Whilst mistakes can easily be made, trying to remedy them can prove more difficult

The courts have the power to rectify documents, so that any mistake is corrected with retrospective effect. Where the mistake has unintended tax consequences HMRC will usually insist on a court order being obtained if those consequences are to be avoided. In order for the court’s discretion to be engaged there must have been a mistake and clear evidence as to the parties’ intentions.

The recent case of Graham (by his litigation friend) v Lynch and others [2020] EWHC 986 illustrates the English court's (the High Court) approach to rectifying several BVI trusts, where the draftsman had made a relatively straightforward drafting error which had potential inheritance tax consequences. 

The case

The claimant (a Mr Graham) had set up a number of BVI trusts to hold UK residential properties for the benefit of his children. It was always Mr and Mrs Graham’s intention (on the advice of their solicitor) that they should both be excluded from benefit from the trusts, and it was their belief that this was how the trusts had in fact been drafted. Mr and Mrs Graham always took care to ensure that they never used the properties, and even stayed in hotels when visiting the UK.

Their tax advisers (including their solicitor who had drafted the trusts) also believed Mr and Mrs Graham were excluded from benefit, and the trustees of the trusts treated them as such. Although Mr and Mrs Graham were not among the class of beneficiaries, due to a drafting oversight there was no overriding clause excluding Mr and Mrs Graham from benefit; so they could technically be added to the class of beneficiaries. Although arguably this did not give rise to a reservation of benefit for inheritance tax purposes, there was a concern that HMRC would take a different view; and if HMRC were successful in doing so the properties would form part of Mr Graham’s estate on death.

All the parties supported the application. As the application had tax implications, HMRC had been informed and given the opportunity to participate in the proceedings. HMRC declined to be joined as a party but (as is their practice) asked for the court to be referred to certain authorities which they considered to be relevant. These included the case of Whiteside v Whiteside [1950] 1 WLR 65. HMRC relied on Whiteside as authority for the proposition that the court should not rectify a document where the sole motivation is to secure a fiscal advantage (because there is no issue between the parties before the court).  

The position here was complicated by the fact that the trusts had been terminated in 2017 and the assets appointed out to the two sons. Although the tax analysis is not fully covered in the judgment, had Mr Graham not been excluded from benefit under the trusts the appointment to the sons would have been a potentially exempt transfer (chargeable had Mr Graham died within seven years); and it is clear from the judgment that he was in poor health. 

As the sons would now be entitled to the properties whether the trusts were rectified or not, the facts clearly lent themselves to an argument based on Whiteside. However, the High Court found that the trusts still had a continued existence despite the appointment out of the properties; the trustees still had continuing rights to indemnify themselves from the properties under their trustees’ lien, as supported by the indemnities included in the deeds of appointment, termination and indemnity. If property came back in to the trusts for some reason they would be oblige to deal with it in accordance with the terms of the trusts; so rectifying the trusts would have implications beyond obtaining a fiscal advantage.

The High Court therefore distinguished Whiteside and rectified the trusts to exclude Mr and Mrs Graham.

Commentary

This is an interesting decision. It indicates that the courts may be inclined to work round the decision in Whiteside, which might otherwise represent a technical bar to relief in cases where it would seem entirely fair for rectification to be available. 

Another point of note is that the High Court had no difficulty in accepting jurisdiction and granting the order sought despite the fact that the trusts were governed by BVI law. This was partly on the basis that the trustees (although resident overseas) had submitted to the jurisdiction; but also because the parties had decided that the English courts were the most appropriate forum for the proceedings, bearing in mind HMRC’s interest in the case.

There have now been a number of recent cases in the English courts where judges have been prepared to exercise their powers to set aside or rectify voluntary transactions relating to trusts where there has been a genuine mistake and where the main issue has been the tax implications of that mistake.