Why it is unwise for a Protector to mediate between beneficiaries

There is no statutory definition of the role of a trust Protector [‘P’]. What P’s role is called is much less important than the powers the trust deed confers on the Protector. P can be given the right to settle disputes between the trustee and the beneficiaries. Therefore, P can e.g. mediate between two different classes of beneficiaries such as income and residuary beneficiaries in the event of a dispute or disagreement. P can also be set up as the ‘decision-maker’ rather than a mediator. 

The HMRC internal Trusts Settlements and Estates Manual states – TSEM10050 – Non-resident trusts: residence rules: professional trustees not resident in the UK – introduction and background states, ‘The rules that came into force on 6 April 2007 treat the trustees of a settlement as a single person, as distinct from the persons who may be trustees from time to time. The residence status of that single person (referred to below as the “body of trustees”) at any given time is determined in the first instance by the residence status of the persons who are trustees at that time:
·        If all the trustees are either resident in the UK or not resident in the UK, the residence status of the body of trustees follows that outcome.
·        If at any time at least one trustee is resident in the UK and at least one is not, the body of trustees is resident in the UK only if any settlor of the trust was resident, ordinarily resident or domiciled in the UK at any time when he or she introduced property into the trust.’

Therefore, could an offshore trust be treated as being resident in the UK for both income tax and CGT, where by virtue of the powers conferred on P under the terms of the trust, P is a ‘de facto’ trustee, and is resident in the UK, i.e. because P is a decision maker?

What concerns me, is whether a judge may one day conclude that where P behaves like a mediator, that even though mediators do not make decisions for parties in dispute, that by becoming actively involved in the dispute resolution process, P has stepped out of his conventional role as a Protector, and stepped into a role which has as its objective the making of a decision about the administration of the trust. In which case depending upon what P says and does, the boundary between P being either a decision maker or a mediator is blurred.

As Lewin on Trusts states in paragraphs 28-045 & 28-047 “A protector … is typically the holder of a group of powers or requirements of consent. The word is not a term of art … If the protector holds an office under the trust, it will ordinarily be impossible to construe the power or powers as beneficial: the protector will be there for the protection of the beneficiaries and his powers will be fiduciary. … The scope of the protector’s functions depends on the provisions, express and implied, of the trust instrument.”

While protection may involve advising mediation, it does not require a protector to be a mediator, and in sharp contrast to a mediator, P owes fiduciary duties toward beneficiaries in dispute who participate in mediation.

As far as I am aware, few trust administration professionals, i.e. TEP’s, have trained and become accredited as mediators. I have, and think there is a risk that if P is not a trained and accredited mediator, that he/she is not likely to know what they are doing. In which case if the court finds that P has crossed the line and become a decision maker (i.e. by in effect imposing a decision on the beneficiaries and/or trustees), then HMRC can conclude that the trust is UK resident i.e. if P is resident in the UK and the other connecting factors exist, because P has behaved as a de facto trustee. This is purely musing on my part. However, if I am right, this could bring billions into the UK tax net, which I think politically, would be popular.

‘[Even] trusts with powers exercised through a protector may be challenged as shams, particularly where they are exercised for the personal benefit of the settlors. … [With] respect to the taxation of offshore trusts by onshore jurisdictions – If the protector’s power is such that the trust is deemed to be managed and controlled by the protector and not the trustee, it is the protector’s residence that will determine the trust residence for purposes of taxation. This would jeopardize the trust where the protector is a resident of the onshore jurisdiction.’ Trusts and Related Tax Issues in Offshore Financial Law (2005), OUP, by Dr Rose-Marie Antoine. If the trust is challenged in litigation as being either a sham or an onshore trust, what planning rationale can a defendant provide to the court to explain why the settlor [‘S’] went to such lengths to give powers to a protector which S could legitimately have reserved to himself or herself, provided that S did not retain control over the trust?

If the reason for appointing P is that S decided to err on the side of caution and not tempt the court into finding that the trust was a sham, but that insufficient thought was given to the powers conferred on P and the tax residence of P, then while the court may find that the trust is not a sham, or an illusory trust, it could find that the trust is resident for income tax and CGT in the UK, provided all the connecting factors I have previously mentioned existed when S constituted the trust with cash or an asset, e.g. a luxury yacht or art collection.

Therefore, it is unwise for a Protector of an Offshore Trust to become involved in the mediation of an internal trust dispute.

I have been commissioned by Trusts & Trustees (Oxford University Press), to write an in-depth article about the ‘Mediation of International Trust Disputes’ which I am planning to write in July/August.

In the article I will also discuss:

(i) Common challenges to offshore trusts.

(ii) Connecting factors for tax.

(iii) The framework of applicable conflict of laws principles in litigation.

(iv) The opportunity that mediation presents to re-draft a trust deed that is no longer fit for purpose – which is a time-bomb waiting to go off when, e.g. the patriarchs of wealthy families in the gulf either lose capacity or die, and a succession battle results in litigation.

(v) The application of these issues to the mediation of disputes involving Islamic Finance, wealth planning, and family trusts.

If there are any particular issues you would like me to discuss, please send an email to carl@ihtbar.com.

Likewise, if you would like to receive PDF copies of my recent articles published in Taxation (Tolley) about the mediation of probate disputes, and the use of mediation as an estate and business succession planning process to enable an international family to put their house in order before a monumental event occurs.