...and into the fire

The ability of solicitors to 'get out of jail' for mistakes made has been highlighted by a recent High Court decision, concerning a drafting error in a deed of variation: Vaughan-Jones and another v Vaughan-Jones and others [2015] EWHC 1086 (Ch)).The case also illustrates the pitfalls of relying on out-of-date precedents in drafting, and the risks of a deed of variation being ineffective for tax planning purposes, if it was entered into for consideration.

Background

A post-death deed of variation is a well-known tool for retrospective tax planning, but it is important that the deed includes the necessary clear wording that it is intended by the parties, in order for it to have retrospective effect. Unfortunately in Vaughan-Jones, there was a failure to incorporate such wording.

Following the death of Mr Vaughan-Jones, the solicitor-executor and beneficiaries (just before the two year expiry of the anniversary of death) entered into a deed of variation, redirecting the residue of the estate to the deceased's spouse absolutely, the aim being to eliminate inheritance tax (IHT).

This was because the deceased had made a gift of the residue of his estate in equal shares to his three children and his wife. This was not a tax efficient strategy and gave rise to a substantial IHT liability on the children's shares.

The deed however failed to incorporate the necessary statement that the parties were claiming retrospective tax treatment for inheritance tax purposes, pursuant to section 142(1) of the Inheritance Tax Act 1984 (as required by section 142(2)).

Accordingly, while the variation passed the entire estate to the deceased's spouse, the estate was still liable for IHT, effectively increasing the IHT liability substantially from around £30,000 to around £230,000.

Remedy

The court has a power to rectify an inter vivos instrument if; (a) the document fails to give effect to the true intentions of the parties who entered into it; and (b) where there is an issue capable of being contested between the parties, i.e. that their respective rights are affected by such an order.

Rectification will not be ordered where the beneficiaries rights are unaffected and where the only effect of the order is to secure a fiscal benefit.

In this instance the intention of the parties was to secure a fiscal benefit (the IHT saving) but the deed of variation manifestly failed to give effect to their true intentions, with the evidence being that the drafting solicitor had adopted an (apparently highly) out of date precedent, omitting the section 142 wording.

The court found that the beneficiaries rights were affected. The estate was to be relieved of a substantial IHT liability, affecting the surviving spouse's and the children's rights, and the total of the transfers of value should any of the three children fail to survive for seven years from the deed of variation.

The court ruled that the deed should be rectified to include the missing declaration that the parties claimed retrospective tax treatment.

Nonetheless, the family's fortunes were not restored. A deed of variation is ineffective for tax purposes where it is entered into, in 'consideration for money or money's worth, other than consideration consisting in the making' (section 142(3) of the Inheritance Tax
Act 1984).

The evidence put forward in aid of the rectification claim was that the surviving spouse planned to transfer back to the children the tax-free money received by virtue of the deed. HMRC had given notice in the course of the proceedings that it considered the deed was entered into for money's worth as part of a wider arrangement, which fell foul of section 142(3). The battle now passes to the beneficiaries against HMRC.

Summary

The court will order rectification of a lifetime instrument/document where it plainly does not reflect the parties true intentions and where by not doing so it would affect the beneficiaries rights, giving rise to an issue capable of being contested.

A mere misapprehension as to the fiscal effect of the document will not enable parties to rectify.

Use of precedents in drafting is common practice, but clearly precedents need to be updated on a regular basis to avoid simple, but expensive errors, as in this case. 

Lloyd Junor is a partner at Adams and Remers

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