An honest mistake

The unappreciated adverse fiscal effects of a transfer of property into trust may be set aside, as illustrated by the decision of the High Court in Freedman v Freedman and others [2015] EWHC 1457 (Ch).

In Freedman two properties were placed in trust for the benefit of the claimant. The claimant's father had originally loaned her money to purchase the first property (property 1). Later she wanted to move and buy another (property 2), but that move was blocked as she was unable to sell property 1. Her father then suggested he buy property 2 with the proviso that the money advanced was to be a loan, to be repaid on the eventual sale of property 1.

The claimant's father also suggested that the properties be put into a trust (with the aim of protecting the properties from any potential consequences of a relationship the claimant had). The trust was an interest in possession trust, made for the benefit of the claimant. The claimant had also entered into an agreement by which she would pay the loan on property 2 back to her father from the proceeds of sale of property 1.

Unfortunately the solicitor advising the claimant had failed to inform her of the negative effects of transferring the properties into a life interest trust, by failing to realise that the transfer of assets into the trust would be a lifetime chargeable transfer for IHT purposes and (to the extent that the net value exceeded the nil rate band) there would be an immediate entry charge of 20 per cent (section 49(1A) of the Inheritance Tax Act 1984 (IHTA)).

He also failed to realise that there would be a 10-yearly charge and exit charges (on appointing any funds out to her to enable her to discharge the loan). These charges seriously prejudiced the claimant's interests, in particular her ability to repay the loan.

Remedy

The law of rescission of a non-contractual voluntary disposition was set out clearly by the Supreme Court in Pitt v Holt, Futter v Futter [2013] UKSC 26; [2013] 2 AC 108 and concisely summarised in Kennedy v Kennedy [2014] EWHC 4129 (Ch):

1. There must be both a distinct and causative mistake as distinguished from mere ignorance or inadvertence (a 'misprediction' relating to some possible future event). However forgetfulness, inadvertence or ignorance can lead to a false belief or assumption which the court will recognise as a mistake.

2. A mistake may still be a relevant mistake even if it was due to carelessness on the part of the person making the voluntary disposition, unless the circumstances are such as to show that he or she deliberately ran the risk, or must be taken to have run the risk, of being wrong.

3. The mistake must be sufficiently grave as to make it unconscionable on the part of the donee to retain the property. That test will normally be satisfied only when there is a mistake either as to the legal character or nature of a transaction, or as to some matter of fact or law which is basic to the transaction. The gravity of the mistake must be assessed by a close examination of the facts, and the court must make an evaluative judgment whether it would be unconscionable, or unjust, to leave it uncorrected.

4. In some cases of artificial tax avoidance, the court might think it right to refuse relief, either on the ground that such claimants, acting on supposedly expert advice, must be taken to have accepted the risk that the scheme would prove ineffective, or on the ground that discretionary relief should be refused on grounds
   of public policy.

Summary

• The law of mistake provides for rescission or set-aside of transaction where there has been a distinct causative mistake of a serious nature, as to the law or facts upon which the transaction is based.

• The relief may also be available where the mistake is as to the effects of the transaction. This includes negative fiscal or tax consequences, although the court is less likely to grant relief where the mistake arises out of a tax avoidance planning that goes wrong.

• The court is concerned with the unconscionable or unjust nature of the transaction, and will consider all the aspects of the transaction in making an evaluative judgment as to whether the grant relief.

• Escaping the adverse tax consequences of a transaction is possible in the right circumstances. 

Lloyd Junor is a partner at Adams and Remers

He writes the regular in-practice article on wealth structuring for Private Client Adviser