NOTE: This article was published in December 2024 and reflects the law as it stands on the date of publication and not at any later date.

The aim of this paper is to analyse the circumstances in which a voluntary disposition, such as a gift by an individual (often, but not invariably, to a trust) or the exercise of a discretionary power by trustees, may be set aside or rescinded on the grounds of a mistake as to the tax consequences of the disposition.

Following the Supreme Court’s decision in Pitt v Holt [2013] 2 AC 108, a voluntary disposition may be set aside on the grounds of mistake where:

(1) The gift was made by the donor, acting under a mistake of law or fact, as opposed to ignorance, inadvertence or misprediction;

(2) The mistake was serious; and

(3) It would be unjust or unconscionable on the part of the donee to retain the property.

The effect of rescission is to undo the transaction from the beginning. It is thereafter treated for the purposes of the general law, including tax law, as if it never took place. Any IHT paid or payable in consequence of the transaction would have to be repaid or would not be payable (IHTA 1984, s. 50).

Pitt v Holt

In Pitt v Holt [2013] 2 AC 108 there was a claim to set aside a settlement on the grounds that the settlor was mistaken as to its tax consequences. Mrs Pitt was the receiver, appointed by the Court of Protection, for her husband, Mr Pitt, who had been injured in a road accident. She received a lump sum and annuity under the compromise of a damages claim. Exercising her fiduciary powers as receiver (and in effect acting as agent for Mr Pitt as settlor) she settled the award on discretionary trusts for the benefit of Mr Pitt and his family, giving rise to an immediate IHT charge of £100,000, and the prospect of future exit and 10-year charges. Such liabilities could have been avoided by a settlement on a disabled person’s trust. A claim was made to set aside the settlement on the basis of the rule in Hastings-Bass, alternatively on the grounds of mistake.

In the Supreme Court the claim succeeded on the grounds of mistake. Lord Walker concluded that rescission should be awarded because Mrs Pitt had made a sufficiently grave causative mistake in respect of the tax treatment of the settlement to justify the Court’s intervention. There was no artificial tax avoidance. The trust could have complied with IHTA 1984, s. 89 without any artificiality or abuse of the statutory relief. It was precisely the sort of trust to which Parliament intended to grant relief by s. 89.

Legal test

In Kennedy v Kennedy [2014] EWHC 4129 (Ch), para. 36, Sir Terence Etherton set out the grounds for relief as follows:

“(1) There must be a distinct mistake as distinguished from mere ignorance or inadvertence or what unjust enrichment scholars call a “misprediction” relating to some possible future event. On the other hand, forgetfulness, inadvertence or ignorance can lead to a false belief or assumption which the court will recognise as a legally relevant mistake. Accordingly, although mere ignorance, even if causative, is insufficient to found the cause of action, the court, in carrying out its task of finding the facts, should not shrink from drawing the inference of conscious belief or tacit assumption when there is evidence to support such an inference.

(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 causative 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, including the circumstances of the mistake and its consequences for the person who made the vitiated disposition.

(4) The injustice (or unfairness or unconscionableness) of leaving a mistaken disposition uncorrected must be evaluated objectively but with an intense focus on the facts of the particular case. The court must consider in the round the existence of a distinct mistake, its degree of centrality to the transaction in question and the seriousness of its consequences, and make an evaluative judgment whether it would be unconscionable, or unjust, to leave the mistake uncorrected.”

In Van der Merwe v Goldman [2016] 4 WLR 71 Morgan summarised the legal principles as follows, at para. 26:

“In a case concerning a gift made as the result of a mistake, the relevant legal principles are those which were recently restated in Pitt v Holt [2013] 2 AC 108 . These principles apply even if the transaction is under seal: see at [115]. For present purposes, the principles can be summarised as follows (references in square brackets are to the paragraphs in Pitt v Holt):

(1)  a donor can rescind a gift by showing that he acted under some mistake of so serious a character as to render it unjust on the part of the donee to retain the gift: [101], quoting Ogilvie v Littleboy (1897) 13 TLR 399 at 400;

(2)  a mistake is to be distinguished from mere inadvertence or misprediction: [104];

(3)  forgetfulness, inadvertence or ignorance are not, as such, a mistake but can lead to a false belief or assumption which the law will recognise as a mistake: [105];

(4)  it does not matter that the mistake was due to carelessness on the part of 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: [114];

(5)  equity requires the gravity of the mistake to be assessed in terms of injustice or unconscionability: [124];

(6)  the evaluation of unconscionability is objective: [125];

(7)  the gravity of the mistake must be assessed by a close examination of the facts which include the circumstances of the mistake and its consequences for the party making the mistaken disposition: [126];

(8)  the court needs to focus intensely on the facts of the particular case: [126];

(9)  a mistake about the tax consequences of a transaction can be a relevant mistake: [129]-[132];

(10)  where the relevant mistake is a mistake about the tax consequences of a transaction, then:

“[i]n 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.” [135];

(11)  it is not pointless, nor is it acting in vain, to set aside a transaction and to remove a liability to pay tax, even where that is the principal, or the only, effect of the setting aside: [136]-[141].

Voluntary disposition

The claim must be to set aside a voluntary disposition, as opposed to a contractual bargain. The grounds for setting aside a disposition on the grounds of mistake in equity only relate to non-contractual voluntary dispositions and not to bilateral transactions for value. The following elements must be present if common mistake is to avoid a contract: (i) there must be a common assumption as to the existence of a state of affairs; (ii) there must be no warranty by either party that that state of affairs exists; (iii) the non-existence of the state of affairs must not be attributable to the fault of either party; (iv) the non-existence of the state of affairs must render performance of the contract impossible; (v) the state of affairs may be the existence, or a vital attribute, of the consideration to be provided or circumstances which must subsist if performance of the contractual adventure is to be possible. In particular, the mistake must render the performance of the contract impossible.

As Morgan J said in Van der Merwe v Goldman [2016] 4 WLR 71, at para. 30:

So far I have divided the relevant cases into two broad classes, distinguishing between contracts and gifts. It is now necessary to consider more precisely the boundaries between these two classes of case. Some of the decided cases which discuss the equitable rules describe when they do, and when they do not, apply. Different terminology is used. There are references to “voluntary dispositions”, “unilateral transactions”, “gifts”, an intention “to confer a bounty” and these are contrasted with “contracts” and “bargains”. It has been said that the equitable rules apply where the recipient of benefit is “a donee” or “a volunteer”. In In re Butlin’s Settlement Trusts [1976] Ch 251 at p 260F-G, Brightman J distinguished between “a voluntary settlement” and “the result of a bargain, such as an ante-nuptial marriage settlement”. In Pitt v Holt at para 115, Lord Walker distinguished between a “voluntary disposition” and “a commercial bargain” and held that a voluntary disposition which was effected under seal was still a voluntary disposition; he referred to the presence or absence of consideration, and not merely the presence of a seal, as the critical distinction.

Morgan J went on to hold, at para. 31, that the distinction turned upon whether or not consideration had been given for the benefit conferred by the transaction. If the effect of rescission (or a declaration that a transaction is void) would deprive a party of a benefit for which he gave consideration, then the common law rules apply and there is no separate equitable jurisdiction to order rescission. Conversely, if the effect of rescission would deprive a party of a benefit for which he gave no consideration, then there is a separate equitable jurisdiction to order rescission, applying the principles in Pitt v Holt.

Mistake

There is a key distinction is between, on the one hand, a failure to give thought to tax consequences or mere ignorance of tax consequences and, on the other hand, a conscious, or even tacit, mistaken assumption that a transaction does, or does not, have particular tax consequences.

Suppose, for example, that a settlor settles property believing that his son is his legitimate son. The settlor will be making a mistake whether he has a conscious belief that his son is his son, or merely assumes this to be true.

Compare a case where a settlor settles property on his son who has been a member of the Communist party for many years. It has never occurred to the settlor that his son might hold such views. Now that he thinks about it, he can truthfully say that he would never have gifted property to his son if he had known that he was a Communist. In this case, the settlor does not make a qualifying mistake, although knowledge of the relevant fact would have altered his decision to benefit his son.

The line between a tacit assumption and mere inadvertence or ignorance can be difficult to draw. The courts have, however, in some cases, taken a relatively benign approach in finding a tacit assumption that a transaction does not give rise to adverse tax consequences, particularly in the case of tax-driven structures.

In Pitt v Holt Mrs Pitt received general advice, which referred to the various advantages that the proposed trust was expected to secure, and which mentioned income tax and CGT, but not IHT. In fact, the trust gave rise to significant IHT liabilities. Even though Mrs Pitt had not been specifically advised as to IHT, it was sufficient that she had an incorrect conscious belief, or made an incorrect tacit assumption, based on advice received, that the proposed trust (which had been the subject of advice from two professional firms, and approved by the Court of Protection) had no adverse tax effects.

It is not, therefore, determinative that the advice received has not touched directly on the ultimately mistaken feature (Abadir v Credit Suisse Trust Ltd [2021] EWHC 2573 (Ch), para. 10).

In Freedman v Freedman [2015] WTLR 1187 a settlor, on the advice of her father and his professional advisers, settled two properties on trust for herself for life, triggering an immediate IHT charge. Tax consequences had not been considered. One of the properties had been purchased with a loan from the settlor’s father, and the intention was to repay that loan when the other property had been sold. However, after payment of the IHT, there was insufficient value in the settlement to enable an appointment to be made to the settlor of a sufficient sum which would enable her to pay off a debt owed by her to her father.

HMRC argued that this was mere ignorance or inadvertence, but Proudman J did not agree. A person is ignorant of something when they have not thought about the consequences of an action at all. On the evidence, the settlor had a broad understanding based on the receipt of a professional letter of advice that the transaction was beneficial, coupled with a belief that her father would not advise her to act to her detriment.

Accordingly, there was at least a tacit assumption that entering into the settlement did not involve any impediment to compliance with the settlor’s agreement to repay the relevant loan. Indeed, based on the advice that the settlor have received, it was entirely reasonable for her to say that she had broadly understood that there would be no adverse tax consequences for her in entering into the settlement (an incorrect conscious belief).

In Van der Merwe v Goldman [2016] EWHC 790 (Ch) the claimant transferred, on 27 March 2006, the matrimonial home from his sole name into the joint names of himself and his wife, as trustees of a settlement in which they both had life interests. He did so in ignorance of the Budget announcement made on 22March 2006, later brought into retrospective effect from that date by Finance Act 2006, s. 49(1A). The consequence of the change to the law was that the claimant made a chargeable transfer to a relevant property trust, giving rise to significant IHT liabilities. The court held that the claimant’s ignorance of the effect of the Budget announcement, together with the effect of earlier advice in November 2005, led him to believe that no IHT charge would arise. The transaction was set aside.

If, therefore, a belief is mistaken, it does not matter that the applicant was ignorant of the fact or law which caused the belief to be mistaken.

However, in Rogge v Rogge [2019] EWHC 1949 (Ch) the Deputy Master examined the statements made by the claimants in relation to alleged mistakes, and considered that the statements demonstrated “mere ignorance” of the relevant tax positions, rather than ignorance giving rise to a conscious belief or tacit assumption as to a particular state of affairs. The fact that the statements were phrased as negative beliefs (such as that the claimant “did not understand that this charge would apply”), rather than positive beliefs, led the deputy master to this conclusion.

In Mackay v Wesley [2020] EWHC 1215 (Ch) Deputy Master Henderson held that the claimant’s decision to execute a deed appointing herself as trustee had been made due to causative ignorance, rather than a mistaken tacit assumption. The claimant’s evidence was that she had signed the deed because she would not have expected her father, the defendant, to ask her to sign a document that would put her in danger of liability for a large tax bill. The Deputy Master accepted the claimant’s evidence.

The Deputy Master did not think that such an assumption was a distinct mistake within the meaning of the equitable principles in Pitt v. Holt. While accepting that the claimant was mistaken about the effects of the deed, the Deputy Master found that the tacit assumption that her father would not ask her to sign a damaging document was too wide and vague to be a relevant mistake. The belief or assumption has to be more distinct and specific than that (para. 154).

The Deputy Master expressed the view that the claimant was essentially submitting that she did not think the deed would have any bad effects, and that this was “always going to be the case when a document has unanticipated effects.” The Deputy Master held that this was not a “distinct” mistake that was capable of triggering the equitable principles.

Evidence

It is important to present evidence as to the precise nature of the disponor’s belief. A transaction will not be set aside if there is an absence of sufficient certainty as to the donor’s belief as to the tax consequences. In Dukeries Healthcare Ltd v Bay Trust International Ltd [2021] EHC 2086 (Ch) the claimants sought orders that 3 trust deeds and their contributions to the trusts should be set aside. The claimants were a businessmen (Mr Levack) and companies which he owned. They had entered into a tax avoidance scheme which involved employee benefit trusts established with offshore corporate trustees, into which were settled the shares in a successful care-home business. The scheme was marketed by specialist tax advisers who produced information about the scheme for the client, prepared the relevant trust deeds, company resolutions and other necessary documents.

Although the scheme was said to have been marketed as not involving any tax avoidance, the scheme did not have the desired tax consequences, and indeed prevented the key individual, or any of his family, from benefiting after his death.

Mr Levack gave evidence under cross-examination that he had not in fact read any of the key documents of time, had delegated key functions to minor employees and did not think about most of the aspects of the schemes. Deputy Master Marsh accepted that it was not necessary for the director to have actually reviewed the trust deeds himself:

Clearly a lay person cannot be expected to obtain an understanding of the way in which the Remuneration Trusts were intended to work at a technical level. It suffices in the understanding, and therefore the mistake, is limited to the headline benefits that were expected to flow from the trusts. In order to be causative the understanding must flow through and be capable of being articulated when the deeds were executed. In order to be causative the understanding must flow through and be capable of being articulated when the deeds were executed.

The complete lack of understanding of the director, together with a lack of evidence from his chief tax adviser as to what his understanding was that the relevant time, failed to establish a causative mistake such as to justify relief. It was not possible to discern with sufficient certainty what Mr Levack’s understanding of the schemes was when he signed the relevant documentation. The claims, therefore, failed due to the inadequate evidence that have been provided that the claimants had acted under a mistake as to what the trust were expected to achieve.

Legal advice

If the disponor has taken tax advice, which fails to point out the relevant tax liability, it will, of course, be easier to establish a causative mistake as to tax consequences (see, for instance, JTC Employer Ser Trustees Ltd v Khadem  [2021] EWHC 2929 (Ch), paras. 35 to 36). In Suckling v Furness [2020] EWHC 987 (Ch), for instance, a settlor was not merely ignorant of the tax implications of setting up a trust, but was operating under a mistake, in the sense of a positive false belief, as to its tax implications. She had specifically raised the question of the tax implications of setting up a trust with a solicitor, who had wrongly advised that the Trust would not affect her tax position. That belief was basic to the transaction and was false.

A mistake may 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 (Pitt v Holt para.114).

In Hartogs v Sequent (Schweiz) AG [2019] EWHC 1915 (Ch) the claimant made a mistake in settling assets on trust, not appreciating that this would give rise to a substantial immediate IHT liability, as he had become deemed domiciled in the UK. He had received an email from his accountant which mentioned the change in his domicile status. He had asked his professional advisers to explain the email, but did not recall receiving a reply. Judge Hodge QC accepted the submission that even if it had been possible for the claimant to have pieced the consequences together, there would still have been a mistake. At its worst, the claimant had been careless, because he did not appreciate the implications of the email, but such carelessness was no bar to relief and did not change the position.

However, in the Dukeries case, the Deputy Master concluded that the failure by Mr Levack to consider the documents, or to obtain advice from someone who could interpret them, demonstrated a cavalier attitude to risk. There was no evidence of any due diligence having been undertaken by Mr Levack. He had failed to read any of the documents that were provided or to seek independent advice. The evidence pointed to Mr Levack being willing to run the risk of being mistaken.

Also, equally, there was inadequate evidence about the attitude to risk of the board of directors of the relevant companies. The evidence came nowhere near to demonstrating that their collective understanding was materially mistaken or what their view was about the risks involved. Where necessary to do so, the Deputy Master would have concluded that the claimants deliberately ran the risk of the schemes not operating in the way their tax adviser’s sales pitch had suggested.

Misprediction

A mistake must be distinguished from a misprediction. A misprediction relates to some possible future event, whereas a legally significant mistake normally relates to some past or present matter of fact or law. So, for instance, the failure of a person to predict that he will be killed in a road accident is not an operative mistake (Pitt v Holt, at [113]).

In Ogden v Griffiths Trustees [2009] Ch 162 Mr Griffiths made a number of PETs into trust. He died within 3 years, with the result that the transfers were chargeable to IHT. He was, when he made the last and largest transfer, suffering from undiagnosed lung cancer. His executors sought to set aside the transfers on the grounds that they had been made under a mistake as to his short life expectancy. If the transfers were set aside, the property would fall into residue for the benefit of Mrs Griffiths by way of an exempt transfer. The claim succeeded.

Lewison J held that, at the time of the two earlier transfers, Mr Griffiths did not have lung cancer. He did not, therefore, then make any mistake about his state of health. The earlier transfers were, therefore, not set aside.

Lewison J did, however, set aside the last transfer on the grounds that Mr Griffiths then made a mistake about his state of health (a mistake as to an existing fact). He was at that time unaware that he was suffering from lung cancer, such that his chance of surviving for 3, let alone 7, years was remote. For this reason, he could be said to have been operating under a mistake, rather than a misprediction. He would not have made the transfer, if he had known this.

In Pitt v Holt (para. 113) Lord Walker cast some doubt on this conclusion, commenting that the position seemed close to the residual category of mere causative ignorance, rather than a tacit assumption. He also referred to Lloyd L.J.’s observation in the Court of Appeal in Pitt v Holt that it was strongly arguable that, having declined to follow a financial consultant’s recommendation of term insurance, Mr Griffiths had taken the risk of deterioration of his health and failure to survive the statutory period.

In Bhaur v Equity First Trustees [2021] EWHC 2581 (Ch) the High Court refused an application for rescission of a marketed tax avoidance scheme involving property transferred to an employee benefit trust. The trust property comprised shares of one of the companies which in turn held the equitable title to various properties. The purpose of the arrangement was to mitigate inheritance tax and the death of Mr Bhaur, whilst enabling his family to continue to maintain a degree of control over the underlying assets. The scheme did not, however, work for tax purposes. It was, in essence, a sham involving the transfer of assets into a company remuneration trust for employees that the company did not have and did not propose to have.

Nonetheless, the court held that the Bhaur family in general, and Mr Bhaur in particular, were not mistaken at the time they signed up to the scheme. The family were careful and painstaking in their approach to the family businesses. Documents were read; points considered; issues evaluated. The family knew that entry into the scheme was a decision of considerable moment and that there was a risk of challenge by HMRC.

The family’s principal miscalculation was that if the scheme went wrong, and the tax authorities became involved, the scheme could simply be reversed. The only downside, to their way of thinking, was that they would have incurred irrecoverable fees and expenses. That belief was undoubtedly wrong, but it was held not to be a mistake. It was a misprediction. They gave no thought to the point that the transactions would not be reversible at will if things went wrong.

On appeal ([2023] EWCA Civ 534), the Court of Appeal held that the scheme was properly characterised by the Judge as a misprediction. Mistakes related to past or present matters of fact or law, whereas mispredictions related to possible future events. Equity might intervene to correct a mistake, but would not do so in relation to a misprediction. Even if a person was operating under a mistaken belief of fact or law that was relevant to their assessment of the risks of making a gratuitous disposition, they could still be denied relief if they deliberately decided to go ahead and run the risk of being wrong. The individual appellants knew that there was a risk that the scheme would be successfully challenged by HMRC, although they might not have appreciated the full extent of the potential adverse consequences for them if the scheme did not work. However, they must at least have appreciated that there was a risk that the financial consequences of the scheme’s failure would not be entirely neutral, and might even be worse than the inheritance tax regime that would have applied in its absence. On the judge’s findings, two of the appellants had made a deliberate decision to implement the scheme in the knowledge that there was a risk that it would fail to achieve the desired tax benefits and that they might end up worse than before. Accordingly, even if they were mistaken as to their ability to reverse the transactions, they deliberately decided to run the risk of being wrong.

Serious mistake

The mistake must be causative, in the sense that, but for the mistake, the disponor would not have entered into the transfer at all, if they had been aware of adverse tax consequences, or of the real risk of adverse tax consequences (Hopes v Burton [2022] EWHC 2770 (Ch), para. 63). This may, as in Rogge v Rogge [2019] EWHC 1949 (Ch), involve a careful analysis of the evidence as to whether, at the date of any particular disposition, the disponor was influenced by the mistake to make the transfer.

It is sufficient if the disponor would not have made the relevant disposition, in the manner that they did, but for their mistake as to the tax consequences. In Payne v Tyler [2019] EWHC 2347 (Ch) a premature appointment was set aside, as giving rise to a tax liability, where no such liability would not have been incurred if the appointment had been made at a later date. In Smith v Stanley [2019] EWHC 2168 (Ch) an appointment giving rise to an unexpected tax charge was set aside on the basis that, but for the mistake as to tax, another mechanism would have been found to appoint without giving rise to a tax liability.

In Pitt v Holt there was a transfer into a relevant property trust of assets worth £800,000, giving rise to an entry charge of £100,000, and to the potential for 10-year and exit charges. The uncontroverted evidence was that the tax liability including both interest and penalties (if exacted) would be between £200,000 and £300,000. Such liabilities could have been avoided by a settlement on a disabled person’s trust.

Mr Pitt had died by the time the matter came before the court. On his death, there was only £6,259 left in the trust, as the fund had had many calls on its resources with heavy professional costs and expenses as well as making provision for the welfare and care of Mr Pitt and the maintenance of Mrs Pitt.

In the Guernsey case of Re Abacus Global Approved Management Trust 18 ITELR 753 the Bailiff said this, at para. [33]:

It is my understanding that having looked at the facts of Pitt in the round, a significant element in the Supreme Court’s objective analysis was that if the mistake had not been corrected, there would have been insufficient funds in the settlement to pay the inheritance tax which would have been or become due and, of greater significance, that there was not then have been funds available to provide for Mr Pitt. Thus the whole purpose of the structured settlement for the payment of damages to him would have been frustrated and defeated. For those reasons it would have been unconscionable (or unjust or unfair) on the part of the trustees to insist on upholding the terms of the vitiated trust.

At paragraph [47] the Bailiff went on to say:

In Pitt, the husband of the first claimant, if he had not died, would have been deprived of the funds needed to provide for his needs for the rest of his life, which was the sole purpose for which the settlement was established.

Some support for this analysis derives from the judgment of Lloyd L.J. in the Court of Appeal in Pitt v Holt, at para. 214:

Instead, the moment that the assets were transferred into the Special Needs Trust, the assets, then worth of the order of £800,000, became subject to a liability for about £100,000 IHT, secured by an immediate charge on the assets, and to the prospect of future liabilities on the withdrawal of assets from the trust, and on the assets in the trust every ten years. The assets which can be assumed to have been adequate, but no more than that, to provide for Mr Pitt’s needs for the rest of his life, and which, apart from his home, were the only assets of any substance that were available for that purpose, thereby immediately became significantly less than adequate for that purpose. It could be foreseen that they would become even more inadequate when further charges to IHT arose.

It is implicit that relief might not have been given if the tax charges were not so great as to frustrate the purpose of the trust.

However, there are cases where a tax liability is, in itself, sufficiently serious, if sufficiently large. In Bainbridge v Bainbridge [2016] EWHC 898, a disposal of land gave rise to a CGT liability of £200,000. The disposal was set aside, notwithstanding that the recipient trustees sold some of the land. In Payne v Tyler [2019] EWHC 2347 (Ch) the mistake was characterised as serious. First, the amount of tax payable as a result of the mistake (£112,000) was significant in real terms, representing about 40% of the value of the trust fund. Second, the effect of the mistake was completely to negate the effect of a Deed of Variation which was an unexceptionable step of tax mitigation. In Van der Merwe v Goldman [2016] 4 WLR. 71 the key factor leading to Morgan J’s conclusion that a sufficiently serious mistake had been made was the heavy size of the tax bill resulting from the claimants’ arrangements: this amounted to about £450,000. Likewise in Kennedy v Kennedy [2014] EWHC 4129 (Ch), the size of the claimants’ tax bill was material – in that case, it was around £650,000. In Smith v Stanley [2019] EWHC 2168 (Ch) trustees appointed assets in such a way as to give rise to an unexpected IHT liability of £737,000. That was a serious mistake. In Suckling v Furness [2020] EWHC 987 (Ch) the tax charges represented between 13% and 23% of the value of the property in question. Those could not be paid unless the trust property were sold, there being insufficient rental income to fund the tax liabilities.

In Freedman v Freedman Proudman J suggested that if the only consequence of the mistake made by the claimant had been the payment of inheritance tax, this might not have been sufficiently serious. However, on the facts, it was clear that the purpose of the transactions had been to protect the properties that were in the claimant’s name, while also facilitating the repayment of a loan to the claimant’s father. The extent of the inheritance tax liability was such that the claimant would not be able to repay the loan, and as such, it was a sufficiently serious mistake. In other words, the purpose of the trust was frustrated by the tax charge.

However, it seems that the creation of a significant, and unexpected, tax liability may in itself be sufficient, even if there are no other consequences. It is not pointless, nor is it acting in vain to set aside a transaction and to remove a liability to pay tax, even where that is the principal or the only effect of rescission (Pitt v Holt, paras. 136-141).

Unconscionability

The assessment of what is or would be unconscionable is an objective one. The gravity or seriousness of the mistake must be assessed by a close examination of the facts, whether or not tested by cross-examination, including the circumstances of the mistake and its consequences for the donor. The injustice of leaving the disposition uncorrected must also be evaluated with an intense focus on the facts of the particular case.

In many cases, such as where assets are transferred into a trust for the benefit of a class of beneficiaries, the trust would be better off if the transfer into the trust were not set aside. If there is rescission, the trust assets would revert to the settlor, and be lost to the trust.

It may not, therefore, be unconscionable for the recipient of a gift to retain beneficial ownership of the gifted property, if the only person affected by the tax liability is the recipient.

In the Guernsey case of Re Abacus Global Approved Management Trust 18 ITELR 753 the applicant received a distribution from a pension fund, having been advised that it would be tax-free so long as it was not remitted to the UK. That advice was wrong. The recipient was liable to pay 40% income tax in the UK. The Guernsey Royal Court considered the issue of unconscionability in the light of Lord Walker’s judgment in Pitt v Holt. The only person affected, if the distribution was not set aside, would be the donee, i.e. the applicant. No other person, such as family members or third parties (apart from HMRC) would be affected. It was not, therefore, unconscionable, unjust or unfair as against any third party that the applicant should retain the proceeds of the distribution made to him, net of his tax liability.

In Rogge v Rogge [2019] EWHC 1949 (Ch) a transfer into a trust gave rise to a number of tax liabilities (such as IHT on the death of the life tenant, or the termination of his interest, and a CGT liability on the disposal of the trust property) affecting the trust to which property had been transferred by the settlors. The persons who would potentially suffer the consequences of the alleged additional mistakes were the beneficiaries, and not the settlors. The trustees would not, therefore, be acting unconscionably if they wished to keep such rights as the trust gave them in the settled funds. The Deputy Master said, at para. 122:

In the present case the persons who will suffer from the consequences of the alleged additional mistakes are not the First Claimant or the Second Claimant who provided the funds for the Trust, but potentially some of the beneficiaries or potential beneficiaries of the Trust who the Claimants had intended to benefit. In my judgment, looked at objectively, as required by Pitt v Holt , those beneficiaries or potential beneficiaries would not be acting unconscionably in relation to the alleged additional mistakes if they said that they would prefer to stick with such rights or interests as the Trust gave them in the settled funds and the property, rather than effectively letting it all go back to the Claimants for them to deal with under an undertaking to the court or, perhaps otherwise as they saw fit.

Thus, if the tax charges fall on the trust, and not on the settlor, that may be a bar to relief, on the basis that trustees would not be acting unconscionably if they sought to retain the trust property. Presumably, that would be the case even if the trustees do not actually contest, or support, the claim. The court must still determine whether retention of the trust property would be unconscionable; if it is not, the claim may fail.

There may, however, be considerations which make it proper for trustees to accede to an application for rescission and/or which would persuade the court that it would be unconscionable if the trustees were to oppose rescission.

The settlor may be prejudiced by the tax charges, if the settlor is the beneficiary, or the principal beneficiary, of the trust. The settlor in Suckling v Furness the settlor was the life tenant of the trust. The settlor was liable to IHT and CGT on the creation of the trust, and there were ongoing tax liabilities in the trust. The settlement was set aside.

In Pitt v Holt the trust fund was, on the death of Mr Pitt, held upon trust to vest the same in Mr Pitt’s personal representatives. This meant that any remaining value in the fund was in the same beneficial ownership as if the trust had been set aside by the court (para. 137). Mrs Pitt was the residuary beneficiary of Mr Pitt’s estate. The Trustees, therefore, had a choice as to whether to accede to the claim, in which case the trust property would be held upon trust for Mrs Pitt (by way of a spouse exempt transfer) free of the entry charge, exit and 10-year charges, and the charge on Mr Pitt’s death; or to resist the claim, in which case they would have held the trust property on trust to pay to Mr Pitt’s personal representatives on trust for Mrs Pitt in any event. However, in the latter case, the trust fund would have been diminished to nothing by the entry charge, exit and 10-year charges. Clearly, the correct choice was for the trustees to consent to the claim for rescission.

In Hartogs v Sequent (Schweiz) AG [2019] EWHC 1915 (Ch) the settlor transferred assets to a discretionary trust for the benefit of the settlor’s family, giving rise to an unanticipated IHT entry charge and future charges. The corporate trustee gave careful consideration to the position which it should adopt in the proceedings for rescission, in the light of the interests of the beneficiaries. The trustee, through its director and solicitor, canvassed the views of the claimant’s wife, who was also the mother of one of the minor beneficiaries, and of the claimant’s two adult daughters. The trustee supported the claim on the basis that if there were no rescission: (1) there would be a substantial depletion of the trust’s funds/assets in consequence of ongoing tax liabilities; (2) the trustee had no current intention to make a distribution to the beneficiaries, but would instead consider making an appointment of the entirety of those assets to the claimant and/or his wife in order to avoid any further tax charges; and (3) the claimant intended to pass on his wealth to his family in due course.

In Kennedy v Kennedy [2014] EWHC 4129 (Ch), assets were appointed by trustees to beneficiaries giving rise to an unforeseen CGT liability, which would have fallen on the remaining assets in the settlement held on trust for all of the beneficiaries (para. [38]). Persons other than the appointees were, therefore, affected.

Gifts with reservation of benefit

Where assets are given to a trust, in which the donor mistakenly reserves a benefit for IHT purposes, there will generally be no grounds for rescission. If the transfer into the trust is set aside, the trust property will form part of the settlor’s estate (albeit that the spouse exemption might then apply). In any event, the primary liability for IHT in respect of the reservation of benefit falls on the donees, not on the settlor (IHTA 1984, s. 200(1)(a), 204(9)). Arguably, therefore, it would not be unconscionable if the trust property remained in the trust, subject to the reservation of benefit charge.

In Rogge v Rogge [2019] EWHC 1949 (Ch) transfers of to a trust, used to purchase land on which to build a house, were set aside on the grounds of a mistake by the transferors that they would not be reserving a benefit for IHT purposes in occupying the property. The transferors took professional advice and were wrongly advised that they could avoid a reservation of benefit if they paid rent for the periods when they were physically present at the property, otherwise than as carers for their son. That advice was wrong. In order to avoid a reservation of benefit, the transferors needed to pay rent by reference to the whole period of their occupation and use, including the times when they were not physically present at the property, and even when they were acting as “carers” for their son. Accordingly, the transferors had been mistaken in thinking they could minimise the risk of the reservation of benefit rules applying by paying the rent that they were advised to pay, whereas they needed to pay greater rent.

Deputy Master Henderson accepted that, had the transferors known of the need to pay rent of in excess of £100,000 pa for the period of their future occupation (potentially the rest of their lives costing in excess of £3m), they would not have transferred money to the trust, or gone ahead with the trust transaction. The mistake – as to the need to pay rent – had a very significant impact on the donors. It was, therefore, unconscionable for the trust to retain property, representing the money given to it by the donors.

Artificial tax avoidance

In Pitt v Holt Lord Walker said that in some cases of artificial tax avoidance the court might think it right to refuse relief, either on the ground that they 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 the grounds of public policy. He said that there had been an increasingly strong general recognition that artificial tax avoidance is a social evil which puts an unfair burden on the shoulders of those who do not adopt such measures.

In the Dukeries case there was a significant element of artificial tax avoidance including: the use of a trust having a trustee resident overseas; the nominal interposition of an overseas resident company; the use of a trust described as a remuneration trust when all past and present employees were excluded from benefit; non-commercial loans; and the expectation that the loans would not in practice be repaid.

The Deputy Master held that the schemes were properly characterised as being artificial tax avoidance. Even if there was no actual assumption of risk, it was reasonable to conclude that Mr Levack and the companies must be taken to have accepted the risks of the schemes failing. That conclusion was not unjust. Put another way, the claimants had not shown that it would be unconscionable for them to remain bound by the schemes.

In Bhaur v Equity First Trustees [2023] EWCA Civ 534 the Court of Appeal held that the scheme in question was, on any objective view of the facts, an entirely artificial tax avoidance scheme, given that the company had only three employees who were all members of the same family. The trust had no independent business or commercial purpose and was brought into existence purely for the purposes of tax avoidance. It was a weighty factor against the grant of relief that artificial tax avoidance placed an unfair burden on those who did not adopt such measures. On that basis, it would not be unjust or unconscionable to refuse equitable relief.

Moreover, the scheme was, on any objective view of the facts, an entirely artificial tax avoidance scheme, given that the company had only three employees who were all members of the same family. The trust had no independent business or commercial purpose and was brought into existence purely for the purposes of tax avoidance. It was a weighty factor against the grant of relief that artificial tax avoidance placed an unfair burden on those who did not adopt such measures. Even on the basis that the appellants were not complicit in the dishonesty of Aston Court, it would not be unjust or unconscionable to refuse equitable relief (paras 101-106).

In summary, in the case of an artificial tax avoidance scheme, the court may well find that the disponor subjectively accepted the risk of the scheme failing; but, even if not, that, objectively, they must be taken to have assumed that risk.

Equitable defences

Equitable defences, such as delay and acquiescence,  may be invoked as a defence to a rescission claim.

In Pitt v Holt, after the mistake was discovered, the trust continued to be administered and Mrs Pitt in her capacity as the receiver of Mr Pitt, and she continued to receive and apply payments from the trust. That did not prevent the trust and the transfers onto its trusts from being set aside.

The applicant may in such circumstances be required to undertake not to make any claims against the trustees or the beneficiaries other than the applicant, in respect of distributions from the trust (see Lord Walker’s judgment in Pitt v Holt, paras. 138 and 141; Rogge v Rogge, para. 172).

In Pitt v Holt the mistake was identified in 2003, but no claim was made until around 2009. The party opposing the relief (the Revenue) did not raise any objection on the grounds of delay. It must, however, be good practice to bring any claim promptly once a mistake has become apparent.

Tracing

In Bainbridge v Bainbridge [2016] EWHC 898 (Ch) land had been voluntarily transferred to trustees pursuant to a mistaken belief that this would not trigger a CGT charge. Two pieces of land were later sold by the trustees, and the sale proceeds were used to buy new land. The claimants accepted that the purchasers of the trust land had been in good faith and did not seek an order impugning the sales. Instead, they sought and obtained an order that legal title to the new land should be transferred to them. Master Matthews accepted that third parties should not be deprived of rights that they had acquired. However, that was not a bar to rescission resulting in the rights now belonging to third parties being restored to the claimant. In a case where third party rights could not be disturbed, there was no reason not to apply the tracing process to exchange products of the transferred property in order to find other assets to which to make a claim instead.

Counter-restitution

Rescission may be granted on terms. In Rogge v Rogge [2019] EWHC 1949 (Ch) gifts had been made both before and after the transferor becoming aware of the effect of the gift with a reservation of benefit rules. The gifts had been applied in the purchase of one property. Deputy Master Henderson accepted that any terms and conditions imposed on an order for rescission should at least so far as possible be aimed at putting the parties against whom rescission is ordered substantially into the positions they would have been in if the mistaken transaction had not taken place. Restitution was granted of the whole on the basis that the settlors provided counter-restitution to the trustees in respect of the non-mistaken transfers, and on terms that rescission would not give rise to claims against the trustees.

Professional negligence claim

In Pitt v Holt, the background to the rescission claim was a professional negligence claim, which was settled before the Supreme Court determined the rescission claim.  Lord Walker commented (para. 90), that had it gone to trial the claim, even if successful in establishing duty and breach, might have faced difficulties over causation, since Mrs Pitt executed the trust under the authority of an order of the Court of Protection, which had considered its terms. That difficulty will not, however, apply in many cases. It may well be that a professional negligence claim is appropriate.

A rescission claim does have the attraction that there is no requirement to show any fault or breach of duty. A serious mistake, even one arising out of ignorance, may be sufficient.

If a rescission claim is pursued, the words of Judge Hodge Q.C in Hartogs v Sequent (Schweiz) AG, at para. 37, should be headed:

I should emphasise that the principles established by the Supreme Court in Pitt v Holt 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. The Supreme Court’s decision imposes strict limits on the circumstances in which a voluntary disposition may be set aside on the grounds of mistake.

It will, therefore, be necessary to prove that there was a mistake, rather than a misprediction, with no deliberate running of the risk of adverse tax consequences; that the mistake was sufficiently serious and causative; that it would not be unconscionable on the part of the donee to retain the property; and that there is no artificial tax avoidance.

CHARLES HOLBECH.