The rule in Hastings Bass after Futter and Pitt

The rule in Hastings Bass ("the Rule") sometimes enables trustees to escape the consequences of a mistake. The extent to which trustees can rely on this rule were considered recently in the cases of Futter and Cutbill v Futter and HMRC (2010) EWHC 449 (“Futter”) and Pitt v Holt (2010) EWHC 45 (“Pitt”).

The facts of the cases are not particularly unusual.

Mr Futter had set up two settlements from which he was entitled to the income for life. The settlements contained “stockpiled gains” for Capital Gains Tax purposes and, in order to tackle this problem, the Trustees made various distributions to beneficiaries under the belief that the gains could be offset by the beneficiaries’ personal allowable losses.

However, in doing so, the Trustees overlooked section 2(4) of the Taxation of Chargeable Gains Act 1992 which, in the circumstances, meant that the personal losses could not off set the gains.

Mr Pitt had sustained serious head injuries in a road accident. Mrs Pitt was appointed as her husband’s receiver and put his compensation into a settlement without considering the inheritance tax consequences.

The rule in Hastings Bass

The trustees and the receiver in Futter and Pitt respectively sought to escape the consequences of their mistake by relying on the Hastings Bass Rule.

In the case of Sieff v Fox (2005) 1 WLR 3811 the Rule was stated as follows:

“ Where trustees act  under a discretion given to them by the terms of the trust, in circumstances in which they are free to decide whether or not to exercise that discretion, but the effect of the exercise is different from that which they intended, the court will interfere with their action if it is clear that they would not have acted as they did had they not failed to take into account considerations which they ought to have taken into account, or taken into account considerations which they ought not to have taken into account”.

The role of HMRC

Historically, the Rule has frequently been used to try and set aside decisions that result in increased tax being paid. Notwithstanding this, HMRC has not sought to be involved in such applications despite being notified of them.

However, following comments made by Lord Justice Lloyd in Sieff v Fox HMRC put forward arguments against the Rule in both Futter and Pitt.

What arguments did HMRC advance?

The key argument advanced was that the Rule and the law of mistake should develop together and as a consequence the Rule should not apply where the error related to the consequence of the transaction rather than to the effect of the transaction.

This distinction is important because if the court agreed with HMRC it would have limited the scope of the operation of the Rule in respect of taxation errors as taxation is a consequence of a transaction.

At first instance the court rejected this argument and found that the Rule had its origins not in mistake but in the law of powers.

Consequently, the court has authority to set aside an instrument if a trustee has failed to take into account all relevant factors or has taken into account irrelevant considerations. Tax will nearly always be a relevant consideration and the Rule will therefore apply where tax is not considered or incorrectly considered.

Another matter raised by HMRC was that the Rule should not be used to permit professional advisors to escape the consequences of bad advice – in both Futter and Pitt the person seeking to rely on the Rule had received professional advice. This argument did not succeed.

The court’s decision

In both cases the court found in favour of the applicant. In the case of Pitt the court found that the Rule could also apply to receivers acting for those unable to manage their own affairs.

As a consequence the court found that the actions of the trustees in Futter and the receiver in Pitt were void.

The future

HMRC have been given leave to appeal in both case and if they adopt similar arguments on appeal the Court of Appeal will have to consider, amongst other issues, the following:

• Whether the Rule has been extended to far by the Courts
• Should the scope of the Rule be limited to Trustees?
• Should there be a distinction between cases where the decision maker has received incorrect advice and when no consideration at all was given to the effect of the transaction?
• Does the successful application of the Rule make the decision void or voidable.

Whatever the outcome, if HMRC continues its recent interventionist approach, it should make for interesting times ahead for trustees and their advisors.