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Guest Blog: What are Sham Trusts and How Will Anyone Know?

By Amanda Perrotton, legal partner at Bell Howley Perrotton

It is clear from discussions with prospects and clients alike over the last few months that those looking to incorporate their property portfolios feel they are well versed in not only the process but the ‘relative ease’ with which it can be done.  I have also been quite concerned about questions answered with ‘how will they know’ rather than any clear intention to think through the issue and come up with a robust solution.

I would urge caution against being too ready to gloss over thorny issues such as mortgages and beneficial ownership.  You may very well be the Director and Shareholder of the company to which your personal portfolio is being transferred but the law sees you and the company as completely separate legal entities with autonomy over ownership and interests.

It is clear that the documentation drafted to support any incorporation must not only be robust but must truly reflect the intentions of the parties.  If not, it is clear that equitable doctrines and maxims will step in to provide the courts with the opportunity to look not only at the form of the agreement itself, but the intent or substance underlying it.  Does the agreement reflect the true intentions of the parties and are in fact the parties to the agreement those truly intended to benefit from it?

It is said that equity is concerned to ensure that no party should seek to benefit from an agreement which of itself would be unconscionable.  Equity will recognise a constructive or resulting trust behind a formal legal title which otherwise belies the beneficial interests set out in the legal title itself.  Furthermore equity may refuse to enforce a trust or other agreement which is in fact a ‘sham’ and intended to conceal the true ownership.

The general concept of a sham was given by Diplock LJ in the leading case of Snook v London and West Riding Investments Ltd:

“If it has any meaning in law, it means acts done or documents executed by the parties to the ‘sham’ which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual rights and obligations (if any) which the parties intend to create.”

Lord Wilberforce later added to this during the ‘Ramsay’ case and said, “whilst professing to be one thing, it is in fact something else.”

A ‘sham’ arrangement should not be confused with dishonesty, artificiality, poor execution and general disapproval.

Megarry J held in Miles v Bull that: “A transaction is no sham merely because it is carried out with a particular purpose or object.  If what is done is genuinely done, it does not remain undone merely because there was an ulterior purpose to doing it.”

To illustrate this, artificial and contrived tax avoidance schemes where all parties have a clear intention to enter into trust arrangements cannot, under the established definition of a sham be considered so, as there is a very deliberate common intention on the part of the settlor and the trustees to enter into the trust and carry out the prescribed steps, otherwise inevitably the attempts at tax avoidance will fail.  In the hands of HMRC the Doctrine of Sham is very limited in its application to defeat properly carried out tax avoidance schemes.

The intentions of the parties in respect of a sham are not simply a matter of construction but the courts will also allow evidence of subjective intention to be admitted into evidence in order to establish whether or not a sham exists.

What the courts are looking for is evidence that the intention of the settlor was to mislead third parties.  The courts have held that in order to have a sham “it suffices that the parties to the transaction present it as being different from what they know it to be” thereby satisfying the requirement of intentional deception.

It is likely that the general position on the finding of a sham trust is that its effect will be void, although the courts will continue to consider what legal effect if any the transaction should have subject to any illegality.   The doctrine enables the court to look directly at what the evidence shows the settlors intention was.

There are to be further legislative introductions that will provide an additional restrictive measure on those who would otherwise enter into a trust with sham intentions and indeed everyone involved within the trust sphere.  It has now been successfully argued that the only way to reduce sham trusts is to oblige all trusts to be registered and their beneficial owners named and made available for public inspection.

The United Kingdom is now in the process of introducing the EU’s Fifth Money Laundering Directive (5MLD) which requires changes to the current UK Trust Register and the information which will now be required to be disclosed.

So how will this impact sham trusts?  There will now be an obligation to register the trusts relating to joint ownership of property, whether that be land or bank accounts, where the legal and beneficial owners are different.  There remain some exceptions, notably trusts relating to jointly owned property where the legal and beneficial owners are the same and charities.

With ever greater layers of checks in the name of transparency a well advised client looking to incorporate a property portfolio must satisfy themselves that what they are putting their signature to truly reflects their intentions and if it doesn’t, the extension of the requirements coming into effect in September 2022 means that now – someone will know.