Two recent cases shed light on whether you can undo expensive tax planning mistakes
Sometimes, some of the most complicated legal problems spring out of the simplest facts. If I give you £100, mistakenly thinking I owe you £100 – should I be able to get the money back? If I did owe you £100, but had forgotten I'd already repaid you, and I transfer another £100 – should I be able to get that back? If I give you £100 because I think you're poor, but actually you are secretly a millionaire – what then?
And how about the following: if I transfer money into a trust, thinking that this is a tax-efficient thing to do – but it turns out not to be – can I claim that the trust never existed, because I was mistaken as to its tax effects?
The law of mistake, surprising though it may seem, is one of the most complicated areas of English civil law. The recent Supreme Court decision in Pitt v. Holt and Futter v. Futter (two similar cases which were appealed together) has put the analysis under the spotlight, with some interesting results.
In recent years, trustees have been able to resort to the courts in order to right some expensive 'mistakes', usually in the hope of reversing a large tax bill which would not have been payable if the trustees hadn't made an error.
Unsurprisingly, both the judiciary and HMRC became wary of these cases, and last week, the final twist in the saga relating to a principle known as the rule in Re Hastings-Bass (named after an earlier case) was revealed when the Supreme Court handed down its judgment in the Pitt and Futter appeals.
By way of background, in Pitt v. Holt, a UK individual set up a trust many years ago to hold a damages award for her husband who had been injured in a road traffic accident. She had not realised that this would have disastrous inheritance tax consequences, or that it would in fact have been possible to set up a special inheritance tax-efficient trust given the nature of her husband's injuries.
In Futter v. Futter, trustees of an offshore trust made payments to UK resident beneficiaries, having taken professional advice to the effect that the capital gains tax liabilities that would normally arise (because of historic 'gains' in the trust) could be offset against the beneficiaries' personal losses. This was not in fact the case.
In both cases, the appellants tried to argue that their actions were made in error, and that they should be reversed.
The judgment in Futter confirms the position that a trustee's mistake can only be rectified if the trustee acted in breach of trust (for example, by failing to take relevant circumstances into account). If trustees act reasonably (for example, if they take professional advice on the UK tax consequences of the proposed action) then they are unlikely to be in breach of their fiduciary duties – even if the advice turns out to be wrong.
But interestingly, in Pitt v. Holt, the Supreme Court agreed that the trust established by Mrs Holt should be set aside on the grounds of mistake (even though the mistake was as to the tax effects of her actions, and not as to the factual or legal consequences of her actions).
So, precisely when should it be possible to set aside apparently valid gifts? The Supreme Court judgment arguably poses more questions than it resolves. However, it's clear that trustees can't any longer look to the courts to be their get-out-of-jail-free card if they make an error with serious tax consequences.
Ed Powles is a lawyer at boutique private wealth law firm Maurice Turnor Gardner LLP