No small change
26 July 2010
Obtaining tax relief as a result of a costly mistake is difficult in England. Change may be on the cards, says Richard Wilson
In recent years, the UK tax code has become longer and more complicated, creating many more opportunities for individuals to make mistakes when structuring their affairs. While the courts have held that where trustees exercise a discretionary power in ignorance of the true tax consequences of doing so, they may avoid those consequences by virtue of the so-called ’Rule in Re Hastings-Bass’, the position for individuals who create a trust in circumstances where they are mistaken as to the tax consequences of doing so have, in England, found it more difficult to obtain relief from the Court.
In Gibbon v Mitchell (1990) 1 WLR 1304, Millett J reviewed many of the older authorities on mistake and held that for a person to set aside a voluntary transaction (such as the creation of a settlement) on the basis of mistake, that mistake had to refer to the effect of the transaction in question rather than its consequences. That distinction is not the easiest to draw in many cases, but in Anker-Petersen v Christensen (2002) it was made clear that an unforeseen tax charge falls within the latter category, and therefore cannot form the basis of a successful application to set aside the transaction.
Effect and consequence
The position has been complicated by the decision in Ogden v Griffiths (2009) 2 WLR 394, in which the Judge relied not on Gibbon but on the older Court of Appeal decision in Ogilvie v Littleboy (1897) 13 TLR 399, in which no distinction was drawn between effect and consequence.
In Ogilvie the test applied was whether the mistake was so serious as to make it unjust on the part of the donee to retain the benefit from it. In Ogden the donor made a gift believing that he was in good health and would survive seven years with the result that the gift would be free of inheritance tax (IHT). In fact, he was suffering from cancer and had no real prospect of surviving that long, and died shortly afterwards. On the basis of the test in Ogilvie, the Court granted relief to the donor’s personal representatives.
Ogilvie was not cited to the Court in Gibbon and this has raised the question of whether the distinction between effect and consequence is one that can be justified. Certain offshore jurisdictions appear to have taken the view that it cannot. In both the Isle of Man and Jersey, there have been decisions where the courts have applied the broader test in Ogilvie and granted relief where the donor has been mistaken as to the tax consequences rather than the effect of the transaction.
In the Manx case of Re the Betsam Trust (2009) WTLR 1489, the Deputy Deemster held that a mistake as to the tax consequences was sufficiently serious to enable relief to be granted. Similarly, in Re the A Trust (2009) JRC 245 the Jersey Royal Court came to a similar conclusion. That decision has been followed recently by the Jersey Royal Court in two cases: Re the First Conferences Limited 203 Employee Benefit Trust (2010) JRC 055A and Re The Lochmore Trust (2010) JRC 068.
In Lochmore the Court held that where a settlor had created a settlement believing that no charge to IHT would arise, but in fact it gave rise to a substantial immediate charge to IHT, that mistake was of a sufficiently serious nature to enable relief to be granted in the form of rescission of the settlement on the basis that it would be unjust for the beneficiaries to retain the benefit of the settlement in those circumstances.
Interestingly, the injustice was held to arise because the settlor was liable for the charge to IHT and therefore had to pay a substantial amount in addition to that which he had intended to give away. Had the settlement been charged to tax, it is highly questionable whether the injustice test would have been satisfied, as the result of the mistake would merely have been that the beneficiaries would receive less than the settlor had hoped they would.
The English Courts have not, so far, followed the approach of the Manx and Jersey Courts. In Pitt v Holt (2010) EWHC 45 (Ch) the Court applied Gibbon and declined to follow the Betsam Trust case, holding that it did not accord with English law. However, the Deputy Judge in Pitt left open the question of whether relief could be granted in a case where there was a mistake as to the consequences where “tax planning was the objective of a disposition”. Very often that is the case, with settlors making their choice of trust structure not on the basis of any desire to have a particular form of trust, but because of the perceived tax advantages.
Permission to appeal has been granted in Pitt and the Court of Appeal’s decision could have wide ramifications not only in England but throughout the offshore world.
Richard Wilson is a barrister at 3 Stone Buildings