Setting aside transactions on the ground of mistake – recent cases

Payne and another v Tyler and another [2019] EWHC 2347 (Ch)

In this case, the trustees of a discretionary settlement sought to set aside a deed of appointment.

Mr Mallett died in 2010 and, under the terms of his will, left half of his estate to Mrs Alston. Upon advice from her solicitor, Mrs Alston varied the relevant provisions of Mr Mallett’s will so that, instead of inheriting her share of the estate outright, it was held on the terms of a discretionary trust. The aim of this was to ensure that the funds did not form part of her estate for inheritance tax purposes on her death.

A short time later, Mrs Alston required additional income and so the trustees decided to exercise their powers of appointment, giving her an irrevocable life interest in the discretionary trust so that she had an automatic right to the trust income. The trustees sought advice on this proposal from a tax specialist, who incorrectly advised that the appointment (within two years of Mr Mallett’s death) would not affect the inheritance tax treatment of the trust. Based on that advice, the trustees entered into the deed of appointment.

Following Mrs Alston’s death in 2016, it became apparent that the tax advice had been wrong. The trust fund in which Mrs Alston had a life interest (created by the deed of appointment within two years of Mr Mallett’s death) did in fact form part of her estate for inheritance tax purposes, giving rise to a tax liability of over £100,000. Accordingly, the trustees applied to the court to set aside the deed of appointment on the ground of mistake.

Hartogs v Sequent (Schweiz) AG and others [2019] EWHC 1915 (Ch)

Here, Mr Hartogs applied to set aside transfers he had made to two offshore trust structures.

Acting on professional advice, Mr Hartogs had made several transfers of funds to offshore trusts between 2009 and 2014. However, although Mr Hartogs was non-UK domiciled, he had become “deemed domiciled” in the UK for inheritance tax purposes prior to 2009, something which his advisors had failed to identify.

As a result of his “deemed domicile” status, the transfers into trust gave rise to an immediate inheritance tax liability of nearly £3m, and the trust fund would also have been subject to 10-yearly charges (at a rate of up to 6%) and exit charges on distributions from the trust. Had he known about these tax consequences, Mr Hartogs would not have made the transfers. He therefore sought to set aside the transfers on the ground of mistake.

The legal principles – Pitt v Holt [2013] UKSC 26

In both cases, the High Court referred to Lord Walker’s judgment in the Supreme Court case of Pitt v Holt, which sets out the principles applicable to the rescission of a voluntary disposition on the ground of mistake. The conditions which must be met can be summarised are as follows:

1. there must be a mistake (which is to be distinguished from mere ignorance or inadvertence);
2. there must be 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; and
3. the mistake must be sufficiently serious as to render it unjust on the part of the donee to retain the property given to him.

Lord Walker confirmed that it does not matter if the mistake in question is due to carelessness by the person making the voluntary disposition, unless the circumstances are such as to show that he deliberately ran the risk, or must be taken to have run the risk, of being wrong. He also dismissed arguments made by HMRC that a mistake that relates exclusively to tax cannot be relieved in any circumstances.

Judgments in the High Court

The High Court applied the principles set out in Lord Walker’s judgment and, in both cases, concluded that all three conditions were met so agreed to set aside the relevant transactions.

In Payne v Tyler, the court acknowledged that the discretionary trust existed solely to ensure that the funds inherited by Mrs Alston from Mr Mallett fell outside her estate for inheritance tax purposes. Had the correct tax advice been given, the trustees would not have entered into the deed of appointment within two years of Mr Mallett’s death. The court also accepted that this mistake was sufficiently serious due to the level of tax payable as a result of the mistake and the fact that the effect of the mistake was to completely negate the purpose of the original variation of Mr Mallett’s will.

Similarly, in Hartogs v Sequent (Schweiz) AG, the court recognised that the transactions in question were entirely tax-driven and entered into on the basis of the mistaken belief that they would not give rise to the inheritance tax charges in question. Had Mr Hartogs been advised of the tax consequences, he would not have made the transfers into trust. It was acknowledged that Mr Hartogs’ lack of knowledge of the tax consequences could be argued to be mere ignorance or inadvertence, rather than being categorised as a mistake capable of fulfilling the Pitt v Holt conditions. However, the court accepted that this lack of knowledge led Mr Hartog to a false belief or assumption and that this was sufficient to constitute a “mistake”. Given that the tax arising on the transfers into trust approached £3m and that Mr Hartogs would not have made the transfers had he known of the potential tax charges, such mistake was sufficiently serious to make it unconscionable for it to stay uncorrected.

Concluding points

In Hartogs v Sequent (Schweiz) AG, the court emphasised that the Pitt v Holt principles “should not be viewed as an available ‘get-out-of-jail-free’ card, which may be invoked wherever a taxpayer finds himself facing a charge to tax which has not been anticipated”, and that relief will only be given where the strict conditions set out in Pitt v Holt are met. It should also be noted that both High Court cases involved unexceptional tax mitigation arrangements. In Pitt v Holt, Lord Walker suggested that “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.”

Nevertheless, in a world where the complexity of our tax rules is ever increasing, it is encouraging that the courts continue to be prepared to take a pragmatic approach and to exercise their powers to set aside voluntary transactions (made either by an individual or trustees) where there has been a genuine mistake which meets the conditions set out in Pitt v Holt.  

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