Tax mistakes – when will the Court assist to unwind a transaction?

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Summary: The Court has a wide discretion under the equitable doctrine of Mistake to undo voluntary transactions which are made on the basis of a mistake. The 2013 Supreme Court case of Pitt v Holt clarified circumstances in which the court will set aside a transaction the test for this purpose but also raised questions over when the Court might refuse to grant relief in the context of tax avoidance. BLP recently acted in the case of Van der Merwe v Goldman which provides some further clarity on the issue.

You should read this if you or your client are looking to set aside a transaction on the basis of a mistake relating to tax.

The test distilled in Pitt v Holt

The landmark case of Pitt v Holt clarified the test for setting aside a voluntary transaction on the basis of a mistake. Lord Walker gave the lead judgment and held that for the Court to intervene and set aside a transaction:

  • there must be a mistake (rather than mere ignorance, inadvertence or misprediction);
  • there must be a mistake of sufficient gravity (i.e. as to some matter of fact or law that is basic to the transaction); and
  • the Court must be satisfied that it would be unconscionable, unfair or unjust to leave the mistake uncorrected.

Tax mistakes

Lord Walker also gave specific consideration to tax mistakes. He rejected HMRC’s submission that, as a matter of principle, mistakes as to the tax consequences of a transaction should never be relieved. However, he went on to state that:

In some cases of artificial tax avoidance the court might think it right to refuse relief… on the ground that discretionary relief should be refused on grounds of public policy…. there has been an increasingly strong and 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…”

These obiter comments left practitioners, and indeed HMRC, in suspense over the circumstances in which the Court might refuse to set aside tax mistakes.

Van der Merwe v Goldman

The case of Van der Merwe v Goldman is the first time the Court has had the opportunity to consider Lord Walker’s comments.

The case concerned a transfer of a family home into a life interest trust. This gave rise to an inheritance tax charge that the settlor was not aware of (the tax charge arose as a result of changes introduced by the Finance Act 2006 which came into effect after he had taken advice). The settlor therefore applied to have the settlement set aside on the grounds of mistake. 

HMRC’s public policy argument

HMRC opposed the application and alleged that the steps taken by the Settlor constituted artificial tax avoidance and that the Court should therefore refuse relief on the grounds of public policy (as anticipated by Lord Walker). HMRC accepted that the judge at first instance did not have jurisdiction to make a decision on this issue and so applied for a certificate for leave to appeal directly to the Supreme Court on this point. Their application was denied.

In refusing HMRC’s application, Morgan J commented that he could “well understand” why HMRC wanted clarity over the public policy principle raised by Lord Walker but he found it “very unlikely” that the principle “if it existed, could be of such an ambit as to extend to the facts of this case.”

So what can we expect from the Court?

First off, Van der Merwe reaffirms that, as a matter of principle, the Court can intervene to set aside a voluntary transaction on the basis of mistake where the mistake is about the tax consequences of the transaction

The decision also makes clear that Lord Walker’s obiter suggestion in Pitt v Holt was only that: a suggestion. That the Court might not intervene in cases of artificial tax avoidance is not a principle of current law. Morgan J’s comments also indicate that, even if such a principle were to be introduced, the threshold for “artificial tax avoidance” would not capture legitimate inheritance tax mitigation of the type in Van der Merwe.

 

Van Der Merwe v Goldman & Anor [2016] EWHC 926 (Ch)

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