It was a mistake

The recent decision of the Court of Appeal in Bhaur and others v Equity First Trustees (Nevis) Ltd and others [2023] EWCA Civ 53 (Bhaur) provides helpful guidance on when a court will set aside a transaction (and thereby unwind adverse tax consequences) on the grounds of mistake.

"A claim to set aside voluntary transactions on grounds of mistake is always worth considering where a taxpayer is faced with unexpected tax consequences." 

The case concerned a tax avoidance scheme involving the establishment of an employee benefit trust, and the court refused relief on the basis that this was artificial tax avoidance, where the taxpayer had deliberately run the risk of the scheme failing.

While the decision is not surprising on the facts of the case, a key takeaway is that the English courts remain receptive to claims to set aside voluntary transactions on grounds of mistake in the right circumstances – such a claim is always worth considering where a taxpayer is faced with unexpected tax consequences.

Background

Mr and Mrs Bhaur, a married couple, had built up a substantial property business in the United Kingdom over several decades, funded from the profits of a retail clothing venture. In late 2006, Mr and Mrs Bhaur were considering their estate and tax planning options. They were introduced to Aston Court, a tax advisory business operated by a solicitor named Mr O’Toole. Mr O’Toole subsequently devised a tax scheme for the Bhaur family.

The scheme involved Mr and Mrs Bhaur transferring their business into a trust designed to take advantage of the favourable tax treatment for employee benefit trusts (EBTs) under IHTA 1984, s 13. Where that section applies, a disposition of property made to the trustees of an EBT by a close company will not be treated as a transfer of value for inheritance tax purposes (and so no upfront inheritance tax charge will arise).

In accordance with Aston Court’s advice, in February 2007, Mr and Mrs Bhaur incorporated their business and transferred the beneficial interests to a UK company owned by them, Safe Investments UK (SIUK).

SIUK then hived those interests down to a newly created wholly-owned subsidiary, Gooch Investment (GI), a BVI company. The GI shares were then transferred to a BVI trust (known as the ‘First Staff Remuneration Trust’ (FSRT)) for a class of beneficiaries including employees and former employees of SIUK and their spouses, children or dependents (but excluding ‘participators’ in SIUK and persons connected with them). Notably, upon establishment of the trust, SIUK had no employees and the Bhaur family accepted that there was never any intention to enable non-family staff to benefit. The entire purpose of the trust structure was to benefit the family by passing the business to the children while avoiding inheritance tax.

The intended analysis was that the transfer of the beneficial interests to SIUK would be tax neutral under the exemption for transfers to EBTs in IHTA 1984, s 13. For these purposes, SIUK was a close company, both Mr and Mrs Bhaur were participators in it and their sons were connected to them. As participators in the company, in order for IHTA 1984, s 13 to apply, Mr and Mrs Bhaur and their sons could not benefit from the trust save through payments of income. However, at the time of establishing the EBT, there was a view held by some in the tax planning industry that the exemption would become available after the death of Mr and Mrs Bhaur, on the basis that the sons would no longer be ‘connected persons’ for the purposes of IHTA 1984, s 13(2)(d).

On that analysis, the sons would be entitled to benefit from distributions of assets from the trust free of inheritance tax.

That view of the legislation was initially upheld by the High Court in Barker v Baxendale Walker. However, it was firmly rejected by the Court of Appeal in the same case, who held that it was implausible that Parliament had intended for EBTs to be used for dynastic estate planning in this way.

HMRC challenged the arrangements in July 2010, arguing that IHTA 1984, s 13 did not apply to the transfer of the shares by SIUK, thereby giving rise to an upfront inheritance tax charge. The dispute had not formally been resolved at the time of the claim. However, the claim was premised on the assumption that the scheme would not only not deliver the intended tax benefits described above, but would also have other seriously disadvantageous tax consequences.

In addition, while not relevant to the claim, following the HMRC investigation and disagreements with the family, the interests in the business ended up being held by a Mauritius protected cell company on the terms of a Mauritius purpose trust. This was subsequently terminated and the whole trust fund was appointed out to the NSPCC.

With this background, the Bhaur family issued a claim in the High Court in October 2018, to set aside on grounds of mistake the initial settlement by SIUK of the GI shares onto the terms of the FSRT.

Legal principles

It is helpful first to consider the legal principles underpinning a claim for mistake.

The leading case on the doctrine of mistake is the Supreme Court decision in Pitt v Holt. Under that doctrine, a court may set aside a voluntary disposition on grounds of mistake provided the following conditions are satisfied:

1. there must be a distinct causative mistake as distinguished from mere ignorance. The court may draw an inference of a conscious belief or tacit assumption from the evidence;
2. carelessness is not a bar, unless the taxpayer deliberately ran the risk of being wrong;
3. the mistake must be sufficiently serious so as to render it unjust or unconscionable on the part of the donee to retain the property given to him (derived from Ogilvie v Littleboy). The test is normally 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; and
4. the injustice of leaving a mistaken disposition uncorrected must be evaluated objectively but with an intense focus on the facts of the particular case.

If a transaction is set aside on this basis, the legal effect is that it never happened. The tax treatment will follow this – so any adverse tax consequences arising from the transaction itself will no longer follow.

In the present case, the Bhaur family argued that the disposition by SIUK under the scheme should be set aside for mistake as to their understanding of the tax consequences, that they were mistaken in their belief that the advice given by Mr O’Toole was that of an honest solicitor and that they mistakenly believed they would retain control of their properties. If successful, the transfer of property into the EBT would be set aside ab initio, thereby extinguishing the inheritance tax liabilities on the transfer (including all interest and penalties). Other consequences would need to be worked through.

It will be noted that the disposition in question was made by a company, SIUK. The case proceeded on the basis that the mistake jurisdiction applies equally to companies as to individuals; and that for this purpose the relevant states of mind to be attributed to SIUK were those of Mr and Mrs Bhaur, its shareholder-directors.

"The case proceeded on the basis that the mistake jurisdiction applies equally to companies as to individuals."

Mistakes about tax

One key point established by Pitt v Holt was that the equitable doctrine of mistake can apply to a mistake as to the tax consequences of a transaction. There had previously been thought to be a distinction between a mistake as to the effect of a transaction and as its consequences, but that was rejected by Lord Walker in Pitt v Holt as unworkable.

At the same time, the jurisdiction has its limits. In Pitt v Holt, Lord Walker considered the question of whether there were some types of mistake about tax that should not attract equitable relief.

He identified that in some cases of ‘artificial tax avoidance’ the court might refuse relief, either on the ground that the claimants must have accepted the risk or as a matter of public policy. It is interesting to note that courts in other jurisdictions which recognise the law of mistake do not take the same view in relation to artificial tax avoidance.

Mistake or misprediction?

The law distinguishes between a mistake and a misprediction. The court will not intervene where the disposition is based on a misprediction as to some future event. For example, in Re Griffiths it was held that the taxpayer had merely mispredicted that he would survive a lifetime disposition (a potentially exempt transfer under IHTA 1984) by seven years, such that the doctrine of mistake was not engaged.

Decision in Bhaur

Mr Justice Marcus Smith dismissed the claim in the High Court. He found that Mr Bhaur and the other members of the family did not make a relevant mistake but simply mispredicted the adverse consequences of the scheme failing and that they could simply reverse it if necessary. Furthermore, Mr Bhaur and his family were not mistaken about the essentially tax evasive nature of the scheme but gave their implicit agreement to Mr O’Toole and Aston Court’s dishonest attempt to mislead HMRC as to the true nature of
the EBT.

The Bhaur family appealed to the Court of Appeal. The Court of Appeal dismissed the appeal. It was held that the Bhaur family had made a deliberate decision to implement the scheme, knowing that there was a risk that it might fail to achieve the desired tax benefits, and that it may be successfully challenged by HMRC. The court also found that the Bhaur family’s mistaken belief as to Mr O’Toole’s honesty was not relevant to mistake.

Further, even on the basis that the Bhaur family were not complicit in the dishonesty of Aston Court, it would not be unjust or unconscionable to refuse equitable relief and leave the consequences of their mistaken belief uncorrected. It was held to be of significant weight that the scheme was, on any objective view of the facts, an entirely artificial tax avoidance scheme.

In the circumstances, it was difficult to imagine a more artificial construct. The Bhaur family had themselves pleaded that SIUK had no need to set up an EBT to reward any employees.

Indeed, the company only hired three personnel, who were all members of the Bhaur family and who were not intended to benefit as employees under the trust structure. While recognising that tax avoidance is not unlawful, the court agreed with Lord Walker’s observations in Pitt v Holt that artificial tax avoidance is a social evil. The court considered that this was a very weighty factor against the grant of any relief.

Practical considerations

The judgment of the Court of Appeal in Bhaur is a salient reminder that the English courts will not look favourably upon claims for mistake to unwind artificial tax planning arrangements. The court was unequivocal that artificial tax avoidance will count as a compelling factor against exercising its mistake jurisdiction.

Whether the arrangements are ‘artificial’ will depend on the particular facts of the scheme and its implementation. Dukeries Healthcare Limited v Bay Trust International Limited is an example of another case where the High Court refused relief in a similar context involving the use of ‘remuneration trusts’.

Both Dukeries and Bhaur are towards the extreme end of the artificial tax avoidance spectrum. It will be interesting to see how the courts explore these issues in future in cases that are more at the margins.

Mistake claims and the resolution of tax issues

There have however been a number of recent examples of successful claims for mistake involving unexpected tax liabilities where the tax arrangements involved have not been artificial tax avoidance. For example:

• In Hartogs v Sequent, the High Court set aside transfers of various assets including a classic car collection by an individual to a BVI company held under a Guernsey trust, at a time when he was advised that he was non-domiciled for UK tax purposes but was, in fact, deemed domiciled. This would have given rise to over £3m in unpaid inheritance tax (including interest and penalties) absent the application.
• In Payne v Tyler, the High Court set aside a deed of appointment entered into by the trustees of a will trust to give the beneficiary an irrevocable life interest. The trustees were incorrectly advised that on the death of the beneficiary the deed of appointment would not give rise to an immediate post-death interest (IPDI) for the purposes of IHTA 1984, s 49A. As the deed was executed within two years of death, it was treated as an IPDI under IHTA 1984, s 144 which would have given rise to an additional inheritance tax liability.
• In Mackay v Wesley (a case in which the authors acted for the claimant), the High Court (on appeal) set aside an individual’s acceptance of her appointment as a trustee of an offshore trust used as part of a ‘round the world’ scheme, the effect of which was to leave the individual liable to over £1.6m in unpaid capital gains tax (including interest and penalties). At first instance, the High Court considered a number of points on the law of mistake, but ultimately refused relief (albeit not on grounds that it was artificial tax avoidance). The appeal was allowed, albeit on different grounds (namely undue influence). The effect was that the claimant was treated as if she had never been a trustee of the trust, with the result that she was not liable for the CGT.

These cases demonstrate the merit for taxpayers and their professional advisers of considering whether a claim for mistake (or other equitable remedy such as rectification) may be available when faced with unexpected tax consequences of a historic transaction. A successful claim for mistake will have the effect of unwinding a transaction, thereby extinguishing adverse tax consequences (although other consequences will need to be considered).

Such a claim will need to be brought in the High Court. There is something of an open debate about whether, notwithstanding the fact that it cannot grant the remedy itself, the First-tier Tribunal has jurisdiction nevertheless to decide a taxpayer’s tax position as if an equitable remedy such as mistake would have been granted (assuming the conditions are made out).

There is some authority to this effect, albeit the leading case (Lobler v HMRC) relates to a claim for rectification in an exceptional set of circumstances. While a full exploration of the arguments is outside the scope of this article, it suffices to say that HMRC has challenged the tribunal’s jurisdiction in a number of recent cases, and many taxpayers (such as the Bhaur family and those in the other cases referred to above) have launched proceedings in the High Court. In the authors’ view, a High Court claim is frequently the better option, given the jurisdiction is clear (and HMRC often will not contest the claim).

"In the authors’ view, a High Court claim is frequently the better option, given the jurisdiction is clear (and HMRC often will not contest the claim).”

Conclusion

When unexpected tax issues arise, consideration should be given to whether a claim for mistake (or another equitable remedy such as rectification) might be available which would have the effect of eliminating the tax liability.

This is particularly so in a case involving any trust or gift, although such remedies are available in a much broader range of cases. The decision in Bhaur makes clear, however, that the law of mistake is not some form of get out of jail free card for those who engage in artificial tax avoidance schemes. The view of the English courts remains that if you play with that sort of fire, you may well get burnt.

This article first appeared in Taxation on 22 June 2023 and is reproduced with the kind permission of the publishers.