for the classification of a trust do not exist and indications of the tax administration are sparse. Tax practitioners essentially draw on case law, according to which the legal type comparison of a trust must be determined in each individual case on the basis of the structure of the trust relationship.3 The trust deed, a last will of the settlor and any ‘letter of wishes’ or similar provided by the settlor in the course of the settlement of the trust are used. Actual circumstances must also be taken into account. Of particular relevance is the question of who can dispose of the assets and income of the trust, who is in charge of the management of the

3 The Court, decision of 5 November 1992, I R 39/92, BStBl. 1993 vol.II, p.388. See also the Court, decision of 28 June 2007, II R 21/05, BStBl. 2007 vol.II, p.669.

trust’s assets and who is actually exercising it.4 This view has been confirmed in two recently published decisions.5 In any case, the overall circumstances of the individual case must be examined.

If the characteristics of the trust are comparable to a German corporate entity, such as a foundation, it is treated as an independent property fund for tax purposes and is non‑transparent with regard to the German taxation of any individual, in particular the settlor or the beneficiaries. This is particularly the case where the settlor has transferred the assets to the trustee in such a way that the trust fund is legally and factually irrevocably and completely separated from the settlor and the beneficiaries. In this case, the trust itself can be subject to German tax. This non‑transparency should apply to most irrevocable discretionary trusts where the trustee is free to dispose of the trust’s assets within the scope of their reasonable discretion.

If the trust is comparable to a German partnership or fiduciary arrangement, it is transparent from a German tax point of view. This is the case if the settlor can continue to dispose of the assets transferred to the trust; for example, if they can arrange for a transfer back to themselves or they reserve essential rights of instruction to the trustee. In addition, if the settlor or a beneficiary can exchange the trustee at any time, a transparent trust is regularly assumed. Most revocable trusts should be seen as transparent.

A transparent trust is ignored for German tax purposes. The assets and income are still attributed to the settlor for tax purposes. The settlor will continue to pay income tax on the trust’s income. In individual cases, a direct allocation to the beneficiaries of the trust may be assumed. This is the case, for example, if the settlor does not hold the rights of instruction over the trustee but a beneficiary does. Transfers from the settlor to the trustee are then considered direct transfers to the beneficiary, which may

4 See, e.g., Werder/Wystrcil, ‘Steuerliches “Zuzugsverbot” für Begünstigte eines trust in Deutschland?’ in Betriebs Berater, 2015, p.412, for a more detailed overview.

5 The Court, decision of 25 June 2021, II R 13/19, BStBl. 2022 vol.II, p.481. See also the Court, decision of 25 June 2021, II R 32/19, BFH/NV 2022, p.595 (not published).

be subject to gift tax, provided that the settlor and/or beneficiary is subject to unlimited tax liability in Germany,6 i.e., a German tax resident. German unlimited tax liability is given where the residence (Wohnsitz) or habitual abode (gewöhnlicher Aufenthalt) of a person is in Germany. In this case, the German beneficiary is subject to income tax on the current income of the trust.

The following will only describe the German tax consequences of a non‑transparent trust. For ease of reading, the term ‘trust’ will mean the non‑transparent trust. Further, the scope will be limited to the German taxation of the beneficiary and will not look at the lifecycle of a trust as a whole.

TAX TREATMENT OF TRUST DISTRIBUTIONS

IN GERMANY

Distributions from trusts can be subject to German income tax and gift tax at the level of the beneficiary.

Income tax regularly applies to current or one‑off distributions of trusts to German tax‑resident beneficiaries, in accordance with s.20(1), no.9, of the German Income Tax Act (Einkommensteuergesetz, the EStG), taxed as investment income. The tax rate is 25 per cent plus a solidarity surcharge, i.e., a total of 26.4 per cent and, if applicable, church tax.7,8 Details on the applicability of this provision are disputed, as the wording is unclear, in particular with regard to any required legal position of the beneficiary in relation to the trust.9

Gift tax may apply to distributions under the provisions of two separate sections of the German Inheritance and Gift Tax Act (Erbschaft und Schenkungsteuergesetz, the ErbStG), s.7(1), no.1, of the ErbStG (gratuitous transfer

6 In contrast to most common‑law states, in Germany the tax residency of the heir or donee in Germany can trigger German inheritance and gift tax. See s.2(1), no.1, of the German Inheritance Tax and Gift Tax Act

7 e.g., Ratschow, Brandis/Heuermann, Commentary to the EStG, Section 20 MNo. 336 (Ed. 162. May 2022). See also the Court, decision of 3 November 2010, I R 98/09, BStBl. 2011 vol.II, p.417.

8 In Germany, a church tax (Kirchensteuer) is imposed on members of certain religious congregations, amounting to 7–8 per cent of their annual income tax bill. This figure is tax‑deductible.

9 The Court, decision of 3 November 2010, I R 98/09, BStBl. 2011 vol.II, p.417. If the beneficiary has no influence on distributions by the trust and the distributions are of a recurring nature, this may result in an application of the progressive income tax rate, with a charge of 28.5 per cent including the solidarity surcharge as the maximum (marginal) tax rate and, if applicable, church tax, s.22, no.1, s.2a) of the EStG in conjunction with s.3, no.40i) of the EStG.

inter vivos) or s.7(1), no.9, sentence 2, alternative 2, of the ErbStG (acquisition upon dissolution of a foreign law fund or acquisition by an interim beneficiary).

For gift tax purposes, a gift is defined as a gratuitous transfer inter vivos, insofar as the donee is enriched by it at the expense of the donor, under s.7(1), no.1, of the ErbStG. The donor must objectively and willingly enrich the recipient without any consideration.10 It is therefore necessary for the donor to be aware of the fact that the transfer is without any obligation and without legal connection with a consideration or a common purpose (gratuitousness).11

Distributions in conformity with a trust deed lack the subjective characteristic of gratuitousness and should, therefore, not qualify as gifts in accordance with s.7(1), no.1, of the ErbStG, even though this has not yet been expressly decided for trusts.12

Although the distribution to a German beneficiary upon dissolution of the trust is always subject to gift tax, it was unclear when a current distribution (during the existence of the trust) was made to an ‘interim beneficiary’ (Zwischenberechtigter) within the meaning of s.7(1), no.9 of the ErbStG. In the decision of 3 July 2019,13 the Court ruled that only a person who has a legal right in rem or based on obligation to the distribution from a foreign foundation is an interim beneficiary within the provision of s.7(1), no.9 of the ErbStG, and that this should not be the case when a person receives a distribution on the basis of the discretionary decision of a third party, such as, in the Court’s case, the board of a foundation. This represented a major change since, prior to this, the Court and the German tax authorities had argued that every beneficiary who receives distributions by a foreign foundation during its existence shall be regarded as an interim beneficiary within the meaning of s.7(1), no.9 of the ErbStG.14 However, even though the

10 e.g., Gebel, Troll/Gebel/Jülicher/Gottschalk, Commentary to the ErbStG Act, s.7, no.17f) (Ed. 49. February 2022)

11 The Court, decision of 3 July 2019, II R 6/16, BStBl. 2020 vol.II, p.61, MNo. 15 with further references.

12 Regarding distributions of foreign foundations, see the Court decision of 3 July 2019, II R 6/16, BStBl. 2020 vol.II, p.61, No.22. See below with regard to the current decision dated 25 June 2021.

13 The Court, decision of 3 July 2019, II R 6/16, BStBl. 2020 vol.II, p.61

14 The Court, decision of 27 September 2012, II R 45/10, BStBl. 2013 vol.II, p.84. See also Guidance on the ErbStG, 2011, HE 7.1. [1.].

wording of the decision suggested that it could also be applied to distributions from a trust to German beneficiaries, this was, until now, not entirely clear.15

ADD‑BACK TAXATION UNDER THE ASTG

In addition to income and gift tax on distributions from trusts, the add‑back taxation under s.15 of the Foreign Relations Tax Act (Außensteuergesetz, the AStG) may result in a direct attribution of a trust’s income to the German tax‑resident settlor or beneficiary.

The add‑back taxation is a controlled foreign company (CFC) taxation that applies to foreign foundations and trusts if the majority of their beneficiaries are the founder, their relatives and their descendants (a Family Trust).16 The income of a Family Trust is attributed to the settlor if they are a German tax resident, otherwise to the German tax‑resident beneficiaries according to their share in assets or income.17 This is regardless of any actual distributions of a Family Trust to the beneficiaries. 18 As a result, a Family Trust loses its shielding effect for income tax purposes. The settlor and then the beneficiary are then

15 Schienke‑Ohletz/Version/Trossen, Zuwendungen einer Schweizer Stiftung (Schenkungsteuer), UBG 2019, 715, p.720 ff.; see also Wachter, SchenkSt bei Zuwendungen von einer Schweizer Stiftung, DB 2019, 2430, p.2,431.

16 s.15(2), the AStG

17 s.15(1), the AStG

18 German Federal Ministry of Finance, circular of 14 May 2004, IV B 4‑S 1340‑11/04, BStBl. 2004 vol.I, p.3, No.15.1.4.

taxed on the trust’s income, according to the rules that would apply if the income were received directly by the German tax‑resident settlor or beneficiary (without the trust).19 Foreign taxes paid by the trust (or, in certain cases, the grantor)20 on its income will generally be credited.21 The German tax‑resident settlor or beneficiary is the taxable person and is obliged to file the respective tax return.

In cases where the trust holds shares in a corporate entity,22 generally only its dividend distributions will be taxable on the trust and, via the add‑back taxation, also the German tax‑resident settlor or beneficiary. However, the regular German CFC taxation may lead to an attribution of passive, low‑taxed income to the trust, independent of a distribution. 23

Since the add‑back taxation is triggered independently of actual distributions, liquidity disadvantages arise from such tax payments, unless the income so taxed is distributed. The distribution is then, in general, free of income tax so that, in this regard, double taxation should not arise.

In addition, the add‑back taxation leads to a significant tax compliance burden for the German beneficiary, since the trust’s income must be determined following German tax rules. In practice, the tax base can therefore significantly differ from the income calculated in the trust’s jurisdiction.

One of the major issues with regard to the application of this add‑back taxation is the lack of clarity surrounding under which circumstances individuals shall be regarded as beneficiaries within the meaning of s.15(2) of the AStG (Bezugsberechtigte oder Anfallsberechtigte, translated as current beneficiaries or remaindermen). The current stated view of the German Federal Ministry of Finance on this subject is vague and so entails

19 26.4 per cent flat tax rate for investment income, progressive rate of up to 28.5 per cent for dividend income in business assets, progressive rate of up to 47.5 per cent for other income.

20 The Court, decision of 2 February 1994, I R 66/92, BStBI. 2020 vol.II, p.727, No.32.

21 Note that in case of a qualification mismatch (e.g., for income from certain limited liability companies or S‑corporations held in trust) a tax credit may not be granted, potentially leading to double taxation.

22 As qualified from a German tax perspective, e.g., a corporation or private limited company.

23 Controlled foreign company taxation (Hinzurechnungsbesteuerung), see s.7 subs. AStG.

‘One of the major issues with regard to the application of this add‑back taxation is the lack of clarity surrounding under which circumstances individuals shall be regarded as beneficiaries within the meaning of s.15(2) of the AStG …’

significant uncertainties for taxpayers and tax practitioners.24

For family foundations or trusts with management or a legal seat in an EU/EEA Member State, such as Cyprus, Ireland, Liechtenstein or Malta, there is an exception to the add‑back taxation under the EU’s fundamental freedoms. This requires, inter alia, that the settlor and beneficiaries are legally and factually irrevocably and completely deprived of the assets transferred to the trust.25 In other words, it must be demonstrated that it is a non‑transparent foundation/trust in which neither the founder/settlor nor the beneficiaries can exert decisive influence on the foundation’s/trust’s assets or determine its use.

LANDMARK DECISION OF 25 JUNE 2021

In its decision of 25 June 2021,26 the Court had to decide under which circumstances distributions from a trust to a German tax resident would be subject to gift tax. By publishing the decision in the German Federal Tax Gazette, the German tax authorities have decided to apply the decision beyond the individual case, if comparable.

FACTS OF THE CASE

The decision was based on a case in which a US trust made distributions to a beneficiary who was tax resident in Germany. The trust had been irrevocably established by the deceased husband of the beneficiary and it was intended to distribute the trust’s net income on a quarterly basis. The trustees were in charge of the management of the trust’s assets, of which they could freely dispose. Neither the deceased husband nor the beneficiary could affect the trustee’s decisions on the management of the trust’s assets.

From a German tax point of view, the Family Trust (as defined above) qualified as non‑transparent and a trust, so the add‑back

24 German Federal Ministry of Finance, circular of 14 May 2004, IV B 4‑S 1340‑11/04, BStBl. 2004 vol.I, p.3, No.15.2.1. It remains to be seen whether the German Federal Ministry of Finance will change its view on the conditions under which individuals should be regarded as Bezugsberechtigte or Anfallsberechtigte in the revised circular on the AStG, which might be published as a draft in the first half of 2023.

25 s.15 (6) of the AStG. An additional requirement is that the EU/EEA Member State exchanges information with Germany, which is given for all EU Member States and, according to the general view, also for Liechtenstein. See also Vogt, Brandis/Heuermann, annotation to s.15, no.85 of the AStG (March 2022).

26 The Court, decision of 25 June 2021, II R 31/19, BStBl. 2022 vol.II, p.497

taxation applied and the German beneficiary was subject to income tax on the trust’s income, independent of actual distributions. Further, the trust reported the quarterly payments to the beneficiary to the competent German gift tax office as a distribution received by an interim beneficiary, under s.7(1), no.9 of the ErbStG. The tax office assessed gift tax accumulating the quarterly distributions on the basis of the (beneficial) tax class I and an allowance of EUR500,000.

Subsequently, the beneficiary raised an objection against the gift tax assessment, which was rejected by the tax office. The beneficiary based their action against the rejection, in particular, on the inadmissibility of double taxation of the same fact pattern (lebenssachverhalt); that is, income from a trust with income tax (add‑back taxation), as well as gift tax.

THE DECISION

The view of the German tax authorities in this case was that income and gift tax may apply in parallel. This view is highly controversial as it may lead to double taxation and an excessive tax burden on the distributions, which amounted to more than 50 per cent in this case.27

In the first instance to the Court’s decision of 25 June 2021, the Tax Court of Munich (the Lower Court) ruled on 15 May 2019 that the beneficiary should be regarded as an interim beneficiary and, therefore, the distributions to the beneficiary were subject to gift tax.28 The Lower Court argued that every beneficiary who receives distributions from the assets of a trust during its existence should be regarded as an interim beneficiary. Further, it considered double taxation of the same fact pattern with income and gift tax admissible.29

In the decision of 25 July 2021, the Court ruled, by way of derogation from the Lower Court, that the view taken by the Lower Court contradicted the decision of the Court of 3 July 2019.30 According to this, only beneficiaries of a foreign

27 Schienke‑Ohletz/Kühn, Erwerb durch Zwischenberechtigte eines anglo‑amerikanischen Trusts, IStR 2022, 357, p.361

28 s.7(1), no.9, sentence 2, of the ErbStG

29 The Lower Court, decision of 15 May 2019, 4 K 2033/16, EFG 2019, p.1,233

30 The Court, decision of 3 July 2019, II R 6/16, BStBl. 2020 vol.II, p.61

foundation with a legal right in rem or based on obligation to the distribution should be regarded as an interim beneficiary. The Court now expressly clarified that these principles also apply to distributions of a trust, since both trusts and foreign foundations qualify as Vermögensmassen under s.7(1), no.9 of the ErbStG. Moreover, in the Court’s view, there are no reasons for treating trusts differently to foreign foundations. Since, in the opinion of the Court, the Lower Court had not sufficiently assessed whether the beneficiary should be regarded as an interim beneficiary based on the principles of the decision of 3 July 2019, the Lower Court would have to re‑examine this in a second legal process.31

The Court also commented at great length on the duty of the Lower Court to determine under the foreign law applicable to the trust, under which legal conditions a beneficiary of the trust is entitled to a legal right over the assets and/or income of the trust, which cannot be easily withdrawn.

In a scenario where the Lower Court came to the conclusion that the beneficiary should not be regarded as an interim beneficiary and that the distributions of the trust would therefore not be subject to gift tax under s.7(1), no.9 of the ErbStG, the Court indicated that the Lower Court would have to decide whether the distributions constituted a gratuitous transfer inter vivos,32 and should be subject to gift tax. The Court did not comment on this any further, so one can assume that the principles laid down for foreign foundations in the decision of 3 July 2019 will apply, as described above. The facts of the case do not indicate that this provision might be relevant for a decision of the case.

31 Zurückverweisung in den zweiten Rechtsgang 32 According to s.7(1), no.1 of the ErbStG.

In a scenario where the Lower Court came to the conclusion that the beneficiary should be regarded as an interim beneficiary and that the distributions of the trust would therefore be subject to gift tax under the provision of s.7(1), no.9 of the ErbStG in the second legal process, the Court commented on the admissibility of trust distributions being subject to double taxation with income tax as well as gift tax, as follows.

First, the Court pointed out that, contrary to the arguments of the beneficiary, there was no taxation of the same fact pattern in the present case since income taxation under the add‑back taxation rules, in contrast to gift taxation, takes place independently of actual distributions. Further, the Court expressed no doubts on the admissibility of the taxation of the same fact pattern with income and gift tax. Doubts on the admissibility of the taxation of the same fact pattern with income and gift tax expressed by the Court in the past,33 on the other hand, were only due to the legal characteristics of the preliminary proceedings in the case subject to the decision.

Finally, the Court did not explicitly comment on the compatibility of the taxation of distributions from a trust with the free movement of capital under the EU’s Charter of Fundamental Rights. This would need to be decided by the Lower Court in the second legal process.

STRUCTURING IDEAS

Considering the hitherto existing risk of double taxation of a trust’s distributions to German tax‑resident beneficiaries with German income and gift tax, the non‑transparent trust was usually not considered in German estate planning

33 The Court, decision of 21 July 2014, II B 40/14, BFH/NV 2014, 1554, MNr. 15.

‘Doubts on the admissibility of the taxation of the same fact pattern with income and gift tax expressed by the Court in the past … were only due to the legal characteristics of the preliminary proceedings in the case subject to the decision’

(except where settlor and beneficiary are outside of Germany and German‑situs assets were transferred). However, a non‑transparent trust can bring significant tax advantages for German beneficiaries. Transfers of assets to the trust by a non‑German tax‑resident settlor are not subject to German gift tax, except for certain German‑situs assets.34 In addition, such assets will be excluded from the German beneficiary’s estate and German exit tax will not apply in cases where the beneficiary relocates, to name only some advantages. Therefore, a trust may be seen as an alternative to a foreign foundation.

Considering the increased legal certainty after the decision of 25 June 2021 on the gift tax side, the trust and estate practitioner may have additional options. This requires structuring the trust deed in line with the Court’s decision: the German beneficiary can neither have a legal right in rem nor based on obligation, according to German legal understanding, to distributions from the trust, based on the trust deed and the law in the jurisdiction of the trust. This must be carefully planned and reviewed on a case‑by‑case basis. The impact of the law in the trust’s jurisdiction will be especially difficult to assess. In any event, a request for a binding ruling from the responsible German tax office is usually recommended, 35 both to receive legal certainty and to ensure that the trust is considered non‑transparent in Germany.

With regard to the add‑back taxation, which applies to Family Trusts with a German settlor or beneficiary, practitioners are still facing significant legal uncertainties. This is especially due to the vagueness of the terms Bezugsberechtigte and Anfallsberechtigte, expressions that determine for which beneficiaries or remaindermen the rules apply.36 Nevertheless, the following routes could be considered to make use of trusts for German settlors or beneficiaries.

34 In the sense of s.121 of the Valuation Act (Bewertungsgesetz), especially German real estate, partnerships, shares of 10 per cent or more.

35 See s.89(2) of the General Tax Code (Abgabenordnung). The binding ruling has to be requested for a concretely planned future transaction. It is subject to a fee payable to the tax office, which depends on the amount of taxes in question (up to EUR120,721 for taxes in question over EUR30 million).

36 Wassermeyer, Flick/Wassermeyer/Baumhoff/Schönfeld, Commentary to the AStG, s.15, no.15, 102. Ed. May 2022. See also Fuhrmann, Fuhrmann, Commentary to the AStG, s.15, no.55., 3rd edn 2017.

One approach to avoid the application of the add‑back taxation is the statutory exception to the add‑back taxation for trusts with management or their legal seat in an EU/EEA Member State, such as Cyprus, Ireland, Liechtenstein or Malta. See above for the requirements. For an existing trust outside the EU/EEA, the transfer of management (trustee) or legal seat may lead to complex exit tax issues in the previous jurisdiction of the trust and must be carefully planned.

If the add‑back taxation cannot be avoided, transferring the ‘right kind of assets’ to the trust can mitigate its effect. This could, in a best‑case scenario, avoid any attribution of income to the German tax‑resident settlor or beneficiary or at least reduce complexity in German tax compliance. In an existing trust with several beneficiaries, of which the German beneficiaries are only one, a separation of such assets by splitting up the trust may be a solution.

One might also consider transferring assets that do not regularly generate income, as determined under German income determination rules, such as life insurance or zero bonds. In that case, there would not be a regular income attribution to the German beneficiary. Further, it can be argued that the add‑back taxation may not apply to such income, which would not be taxable in Germany under a double‑taxation treaty (DTT), in cases where the beneficiary had generated the income directly (without the trust).37 The commonly cited example for this is non‑German real estate income, which is exempt from German tax under most German DTTs. The tax authorities’ view on this is not clear.

Finally, if the trust holds shares in a corporate entity that is not considered a CFC under the regular German CFC taxation, this entity may block its income from being taxed at the level of the trust and the trust’s beneficiary until it is actually distributed. In a nutshell,

37 The prevailing view in German tax literature, see e.g., Peiner, Die Nutzung des US‑Trust für deutsche Investoren – Wirtschaftliche, rechtliche und steuerliche Überlegungen, RIW 1983, 593, 598; see also Seibold, Die ertragsteuerliche Behandlung von Common Law Trusts, IStR 1993, 545, 550; see also Schienke‑Ohletz, Die Besteuerung von Begünstigten ausländischer Trusts, ISR 2022, 52, 58; see also Vogt, Brandis/Heuermann, Commentary to the AStG, s.15 of the AStG, no.66 161. EL 2022; see also with further references, Fuhrmann, Fuhrman, AStG, s.15, no.27, 3rd edn 2017.

this requires that the corporate entity has no low‑taxed (effectively less than 25 per cent) and passive income.38 The corporate entity could, for example, be engaged in an active business.

CONCLUSION

The Court’s decision of 25 June 2021 increases legal certainty that current distributions from trusts to German tax‑resident beneficiaries will not be subject to German gift tax. This requires that the German beneficiary has neither a legal right in rem nor based on obligation to distributions from the trust.

On the other hand, the Court has also made clear to the disadvantage of the taxpayer that

38 s.8(1) of the AStG provides an exclusive catalogue of active income. Income not mentioned is considered passive, such as interest income, dividends if the shareholding is below 10 per cent, etc.

there are no doubts on the admissibility of double taxation of trust distributions with income and gift tax. This should not only be relevant for distributions during the existence of a trust where a beneficiary has a right to a distribution but also for distributions upon the dissolution of a trust.

The decision of 25 June 2021 should allow trust and estate practitioners to consider additional tax‑structuring options for German beneficiaries. However, the add‑back taxation will limit the investment options of the trust.

JÖRGCHRISTIAN KLETTE AND DANIEL SCHÜTTPELZ ARE DIRECTORS AT EY

ADAPTIVE AND RESPONSIVE

Recent innovations in British Virgin Islands trust and estate law

BY CHRISTOPHER MCKENZIE

ABSTRACT

• The British Virgin Islands (BVI) has made a substantial number of changes to its trust and estate legislation. These reforms were made following detailed recommendations from the Trust and Succession Law Review Committee of STEP British Virgin Islands.1 Five new Acts and one new statutory instrument came into force on 9 July 2021.2

• The BVI Trustee Act (the Trustee Act) has been amended to, among other things:

� include ground breaking provisions relating to variation of trusts;

� give the BVI Court3 jurisdiction to set aside the flawed exercise of a fiduciary power;

� enhance the ‘firewall’ provisions in s.83A of the Trustee Act;4 and

� replace the reserved power provisions in s.86 of the Trustee Act with a more up to date reserved power offering, enabling settlors to reserve certain powers to themselves, or to grant them to others such as protectors, thereby providing them with an additional level of comfort.

1 The Committee is chaired by the author. Its proposals led to all the BVI’s other trust reforms over the last 20 years, including the Virgin Islands Special Trusts Act, 2003 (VISTA) and the jurisdiction’s private trust companies regulations.

2 These are the Trustee (Amendment) Act, 2021, the Probate (Resealing) Act, 2021, the Property (Miscellaneous Provisions) (Amendment) Act, 2021, the Administration of Small Estates (Amendment) Act 2021, the Virgin Islands Special Trusts (Amendment) Act, 2021 and the Financial Services (Exemptions) (Amendment) Regulations, 2021.

3 The BVI’s court system is part of the East Caribbean Court system which recently celebrated its 50th anniversary. The Eastern Caribbean Supreme Court’s specialist commercial court is also located in the BVI. Appeals from the High Court in the BVI are made to the Eastern Caribbean Court of Appeal in St Lucia and the final court of appeal is the Privy Council in London.

4 Aimed at insulating BVI trusts and trustees against ‘forced heirship’ and matrimonial claims.

INNOVATIVE NEW VARIATION OF TRUST PROVISIONS5

BACKGROUND

The British Virgin Islands (BVI) Trustee Act (the Trustee Act)6 has been amended to include some cutting edge reforms in relation to the ability of the BVI Court (the Court) to vary BVI trusts, including the dispositive provisions of such a trust, without the consent of beneficiaries. The appropriate safeguards are, however, included: the new provision will only apply if the settlor or trustees ‘opt in’ to the new statutory provision (whether on establishing a new trust or on changing the governing law of an existing trust to BVI law).

NEW POWER TO VARY

The Trustee (Amendment) Act, 2021 (the 2021 Act) confers upon the Court an additional power to vary BVI trusts. It does this by inserting a new section, s.58B, into the Trustee Act, which applies to two types of trust.7 First, it applies to trusts created after the date upon which the section came into force,8 but only if the trust instrument expressly so provides. Secondly, it applies to trusts created before or after the section came into force that were previously governed by the law of a jurisdiction other than the BVI where an election is made to opt in to the provisions of the section. In circumstances in which s.58B applies

5 For fuller information on the new statutory provisions, see ‘Groundbreaking New Provisions in Variation of BVI Trusts’ in Trusts & Trustees, 28:5 (2022), pp.381–5.

6 The Trustee Act was originally enacted in 1961, but had previously been amended by the Trustee (Amendment) Act, 1993, the Trustee (Amendment) Act, 2003, the Trustee (Amendment) Act, 2013 and the Trustee (Amendment) Act, 2015

7 Under s.58B(1)

8 9 July 2021

to a trust, the court has the power to change the terms of the trust in question, but only if it determines that this would be ‘expedient in the circumstances then existing’.9 Further, s.58B(5) sets out the factors to which the court must have regard when making the relevant determination, including the expectations of the settlor and changes in circumstances. Section 58B(6) sets out who may make an application to the Court under s.58B, with the relevant persons including trustees, beneficiaries and those authorised to make the relevant application under the terms of the trust. Section 58B(7) makes it clear that the Court’s powers are subject to any exclusions or restrictions in the terms of the trust, and s.58B(8) makes it clear that no order may be made that affects interests that have already ‘vested’.

The new s.58B of the Trustee Act makes the establishment of BVI trusts attractive in circumstances in which beneficiaries are, say for tax reasons, unable themselves to consent to any changes to the trust’s terms. It permits the Court to approve variations that would be in (or that would not be detrimental to) their interests. It would also permit variations in circumstances in which beneficiaries with remote interests might otherwise block certain variations that would plainly be in the interests of those who would be regarded as the trust’s principal beneficiaries. Particularly since there is no equivalent to this statutory provision in the laws of any other jurisdiction, s.58B will also mean that changing the governing law of a foreign trust to that of the BVI to take advantage of the new statutory provision might be beneficial in certain circumstances.

COMPREHENSIVE NEW RESERVED POWER LEGISLATION10

When international trusts are established, settlors will inevitably require a certain level of comfort by ensuring that specified critical powers are reserved by themselves or are granted to others such as protectors. The BVI was the first jurisdiction to introduce legislative provisions expressly permitting such reservation or grant of powers and these legislative provisions were

9 As a result of s.58B(4)

10 For more detailed information about the BVI’s new reserved power legislation, please see the author’s article ‘BVI Introduces New Reserved Power Trust Legislation’ in Trusts & Trustees (OUP) Vol 28, No 7, 2022.

contained in (the now substituted version of) s.86 of the Trustee Act, which was inserted into the original Act by the Trustee (Amendment) Act, 1993. Since then, numerous offshore jurisdictions have introduced legislation in relation to reserved powers and, inevitably, given the passage of time, such legislation has tended to be somewhat more comprehensive and a little clearer than that contained in the original s.86.

The new version of s.86 of the Trustee Act, which has been in effect since 9 July 2021 and replaces the earlier version of the section, was drawn up after analysing the laws of other offshore jurisdictions with similar provisions and reflects many of the features of their legislation, omitting those of their ingredients that were regarded as potentially problematic.

The new section is largely based on the equivalent laws of other offshore jurisdictions along with additional changes intended to enhance its operation. It makes it clear that the reservation by the settlor to himself or herself (or the grant to any other person) of specified powers will not invalidate the trust or cause the trust property to be part of the estate of the settlor on death. The section applies to trusts whenever created.

ENHANCED FIREWALL PROVISIONS11 BACKGROUND

When s.83A of the Trustee Act came into effect in March 2004, the BVI was regarded as having extremely robust ‘firewall’ provisions; however, since then, a few desirable changes had been made to some of the equivalent provisions in other offshore jurisdictions’ laws in this context. These firewall provisions are aimed at protecting BVI trusts and their trustees against forced-heirship and matrimonial claims.

TECHNICAL FINE‑TUNING

The technical amendments that have been made to s.83A, which were formulated with the assistance of Professor Jonathan Harris KC TEP,12 are aimed at improving the territory’s firewall offering,

11 For a more detailed analysis of the BVI’s new firewall legislation, please see ‘BVI Strengthens Firewall Provisions in Trustee Act’ in Trusts & Trustees, 28:7 (2022)

12 Now co editor of both Dicey, Morris & Collins on the Conflict of Laws (15th edition) and Underhill and Hayton Law of Trusts and Trustees (20th edition). Professor Harris assisted with the formulation of the original provisions of s.83A.

which is considered critical in the context of the establishment of international trusts.

It is anticipated that the BVI’s enhanced firewall provisions will be found to be especially attractive to those who have concerns that family members would otherwise be able to make claims against trusts (on a divorce or following death) that are based on ‘personal relationships’ or ‘heirship rights’; these reforms should further assist in insulating BVI trusts against such claims.

AMENDMENTS TO s.83A

Some additional definitions have been inserted into s.83A(1) so that words and expressions that are referred to in subsequent amendments to the section are appropriately defined. The 2021 Act also replaces the definition of ‘personal relationship’ with a more up to date definition so that the expression now extends to those related via step relationships and children born by artificial fertilisation and surrogacy (and so that it also includes relationships to beneficiaries). Section 83A(12) has been replaced by a new subsection largely based on the earlier subsection, but makes it clear that all questions arising in regard to a trust are to be determined in accordance with the laws of the territory, and that the capacity, powers, rights and obligations of all relevant persons, and not merely those of the trustee, will be determined by the governing law of the trust. Further, s.83A(13) has been amended to make this provision more watertight so that it:

• extends to the protection of ‘claims and interests’;

• subjects the capacity of trustees, beneficiaries, protectors, enforcers and others to BVI law; and

• covers rights conferred by ‘personal relationships’ to beneficiaries as well as those to settlors.

Section 83A(16) has been amended so that it also covers relationships to beneficiaries as well as those to settlors and s.83A(19) has been revised so that it covers foreign declaratory orders purporting to vary BVI trusts.

RE‑INTRODUCTION OF THE ‘OLD RULE IN HASTINGS‑BASS’

A new section, s.59A, has been added to the Trustee Act to give the Court jurisdiction to set aside the

flawed exercise of a fiduciary power, thereby giving statutory effect to what is colloquially known as the ‘old rule in Hastings Bass’.

Such an amendment is in line with recent changes to the laws of some other international financial centres, but unlike the view that appears to have been taken elsewhere, it was considered inadvisable to make any changes to the Court’s jurisdiction under the doctrine of mistake on the basis that this was felt to be appropriate.

BACKGROUND: THE PITT AND FUTTER CASES

The background to these reforms in the BVI and elsewhere is essentially that, as a result of the UK Supreme Court’s (the UK Court’s) decisions in Pitt v Holt and Futter v Futter, 13 it was no longer possible for a trustee to make an application to the court (in a jurisdiction in which the relevant principles of English and Welsh law apply)14 to set aside the exercise by it of a power in circumstances in which the trustee had relied on professional advice that later proved to be incorrect. Prior to that, trustees found it helpful to be able to make an application to set aside the exercise by it of a

13 [2013] UKSC 26 14 Instances of ‘English and Welsh’ are abbreviated to ‘English’ for the remainder of this article.

‘It is anticipated that the BVI’s enhanced firewall offering will be found to be especially attractive to those who have concerns that family members would otherwise be able to make claims against trusts (on a divorce or following death) that are based on “personal relationships” or “heirship rights” …’

discretionary power in circumstances in which they were relying on advice, such as tax advice, that later proved to be incorrect. Following the Pitt and Futter decisions, it had only been possible for such an application to succeed if the trustee had acted in breach of fiduciary duty or breach of trust and that would seldom be the case if professional advice had been taken and where care had been taken in the selection of the advisor; the trustee will not be in breach of trust or duty simply as a consequence of the professional advice subsequently proving to be incorrect.

NEW s.59A OF THE TRUSTEE ACT

Section 59A of the Trustee Act has therefore reinstated matters so that the position which was generally considered to apply before the UK Court decisions now, for the most part, applies once more in the BVI. There is now certainty, whereas even prior to the Pitt and Futter decisions, the previous ambit of the ‘old rule in Hastings-Bass’ was by no means certain.

The new section provides that, if it is satisfied that specified conditions are met, the Court may, in whole or in part, and unconditionally or on such terms and subject to such conditions as the Court thinks fit, set aside the exercise of a power. The relevant conditions are:

• that, in the exercise of the power, the person who holds the power did not take into account one or more considerations of fact, law or both that were relevant to its exercise (or took into account one or more considerations that were irrelevant to its exercise); and

• but for that person’s failure to take into account one or more such relevant considerations (or as a result of their having taken into account one or more such irrelevant considerations), the person who held the power would not have exercised it at all or would have exercised it at a different time or in a different manner.

If and to the extent that the Court sets aside the exercise of the power under s.59A, its exercise is treated as never having occurred. Section 59A(4) makes it clear that no allegation of breach of trust or duty on anyone’s part need be made or substantiated.

Section 59A(5) identifies who may make an application to set aside the exercise of the power.

Such persons include the power holder, the trustee, a beneficiary (or a discretionary object of a trust or power conferred by the trust), the Attorney General (in the case of charitable trusts), the enforcer (in the case of non charitable purpose trusts) and anyone granted leave to apply by the court.

Section 59A(10) makes it clear that the new section does not limit the Court’s jurisdiction under doctrine of mistake. In Pitt and Futter, the UK Court made it clear that there must be a causative mistake of fact or law that is integral to the very nature of the transaction and that has grave ramifications, in order for the transaction to be set aside under that doctrine. The Court must evaluate the facts, looking for the most basic type of mistake, one in which it would be unconscionable for the Court not to intervene.

CERTAINTY AND VALUABLE TOOL FOR TRUSTEES NOW PROVIDED

The new s.59A of the Trustee Act provides much needed certainty and is expected to be of considerable potential use for trustees, beneficiaries and professional advisors who now have the comfort of knowing that if a power is exercised that turns out to have adverse consequences an application may be made to the Court to set it aside. Such a remedy is generally considered preferable to beneficiaries having to rely upon claims for breach of trust or fiduciary duty against trustees or on claims of negligence against advisors: such claims can be time consuming and expensive.

Trustees’ and power holders’ errors are now capable of being rectified simply and cost effectively without the risk that the trustee relationship be forever damaged.

EXTENDED EXEMPTION FROM FILING REQUIREMENTS

The Trustee (Amendment) Act, 1993 exempted most BVI trust deeds and supplementary trust deeds from registration under the provisions of the Registration and Records Act, but it had never been entirely clear whether this exemption only applied when the relevant trust was governed by BVI law. This issue was of relevance because the deeds in question are occasionally retained in

the BVI15 when the relevant trusts are not actually governed by BVI law (e.g., where there are BVI companies involved in the relevant structures). The exemption has now been expressly extended to foreign trusts (to the extent that these were not already covered).

NEW RECORD‑KEEPING REQUIREMENTS

The Trustee (Amendment) Act, 2015 inserted a new s.2A into the Trustee Act requiring trustees to maintain underlying documentation in the BVI relating to trusts for at least five years. A number of concerns had been raised about the precise ambit of that section and so s.2A has now been repealed and a comprehensive new s.92A has taken its place, making it clear what records must be kept in the BVI and by whom. The sanction for non compliance is a fine of up to USD5,000 or a term of imprisonment of up to six months.

The relevant record keeping obligations are imposed on the trustees of trusts (other than implied, constructive and bare trusts), regardless of whether the trusts are governed by BVI law, if such trustees are BVI companies or are individuals that are resident in the BVI (or satisfy other criteria such as administering trusts in or from within the BVI).

AMENDMENTS TO ‘DEALINGS WITH THIRD PARTIES’ PROVISIONS

With the objective of making BVI trusts significantly more attractive in the commercial context, a new Part X was added to the Trustee Act by the Trustee (Amendment) Act, 2003, which came into force on 1 March 2004. The provisions in question are unique, but were based on proposals that had been made by the highly regarded English Trust Law Committee, albeit with a number of modifications, and can make BVI trusts beneficial in the commercial context. They do this by addressing problems arising from the limitations on the right of subrogation as a matter of English trust law (and pursuant to the laws of those other jurisdictions in which the relevant principles of English law apply).

15 As deeds evidencing ‘specialty debts’, the situs of which, pursuant to the English common law principles of private international law, is the place where the deeds are retained.

As a result of ss.95 and 96 of the Trustee Act, which came into force in March 2004, banks and other third parties dealing with trustees have been able to have recourse to the trust fund (and other protection) where, when entering into transactions, they have made reasonable enquiry that the trustee has the express power to enter into such transactions and has complied with any express requirements (such as requirements for consent) contained in the trust instrument. However, because of a drafting oversight, s.95 of the Trustee Act omitted to specify that its protection would not apply if the third party had acted dishonestly when entering into the relevant transaction. This error has now been corrected.

Additional flexibility has also now been provided in that trustees of trusts created before March 2004 are now capable of taking advantage of the BVI’s statutory provisions facilitating dealings with third parties if they elect to do so. In making such an election, they will naturally be constrained by their fiduciary duties and will not be able to exercise such a power if such exercise were detrimental to the interests of the trust’s beneficiaries.

STATUTORY PROVISIONS RELATING TO THE RETIREMENT OF TRUSTEES

Part IV of the Trustee Act, the territory’s statutory regime relating to the replacement of trustees, was overhauled in 1993 to remove outdated requirements based on the England and Wales Trustee Act 1925 to the effect that there had to be two individuals or a trust corporation in office in order to give a valid discharge to an outgoing trustee. These reforms made it a lot easier for licensed BVI trustees to act as sole trustees of BVI trusts and, although by no means all, the vast majority of BVI trusts have as their trustees a licensed BVI trust company acting as their sole trustee.

An argument had however been raised to the effect that s.40 of the Trustee Act (which provides for the retirement of a trustee without a new appointment) only applied if more than one co trustee remained in office following the retirement of one of the trustees in circumstances in which it was not being replaced. Although it was thought this argument would probably not have succeeded, s.40 has been amended to

make it absolutely clear that there need only be one continuing trustee in office following the co trustee’s retirement.

NEW PROBATE (RESEALING) ACT BACKGROUND

The BVI’s earlier Probates (Resealing) Act (the Original Resealing Act), enacted in the 1930s, permitted a simplified procedure to be followed in circumstances in which grants of probate or letters of administration had been issued by the courts of certain other jurisdictions, i.e., by enabling such grants to be resealed by the Court so that the resealed grant has the same effect as if it had been granted by the Court itself.

The simplified procedure itself is set out in the BVI’s Eastern Caribbean Supreme Court (Non Contentious Probate and Administration of Estates) Rules 2017 (the Rules), which were made pursuant to both s.7 of the Resealing Act and s.17 of the UK Supreme Court Order 1967. The Rules provide, among other things, that significantly fewer documents than would be needed for the purposes of a fresh application for a grant of representation need to be filed with the Court and that only one newspaper advertisement need be taken out, thereby expediting the process.

The Resealing Act only applied to grants issued by courts of probate in ‘His Majesty’s dominions’. The term ‘His Majesty’s dominions’ was defined by the Original Resealing Act to include ‘any British protectorate or protected state and any territory in respect of which a mandate or trusteeship is being exercised by His Majesty’s Government in the United Kingdom or the Government of any part of His Majesty’s dominions’. The word ‘dominions’ was additionally defined by s.2 of the BVI Interpretation Act (as amended by the

Interpretation (Amendment) Act, 2014) to include ‘all territories that belong to the Crown or are in the ownership of the Crown including Canada, Australia and New Zealand’.16

The comprehensive new Probates (Resealing) Act, 2021 (the New Resealing Act) has now been enacted. This reform has been made since the provisions of the latter were quite limited and did not enable grants issued from the many other English common law jurisdictions that were not regarded as ‘belonging to the Crown’ to be resealed in the BVI. For instance, it was not previously possible to reseal in the BVI grants that had been issued by the authorities in India, Singapore, South Africa or, unless the grant was issued prior to 1 July 1997, Hong Kong. Nor, until the new reforms took effect, was it possible to reseal Crown Dependencies or US grants in the BVI.

REVIEW BY STEP BVI’S TRUST AND SUCCESSION LAW REVIEW COMMITTEE

The Trust and Succession Law Review Committee of STEP BVI considered the prevailing legislation in a number of jurisdictions and, in particular, that in the UK and those common law jurisdictions with which the BVI competes for the provision of financial services.

After careful consideration, the view (which is reflected in the amended legislation) was taken that the ability to reseal grants should be generally extended to jurisdictions to which the UK Colonial Probates Act 1892 applies and that there should be no requirement in the new BVI statute (equivalent to that in the UK statute) to the effect that reciprocity be required.

16 As a result of s.3(1)(a) of the Interpretation (Amendment) Act, 2014 this definition applies to the use of this term in statutes that came into effect before or after the relevant provisions of the Interpretation (Amendment) Act, 2014 came into effect.

‘The Trust and Succession Law Review Committee of STEP BVI considered the prevailing legislation in a number of jurisdictions and, in particular, that in the UK and those common law jurisdictions with which the BVI competes for the provision of financial services’

Additionally, grants issued by the Crown Dependencies, India and all the states of the US are now capable of being resealed in the territory. Significantly, given the number of BVI companies that have shareholders resident in Hong Kong, Hong Kong grants will now be capable of being resealed in the BVI regardless of when they were issued.

In general, the New Resealing Act, which came into force on 9 July 2021, permits grants issued from the authorities of 67 jurisdictions listed in the New Resealing Act to be resealed in the BVI.17,18

CONCLUSION RE‑RESEALING

Now that the New Resealing Act has come into force, shareholders of BVI companies can take comfort from the fact that a simplified procedure may well apply to the transfer of their shares to their heirs when they pass away.19

REFORMS TO THE BVI’S PRIVATE TRUST COMPANY OFFERING

The Financial Services (Exemptions) Regulations, 2007 (as amended) (the 2007 Regulations) enable unlicensed private trust companies (PTCs) to be established in the BVI if the company satisfies a number of conditions that do not tend to be too onerous to comply with.

PTCs enjoy the benefit of limited liability and perpetual existence, which are usually the features of corporate vehicles and have the following further advantages:

• The principal advantage of a PTC is that, like

17 A full list of recognised jurisdictions can be found in the schedule to the New Resealing Act. The relevant BVI government minister has also been given the power to add and remove jurisdictions from the list.

18 In the BVI, whenever consideration is given to the question of resealing a grant issued by a jurisdiction in which the testator was not actually domiciled at the time of their death, the provisions of rule 30(7) of the Rules may need to be considered.

19 It is, nevertheless, always recommended that shareholders of BVI companies should consider the establishment of a trust. If properly structured, the establishment of a lifetime BVI trust should avoid the need to apply for a grant of representation altogether and tends to make matters much smoother, avoiding unnecessary costs, delays and the public filings that an application for probate or letters of administration involves. Shareholders might be wise, in particular, to consider the establishment of a VISTA trust, since the BVI’s Virgin Islands Special Trusts Act, 2003 creates a bespoke and highly popular trust regime that enables such companies to continue to be run by the settlor (or those selected by the settlor) as directors, free from inappropriate interference by the trustee shareholder, while at the same time avoiding the need to apply for a grant when the settlor passes away. In the event that a shareholder does not wish to set up a trust, consideration should be given to the preparation of a will and, if relevant, making use of the ‘reserve director’ provisions in the BVI Business Companies Act, 2004, which reduce the complications and expenses that can arise when a person who is both the sole director and the sole shareholder of a BVI company dies.

trusts to which the BVI Virgin Islands Special Trusts Act, 2003 applies,20 the establishment of a PTC generally enables settlors or settlors’ family members or their appointees to exercise a significant degree of control over trustees’ decisions by being directors of PTCs; this enables them to respond quickly to issues that arise and to make decisions on the basis of their own personal knowledge and changing circumstances.

• The corporate structure is readily understood by non professionals, especially those from non trust jurisdictions and can be easily integrated into a family office or commercial structure.

• Confidentiality is preserved and this is an issue of increasing importance to those from jurisdictions where concerns over financial privacy are driven by issues of personal safety.

• A PTC enables the trustee’s charges to be kept in check.

• PTCs are often set up in circumstances in which the underlying assets of a trust are to comprise speculative investments or investments that involve a degree of risk, which might be regarded as unacceptable to the risk averse professional trustee.

CONDITIONS WITH WHICH A BVI PTC HAD TO COMPLY BEFORE THE RECENT REFORMS

The conditions with which a BVI PTC must comply were, until the recent amendments to the 2007 Regulations, essentially, as follows:

• The company must be a BVI company (whether or not it was first incorporated in the BVI, so that companies that have been ‘continued’ in the BVI now also qualify). This would naturally mean, among other things, that the general requirements of the corporate and regulatory laws of the BVI must be satisfied.

• The company’s memorandum must state that it is a PTC.

• The company must be a limited company and its name must include the designation ‘(PTC)’ before its permitted ending.

• The company’s registered agent must hold a

20 Known as ‘VISTA trusts’.

Class I trust licence under the BVI Banks and Trust Companies Act, 1990

• The company must not solicit trust business from members of the public.

• The company must carry on no business other than that of being the trustee, protector or administrator of trusts (or managing or administering trusts). 21

• All the company’s trust business must be ‘unremunerated trust business’ and/or ‘related trust business’. These two ‘heads’ of the exemption are explained below.

UNREMUNERATED TRUST BUSINESS

Although the term ‘unremunerated trust business’ was defined widely to prevent potential abuse, in most cases, a company would have been regarded as carrying on as such business where no remuneration was paid to the company (or anyone associated with it) in respect of the provision by the company of its trustee services. However, it has always been permissible for payments to the company to cover its legitimate expenses (such as the government’s incorporation and renewal fees, the fees of otherwise unconnected professional advisors and the fees of the registered agent) since this will never, in general, be regarded as remuneration for these purposes. Additionally, the 2007 Regulations provided that ‘professional directors’, who were not otherwise associated with the company, could be remunerated.

RELATED TRUST BUSINESS

A company will, on the other hand, be regarded as carrying on ‘related trust business’ where all the beneficiaries of the trust/s of which it is trustee are related (in the manner specified in para.3 of the 2007 Regulations) to its settlor.22 However, the trust’s beneficiaries may also include the settlor/s of the trust/s and/or charities.

BVI PTCs tend to be used for the following reasons:

• Provided all the conditions specified above have been satisfied, no licence is needed and a BVI company can be incorporated very quickly.

21 This condition has been repealed: see below.

22 In the case of multiple trusts, the trusts must either have the same settlor or else the settlors of all trusts of which the company is trustee must be related in the prescribed manner to each other.

• It is not necessary to have a local director or authorised representative (or indeed a director with relevant qualifications or experience).

• There are no capitalisation requirements for exempt PTCs.

• The company need not establish a physical presence in the BVI.

• The costs of setting up and running the company tend to be affordable.23

• There is no need to list particular trusts in the company’s memorandum.

• Only the PTC’s memorandum and articles of association, which are likely in most cases to be fairly standard documents revealing little more than the name of the company and the identity of its registered agent, will be filed publicly and (except in cases of abuse) there is no need to supply the regulatory authorities with copies of the trust documentation or to disclose the identity of the settlor or beneficiaries of the trust; the company’s registered agent must instead be provided with copies of the relevant documents.

REVIEW OF THE 2007 REGULATIONS

A review of the practical issues that had come to light since the 2007 Regulations originally came

23 The Government’s fee will in most cases only be an additional USD$800 (i.e., a total of USD1,250 including the Government’s incorporation/renewal fee) on incorporation and annually thereafter.

‘The 2021 Regulations amended the 2007 Regulations so that it is no longer a requirement that a director of an otherwise unremunerated PTC cannot receive remuneration as a condition for eligibility for the unremunerated trust business head of the exemption’

into force 15 years ago was undertaken with a view to identifying issues where improvements were desirable and, as a result, the 2007 Regulations have now been amended to address two issues of potential uncertainty.

ABOLITION OF THE REQUIREMENT THAT A PTC CAN ONLY CARRY ON ‘TRUST BUSINESS’

As indicated above,24 prior to recent amendments, the 2007 Regulations provided that a PTC was prohibited from carrying on any business that was not trust business. It was considered that this restriction created an element of uncertainty in relation to what a PTC could and could not do. Although many took the view that a PTC would not, as a consequence, be prohibited from undertaking activities that are ancillary to acting as trustee, this was not explicitly stated in the 2007 Regulations, giving rise to potential uncertainty. The restriction has therefore been repealed in its entirety by the Financial Services (Exemptions) (Amendment) Regulations, 2021 (the 2021 Regulations), so that it is now quite clear that a PTC can undertake ancillary activities such as opening bank accounts (on its own account), purchasing trust property and acting as enforcer of a non charitable purpose trust and as a council member of a civil law foundation. However, it should be stressed that it does not follow from the removal of this prohibition that a BVI PTC will be able to carry out other regulated activities for which other forms of licence are needed or, indeed, any activities that are otherwise illegal.

DIRECTORS’ REMUNERATION

As indicated in the above summary of the conditions that a PTC had to satisfy in order to qualify for the unremunerated trust business head of the exemption, it was a requirement for eligibility under that head of the exemption (but not under the related trust business head of the exemption) that not only must the PTC itself receive no remuneration in return for the provision by it of trustee services but also that its directors must also be unremunerated, unless they were acting in a professional capacity. The term ‘professional’ was not defined, giving rise to further

24 Under the heading, ‘Conditions with which a BVI PTC had to comply before the recent reforms’.

uncertainty, and possibly an element of circularity to the extent that the view was taken that the test of whether a director would be regarded as acting in a professional capacity was if a charge for the relevant services was made.

The 2021 Regulations amended the 2007 Regulations so that it is no longer a requirement that a director of an otherwise unremunerated PTC cannot receive remuneration as a condition for eligibility for the unremunerated trust business head of the exemption. It does not, however, follow from this reform that directors who are regarded as being ‘associated’ with the PTC (within the meaning of the 2007 Regulations), such as those with a legal or beneficial interest in its shares or employees, will be able to receive direct or indirect remuneration without jeopardising the PTC’s eligibility under the unremunerated trust business head of the exemption.

OTHER REFORMS TO BVI LAW

In addition to the above reforms, two new statutes, the Property (Miscellaneous Provisions) (Amendment) Act, 2021 (the Miscellaneous Provisions Amendment Act) and the Administration of Small Estates (Amendment) Act, 2021 (the Small Estates Amendment Act) have been enacted. These two statutes modernise BVI law in the trusts and estates arena.

THE PROPERTY ACT

The Miscellaneous Provisions Amendment Act, consistently with the spirit of the BVI Status of Children Act, 2014, abolishes (to the extent that it actually still exists) an ancient English rule of public policy that created impediments where dispositions in favour of those born out of wedlock were intended. The archaic English rule was one to the effect that provisions in trust instruments and wills that expressly provide for relatives born out of wedlock are void as being contrary to public policy.

THE ADMINISTRATION ACT

The Small Estates Amendment Act implements a long overdue increase in the qualifying value for the Administration of Small Estates Act. The latter sets out in it a very simple procedure for applying

for a grant of probate or letters of administration in the BVI where the value of the estate is low. The threshold set out in the statute, which had not been amended since it came into force in colonial times, has been increased from USD240 to USD25,000, but, in the case of applications for letters of administration rather than those for probate, the statute will only now be applicable if the deceased died domiciled in the BVI. This should provide an incentive for non BVI domiciliaries to prepare wills.

These reforms, taken together, demonstrate that the BVI is in the forefront of those jurisdictions that keep their laws under constant review to ensure that the needs of their clients are met.

CHRISTOPHER MCKENZIE TEP IS A PARTNER AT O’NEAL WEBSTER, UK

THE FAMILY COURT PRACTICE 2022

ISBN: 978-1784734909 PRICE: GBP670 PUBLISHER: Jordan Publishing

EDITED BY THE RT HON LADY BLACK OF DERWENT ET AL

REVIEWED BY MIRANDA ALLARDICE

The Family Court Practice 2022 (Red Book) is designed to offer authoritative guidance to those who undertake work in the England and Wales Family Court (the Court), including the whole range of ‘family business’ conducted there. It also covers the retained jurisdiction of the Family Division of the High Court; for example, in relation to the Inheritance (Provision for Family and Dependants) Act 1975 (the 1975 Act).

It is important that both private client lawyers and contentious succession practitioners know where to find and how to navigate this useful volume. This brief review will illustrate the breadth of its remit and value as the first port of call for a synopsis of the relevant law. At the commencement of this 30th edition, the chronology sets out important statutes, case law and the major societal changes that affect the modern‑day family unit.

THE STRUCTURE OF THE BOOK

This is a practitioner’s book and so begins with a series of procedural guides, designed for its core

audience. Thereafter, in alphabetical order, it takes the relevant statute and provides a short commentary on each section of the legislation. If litigation is on the horizon, then the guides on procedure provide helpful tables detailing the steps to be taken.

DIVORCE, DISSOLUTION AND SEPARATION ACT 2020

The Red Book incorporates the changes in the divorce legislation with effect from 6 April 2022, as a result of the Divorce, Dissolution and Separation Act 2020. This radical piece of legislation removes all fault‑based concepts in proceedings for divorce or dissolution of civil partnerships in England and Wales. The amendments are incorporated into the Matrimonial Causes Act 1973 (the 1973 Act) and the Civil Partnership Act 2004. There is now only one ground, which is the irretrievable breakdown of the marriage or civil partnership. In the event of this being established, there will now be a conditional order (replacing the old decree nisi) and a final order equating to the old decree absolute.

REVIEW OF THE PRINCIPLES UNDER THE 1973 ACT

Where there is a spouse or civil partner and a will is being drafted or there is a review of succession after death, it will be important to have an overview of the principles that would have been applied upon a lifetime application for a financial remedy order on the dissolution of a marriage under the 1973 Act. This is because of the divorce cross‑check under s.3(2) of the 1975 Act, whereby the court will have regard to the provision that would have been made had the marriage been terminated by divorce, as opposed to by reason of death.

The relevant considerations under the 1973 Act are addressed in the Red Book in the notes to s.25 of the 1973 Act. The three central principles are sharing of matrimonial assets, financial needs and compensation.

These principles and their application in achieving a fair and non‑discriminatory outcome have been developed through extensive case law, and the Red Book contains a valuable round‑up of the relevant cases. The principles are clearly set out and a summary given of the leading cases. This section provides the ideal amount of detail for identification of the relevant law and directs the reader as to whether they need to do further research.

Where at the inception of the marriage the assets owned by one party to the marriage are substantial, there may be a prenuptial agreement in existence. There is a synopsis of the recognition of personal autonomy post‑Radmacher, 1 but this is tempered by the Court’s supervisory role. This is an area of increasing crossover where the prenuptial agreement seeks to cover the position on death as well as divorce.

Another important area for the private client lawyer relates to the interplay between a divorcing spouse and the existence of trusts on either side. The trustees may find themselves embroiled in matrimonial litigation under the 1973 Act, on the premise that the trust is a financial resource under s.25(2)(a) of said Act. Guidance as to the procedural aspects of involvement is to be found in the notes to the Family Proceedings Rules 2010. 2

There is a comprehensive section on the Trusts of Land and Appointment of Trustees Act 1996 (the 1996 Act). Although the 1973 Act provides an exclusive code for the property spouses, there may be third parties whose property rights have to be determined as a preliminary issue prior to the financial remedy proceedings under the 1973 Act between the spouses being undertaken. The position of any cohabitee falls to be dealt with under the 1996 Act and the piecemeal case law. In October 2022, the UK government rejected recommendations of the Women and Equalities House of Commons Committee’s report The Rights of Cohabiting Partners. Therefore, this section of the Red Book will continue to be necessary for many years to come.

THE 1975 ACT

The notes in relation to the 1975 Act are relatively extensive and a useful resource. There is detailed guidance as to the necessary characteristics of each class of applicant. This is particularly helpful in the vexed area of ‘when is a marriage not a marriage?’. It covers the qualification of a marriage as a void marriage that engages the jurisdiction of the court under s.25(4) of the 1975 Act. This contrasts with a non‑qualifying ceremony. This section contains a review of all the recent cases relating to non‑marriages and customary marriages.

The Red Book is particularly helpful in outlining difficulties as to qualification as a child of the deceased. There may be an issue as to paternity and the same is determined by scientific tests in the Court. Recent cases have determined

‘The notes in relation to the 1975 Act are relatively extensive and a useful resource. There is detailed guidance as to the necessary characteristics of each class of applicant.’

that post‑death, pre‑existing DNA samples can be tested.3 Another area giving rise to some complexity relates to assisted reproduction and this is addressed in detail in the very comprehensive notes on the Human Fertilisation and Embryology Act 2008.

There is a substantial section on reasonable financial provision. This covers both the provision for the surviving spouse and for the maintenance class of applicants. There is much case law to cover under both headings. The layout of these passages could be made more digestible by

adding some headings to help the reader navigate through the dense case law. However, in terms of substance the review of the recent 1975 Act cases is comprehensive and provides a valuable starting point for further reading.

The family and private client department share their differing expertise and resources. The private client lawyer should enjoy ready access to the Red Book.

MIRANDA ALLARDICE IS A BARRISTER AND SUCCESSION MEDIATOR AT 5 STONE BUILDINGS

See Anderson v Spencer [2018] EWCA Civ

TRUST QUARTERLY REVIEW

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