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“Shurely Shome Mishtake”: What can be done when someone gets the tax wrong?

Published November 2015

Elsewhere in this Newsletter James Goodwin comments on the decision of Proudman J in Freedman v Freedman [2015] EWHC 1457 (Ch) where (against opposition from HMRC) a voluntary settlement was set aside in circumstances in which the settlor had relied on advice from her father and a solicitor, and the solicitor had failed to appreciate the inheritance tax effects of the transaction. The result of the errors was likely to be that the imposition of charges to inheritance tax would force the settlor and her minor son to give up their home, to which they had moved for its proximity to the son’s school. It was also the case that a loan to the settlor from her father intended to be discharged from the future proceeds of sale of the house could not be repaid.  The Judge found that the solicitor had given wrong advice to the settlor’s father, and that advice had been seen by the settlor.  In the circumstances, the Judge concluded that it was entirely reasonable for the settlor to say that, based on that advice, she had “broadly understood” that there would be no tax consequences for her in entering into the settlement. James Goodwin notes that it is difficult to glean from the case much guidance as to what sort of adverse tax consequences will ground a successful claim in equitable mistake. This article looks at some other recently-reported cases of voluntary transactions that have been impugned in consequence of mistakes made in relation to tax, to see what other signposts they may afford.

Typically of course a disponor’s mistake will involve more than a simple misconception of the tax result of the relevant transaction. In Re the Robinson Annuity Investment Trust, Robinson v Apex Trust Company Limited (2014) JRC 133 the taxpayer bought into a commercially-marketed scheme with the specific intention of avoiding inheritance tax on the assets which he transferred into a Jersey trust. The scheme was however fatally flawed, and it had never been capable of producing the benefits which were advertised for it: elements which involved the payment of annuities were unlawful, since the trustees held no permit to conduct insurance business in Jersey, and a deferred annuity for which the scheme expressly provided could never have been paid because there was an insufficiency of assets. The settlor’s mistakes were therefore twofold: he was advised and believed that entering into the arrangements and establishing the trust would avoid inheritance tax on the assets which he put into the trust, which was quite clearly wrong; but also it was impossible for an annuity to be paid of the amount set out in the documentation. In those circumstances the Royal Court of Jersey was satisfied that the mistakes were of so serious a character that both the trust and the associated annuity documents should be set aside. The Court opined that mistakes whether as to tax consequences or as to a transfer into trust could invoke the equitable doctrine equally, but in that case the substance of the transaction was also different from what the settlor believed it would be.

In Wright v National Westminster Bank Plc [2014] EWHC 3158 (Ch) the intended settlor had not properly understood the dispositive effects of the discretionary settlement which he had established on the bank’s advice, but in any event a defective deed of gift produced by the bank resulted in his wife becoming a settlor and thereby being excluded from benefit for all purposes, which had never been intended. In this case also the preponderant mistakes were of a dispositive nature, so they went to the heart of the documentation employed.

In Giles v RNIB [2014] EWHC 1373 (Ch) the purpose of a deed of variation was to relieve certain charitable beneficiaries of the (indirect) burden of inheritance tax, but the causative mistake was the omission of the testator’s real property from the scope of the deed. The fact that the dominant intention of the administratrix had undoubtedly been to relieve the charities of the indirect burden of inheritance tax was held to be no bar to the equitable relief. In this case, however, the relevant mistake was not itself about the tax.

On the other hand, in Re the Representation of Boyd and the Strathallan Trust, Boyd v Rozel Trustees (Channel Islands) Limited (2014) JRC 056 the settlor’s mistake was that his assumption of residence in the Isle of Man did not prevent him from still being deemed domiciled in the UK for inheritance tax purposes at the time of making his settlement. He was well aware of UK inheritance tax and his accountants had advised him that there was no inheritance tax in the Channel Islands or the Isle of Man. Consideration had specifically been given to the absence of inheritance tax in those Islands, and also to considerations of capital gains tax. Equally however no one gave any thought to the application of the deemed domicile provisions in the UK tax legislation. The result was that some 25% of the trust fund would be lost in tax, and far from protecting the settlor’s assets for the benefit of his family, the making of the trust would in fact have depleted them very considerably if things remained as they were. The evidence was that the settlor was completely unaware that there would be any of these inheritance tax consequences at the time he made the settlement; had he been, either he would not have made the settlement at all, or he would have waited until he had been resident in the Isle of Man for the requisite three- year period to lose his deemed UK domicile.

In the circumstances, the Royal Court (expressing itself to follow Pitt v Holt [2013] UKSC 26) held that the effect of the mistake was that the trust would not achieve that which it was intended to achieve, because inheritance tax would still be due by the settlor’s estate on his death and there were all the other inheritance tax effects attendant upon the trust itself going forward. The Royal Court considered that it would be unjust to require the settlor to litigate against his former professional advisers, particularly since some 17 years had elapsed and the outcome of such litigation might well be uncertain, whether on limitation or other grounds. This was a case in which HMRC was given notice of the proceedings but did not attend, and despite having indicated that it would submit its views to the Court in writing, in the event did not do so. The case was not one of mere ignorance (as characterised by Lord Walker of Gestingthorpe in Pitt v Holt as falling outside the scope of relief for equitable mistake) but it was not one which arose in consequence of actively wrong advice given by the settlor’s advisers. In this sense HMRC might possibly have argued that the case was one of “inadvertence” and therefore inapt for the equitable relief. The Royal Court however preferred to find on the evidence that the settlor had failed to achieve his intended objective as a result of the failures. This characterisation brought the case within the scope of the relief.

In England the Chancellor Sir Terence Etherton in Kennedy v Kennedy [2014] EWHC 4129 (Ch) set aside an appointment by three trustees which mistakenly appointed an absolute remainder interest to the settlor in circumstances in which the respective trustees had not all made the same mistake. The mistakes which each did make however combined both mistakes as to the disposition itself as well as mistakes as to tax. One trustee mistakenly believed that the appointment gave effect to the specific instructions which he had given for transitional serial interest planning, the second that the appointment was a tax efficient method of benefiting her children, and was in accordance with the settlor’s instructions to his legal advisers, and the third believing that the appointment was in accordance with the settlor’s instructions, and that the appointment of the remainder would not give rise to a charge to capital gains tax. In the circumstances, the Chancellor held that each of the trustees made a causative mistake as to the dispositive effect of the appointment, and the decision was not founded exclusively on mistakes as to the tax effects.

Two more recent English cases are however have been more exclusively concerned with the tax effects of the transactions. In Vaughan-Jones v Vaughan-Jones [2015] EWHC 1086 (Ch) Judge Hodge QC rectified a deed of variation which was ineffective to provide relief for inheritance tax purposes, because it omitted any provision stating that the parties elected that s.142(1) of the Inheritance Tax Act 1984 should apply to the variation of the dispositions of the deceased’s estate. Although it was accepted that the Court could not rectify a document merely because it failed to achieve the parties’ fiscal objectives, and the specific intention of the parties as to how the objective was to be achieved had to be shown, the Court considered that, in the circumstances of the case, the solicitor draftsman had, either by using the wrong form of precedent, or by failing to keep up with changes in the applicable law, mistakenly omitted to include the requisite statement in the deed, when both he and all of the parties to the deed intended that it should be backdated to the date of death for the purposes of inheritance tax. A case to rectify the deed of variation by including (for the purposes of capital gains tax) a reference to the statement required by s.62(7) of the Taxation of Chargeable Gains Act 1992 was not however made out.

In analysing the nature of the causative mistake in relation to inheritance tax in Vaughan-Jones, Judge Hodge QC said that it was “a mistake which was not extraneous to the terms of the document itself. It was a mistake within the terms of the Deed of Variation. It went to the terms of that document”: the mistake was in failing to give effect to the right machinery for achieving the inheritance tax savings. That was a sufficient mistake to found the jurisdiction in a court of equity to rectify the deed of variation, so far, at least, as the reading-back statement for inheritance tax purposes was concerned. The Judge accepted, on the evidence, that it was the intention of all parties to the deed of variation that it should be back-dated for the purposes of inheritance tax; but the operative mistake was the draftsman’s failure to provide for that tax result as a matter of employing the requisite formula.

In its letter declining to be joined to the proceedings in Vaughan-Jones, HMRC had asked that the Court’s attention should be drawn to the decision of the Court of Appeal in Racal v Ashmore [1995] STC 1151: it is perhaps difficult not to have some sympathy for their position, since in Racal the Court of Appeal had dismissed an appeal from the decision of Vinelott J to refuse rectification (in a case concerning a mistake in the covenanting of annual payments to charity payable for a period of less than three years), on the basis that the Court could not rectify a document merely on the ground that it failed to achieve the grantor’s fiscal objective: the judgment of Peter Gibson LJ (with which Sir Iain Glidewell and Kenendy LJ agreed) was that the specific intention of the grantor as to how the objective was to be achieved had to be shown if the deed was to be rectified. In this light, Vaughan-Jones seems to be very much a borderline case since, although the parties knew what their fiscal objective was, the draftsman (either through his own ignorance or inadvertence) would not appear to have had any specific intention at all as to how the desired objective was to be achieved.

More recently in Prowting 1968 Trustee One Ltd v Amos-Yeo [2015] EWHC 2480 (Ch) Chancery Master Clark decreed rectification of two share sale agreements by which the former trustees of a 1968 settlement had expressed themselves to dispose to two beneficiaries of a certain number of shares in a public limited company. The trustees intended that the number of shares to be sold should support an application for entrepreneurs’ relief for capital gains tax, but by mistake this number was miscalculated. The Court considered that the parties to the agreements did have a sufficiently specific intention which was not reflected in the agreements as executed by them, and the fact that they left the precise number of shares to be determined by the trustee did not prevent their intention from being sufficiently specific.

Master Clark relied upon the observations on the Racal case made by Barling J in Giles v RNIB, where he said that there must be a flaw in the written document such that it does not give effect to the parties’/donor’s agreement/intention, as opposed to the parties/donor merely being mistaken as to the consequences of what they have agreed/intended. It is not for example sufficient “merely” that the document fails to achieve the desired fiscal objective; the specific intention of the parties/donor must be shown. Equally, it is not sufficient to show that the parties did not intend what was recorded in the document which they executed; they also have to show what they did intend, with some degree of precision. Master Clark’s justification for her decision to order rectification in the Prowting case was founded upon her conclusion that the error in question (as to the number of shares required to be transferred so as to qualify for the relevant tax relief) was one of implementation only, because the trusts’ financial adviser and investment manager had specifically identified what was required to meet the requirements for entrepreneurs’ relief – he just got the number of shares wrong.

Master Clark observed that, in all such cases, there is “a continuum moving from a formulation of a general intent or objective to a specific understanding of how that objective is to be achieved in documentary form”. However, the distinction which the cases assume may be drawn between on the one hand, a mistake as to the effect of a document and, on the other, a misapprehension of what the fiscal or other consequences are of a document which does not in fact mis-implement the parties’ or donor’s intention, is not one that is necessarily clear-cut. As the Chancellor put it in Kennedy v Kennedy [2014] EWHC 4129 (Ch), [43]: “Intention must be distinguished from motive”. It is the relevant intention which a party seeking equitable relief for a mistake in the relevant transaction must establish to the satisfaction of the Court. If the intended effect can be established, then the Court may take a relatively relaxed approach to the precise terms in which that effect was to be achieved in the instrument:  Giles v RNIB per Barling J at para. [35]. As Turner LJ said in another context (Topham v The Duke of Portland (1863) 1 De G J & S, 46 ER 205 at 571, 227) —

“… it is one thing to examine into the purpose with which an act is done, and another thing to examine into the motives which led to that purpose: and what we have to do in this case is, to look to the purpose of the act which was done, and not to the motive which led to it.

Written by Mark Studer

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