Tax authorities are assisted by Pugachev

On the 11th October 2017, the Privy Council handed down a judgement in the case of Mezhprom v Pugachev which should send shivers down the spines of every fiduciary business as well as all families whose wealth is held in offshore trusts.

Sergei Pugachev was the founder of Mezhprom which was once Russia’s leading private bank. In due course, however, it got into financial difficulties and had to be bailed out by the Russian Central Bank.

Creditors of the bank included The Deposit Insurance Agency an arm of the Russian State. It claimed that Mr Pugachev had misappropriated the funds and settled them in five trusts in New Zealand with private trustee companies, of which his adviser and his wife, in New Zealand were directors. Mr Pugachev was the Settlor and Protector and he, and his partner and children were the Beneficiaries.

As Protector Mr Pugachev had extensive powers to block any decision of the Trustee, and if it did not do what he wanted, he could remove and replace it.

The decision of the Judge focused on the intention of Mr Pugachev at the time he created the trust. Did he intend to divest himself of control of the assets when he set up the trust and transferred the assets to his trustee? If not, then his role as Protector was ‘personal’ and not ‘fiduciary’.

The importance of this distinction in the Judgement is fundamental. If ‘personal’, then in exercising his extensive blocking powers over the decisions of the trustee, he need only consider his own needs and requirements. If however, his intention at the outset was that the role of the Protector was ‘fiduciary’ then the Protector must, in exercising his powers, consider what was in the best interests of all the beneficiaries.

If the proper construction of the trust documentation was that Mr Pugachev intended that the role of the Protector was ‘personal’, then the trust was not a sham, it was a trust – but only a bare trust. As a bare trust, the assets were in the name of the trustees, but held to the order of Mr Pugachev. The beneficial interests in the trust assets remained with Mr Pugachev – and were, therefore, available to be seized by the bank Mezhprom to meet the claims of its creditors such as the DIA.

The Judge went on, if on a proper construction of the intention of Mr Pugachev at the time he set up the trust, was to divest himself of control of the assets, then following the Esteem case, he needed to find a common intention by both the trustees and the settlor to mislead, for it to be a sham.

The Judge looked to the divorce case of A v A for a precedent.  A common intention can be construed where the trustee, although not obviously or deliberately out to mislead, had a ‘reckless indifference’ as to what was the intention of the settlor and went along with it to secure the business.  

If this was the proper construction of the facts, then the test set by Esteem was satisfied and the trust as set out in the documentation was a sham and could be set aside as being void ab initio.

The Judge continued; if on a proper construction of all the circumstances leading up to the formation of the trust, Mr Purgachev had the intention to form the trust, the Protector’s powers were fiduciary and the trustee was not reckless as to the intention of Mr Pugachev in setting up the trusts, he would still set aside the transfer of the assets into the trust because they were transferred with the intention of defeating his creditors, so would be available to meet the claims of the creditors of the bank.

Mr Pugachev was defeated on all claims.

Some advisers say that the importance of this case is limited to its facts; Mr Pugachev, was Settlor, Beneficiary and a Protector with extensive reactive reserved powers. I do not agree.

This case, is dynamite for any third party, such as a tax authority. Tax authorities across the globe now know who is the Settlor, whether the Settlor is also a beneficiary and which trusts have a Protector under CRS.

All they now need to do, following the decision in the Pugachev case is to ask the Trustee for a copy of the Trust Deed. With this, they can identify the powers of the Protector and attack the trust on the basis that the Protector’s powers were personal to the Settlor, either directly or through his nominee which they can now glean from an objective interpretation of the trust deed. Before this case the tax authority would need to prove a common intention on behalf of the trustee and the settlor, to deceive.

I have for many years been wary of the office of Protector, and this case justifies my contention that the role of Protector puts the trust at risk of an investigation.

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