Trust Litigation Meets Tax Disputes

Tax-related trust litigation is rife — and for good reason. Trusts were often born of tax planning, and, for trustees, navigating their international tax obligations remains notoriously complex. It is therefore no surprise that tax issues often sit at the very heart of trust litigation.

In this article we explore the interactions between trust litigation and tax litigation. We consider some practical steps required to ensure that both matters (i.e. the trust dispute and the tax dispute) are handled smoothly.

Examples of the Overlap

We set out below some examples of overlapping trust and tax disputes. 

In all of these examples, the litigation strategy must be mirrored by a tax strategy. The two must be developed in parallel and in coordination.

1. Setting aside voluntary dispositions for mistake

The Court has equitable jurisdiction to set aside a voluntary disposition on the grounds of mistake, includes tax mistakes. A voluntary disposition can include things like the settlement of a trust (or a sub-trust) or the exercise of a power. 

In Pitt v Holt [2011] EWCA Civ 197, the Court confirmed that relief is available where there is a mistake — distinguished from mere ignorance or inadvertence — of the relevant type, and where the mistake is sufficiently grave to make it unconscionable for the donee to retain the property.

Pitt concerned the settlement of a discretionary trust on behalf of an individual (Mr Pitt) who had been injured in a road traffic accident. The settlement of the trust resulted in significant Inheritance Tax charges (IHT). These IHT charges could have been avoided had a disabled person’s trust been used. Rescission of the discretionary trust was sought on the grounds of mistake. 

Where such relief is sought, an eventual court order can have retrospective effect and may resolve the underlying tax issue entirely. But until that point, the tax problem remains live and must be carefully managed.

As can be seen from the case outlined above, equitable mistake can be an incredibly useful tool in resolving tax disputes concerning trusts. 

2. Claims for negligent breach of trust

A trustee may face claims for breach of trust where maladministration has given rise to avoidable tax liabilities. Again, there is both a litigation problem and a parallel tax problem that needs immediate handling.

3. Fraud in the administration of trusts

In some cases, fraud is uncovered in trust administration — including misappropriation of trust assets or conspiracies to conceal wrongdoing. Often, funds are moved within or outside the structure to hide the fraud. This can create tax reporting irregularities, which, left unaddressed, compound the legal risks.

The First Rule of Tax-Related Trust Litigation

The first rule is simple: actively manage the tax issue alongside the trust litigation.

Do not assume that rescission, rectification or other equitable relief will make the tax problem quietly disappear. HMRC (or another tax authority) will inevitably discover the proceedings — through public filings, court notifications, or information-sharing mechanisms such as FATCA and CRS.

Even in jurisdictions where confidentiality orders are more readily available (unlike England and Wales), certain proceedings require that HMRC be notified. For example, in mistake claims, HMRC must be given an opportunity to intervene as an interested party.

The first time HMRC hears about the issue should not be when they receive formal notice of the court claim.

Until the equitable relief is granted, the tax problem exists — and so does HMRC’s power to:

• issue an assessment and charge interest; and
• impose penalties, which in offshore-related non-compliance cases can reach up to 200% of the unpaid tax.

The worst-case scenario is fighting both HMRC and the trust litigation at the same time. Avoiding that requires proactive, strategic engagement.

Early Engagement With HMRC

Where appropriate, the safest course is often to make a timely disclosure to HMRC before taking substantive steps in the trust litigation.

In practice, well-planned engagement via HMRC’s Digital Disclosure Service (DDS), Worldwide Disclosure Facility (WDF) or other appropriate channels can yield real benefits:

• Deferment of HMRC action: HMRC may agree not to progress the tax dispute while the trust dispute is ongoing, particularly in mistake cases where the tax position may ultimately be unwound.
• Penalty mitigation: Cooperation can significantly reduce or eliminate penalties.
• Time-to-pay arrangements: If compensation is being sought in the trust litigation to fund payment of the tax, HMRC is often willing to agree staged payments where liquidity is constrained.

A well-timed and well-drafted disclosure can therefore save considerable cost, time and stress.

Do You Need to Admit the Tax Issue?

A nuanced question arises: can you engage with HMRC while preserving your position on the merits of the tax point?

This was considered in JTC Employer Solutions Trustee Limited (as Trustee of the Henderson Family Benefit Trust and of the Henderson Group PLC Employer Financed Retirement Scheme) and others v William Garnett and others [2024] EWHC 3128 (Ch) (a case in which the author acted).

The Court confirmed that:

“it is enough for there to be an operative mistake if there is an incorrect belief or assumption that there is no risk of a particular tax consequence, where in fact that real risk does exist.”

The key takeaway is that acknowledging the existence of a risk in the trust proceedings does not necessarily equate to conceding the point to HMRC. But careful drafting and consistent messaging are essential to avoid undermining either case.

Practical Takeaways

When trust litigation has a linked tax dispute, the litigation strategy and the tax strategy must be developed side by side. In practice, that means:

• Run tax and trust strategies in parallel — trust litigation rarely exists in a tax vacuum. Identify and address the tax angle from day one.
• Engage early with HMRC (or the relevant tax authority) — early disclosure can help control the timetable, limit penalties, and secure time-to-pay arrangements.
• Don’t rely solely on equitable relief — rescission or rectification may ultimately fix the tax position, but until ordered, the liability remains live.
• Plan communications carefully — you can acknowledge a tax risk in litigation without conceding the substantive point to HMRC, but messaging must be consistent across both fronts.
• Manage confidentiality expectations — many proceedings require HMRC to be notified as an interested party, even in jurisdictions with stronger privacy protections.
• Avoid fighting two battles at once — a well-timed disclosure can prevent HMRC from running a parallel tax dispute while the trust case is ongoing.

Conclusion

Trust litigation and tax disputes are often two sides of the same coin. The litigation strategy must be integrated with a proactive tax strategy that manages risk, engages with HMRC early, and avoids unnecessary duplication of battles.

The first rule remains: deal with the tax now, not later — because HMRC will find out, and the cost of delay can be severe.