|Court Revokes Trust Transfer That Triggered IHT Charges|
The England and Wales High Court has agreed to set aside a man's gift of a house into trust for his daughter that attracted an unexpected inheritance tax (IHT) charge of GBP156,000.
Charles Freedman was a wealthy man with three adult children. One of them, Melanie Freedman, was an unmarried mother with little income or other resources.
In 2010, Melanie asked her father to lend her GBP530,000 to buy a house for her and her child to live in while she was selling her previous home. Her father agreed to this, on the condition that the loan was repaid. But he also suggested that both properties should be placed in trust, to protect them from any claim from her previous partner (the father of her child) or any other 'predatory males'. The trust had an additional purpose; Charles Freedman felt that giving her the money outright would have been unfair to her brother and sister. So to protect Melanie's siblings, they were appointed as discretionary beneficiaries of the trust.
Melanie agreed to this without taking any legal advice of her own. Her father had himself taken advice, but the advisor, his solicitor, had not realised that rules introduced in the Finance Act 2006 meant that the gift would be a lifetime chargeable transfer for IHT purposes. It thus triggered an immediate 20 percent entry charge plus further ten-yearly and exit charges.
These charges meant that Melanie would no longer be able to repay the loan to her father. When the family learned of the disaster, they sought to have the settlement revoked on the grounds of equitable mistake. HM Revenue and Customs opposed this and sought payment of the tax charges.
Both the family and HMRC based their cases on the Supreme Court's decision in Pitt v Holt and Futter v Futter (2013 UKSC 26). In this judgment, Lord Walker had observed that a court might think it right to refuse relief in some cases of artificial tax avoidance, either because the claimants 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.
An important aspect of the Freedman case was thus whether the trust had been set up to avoid IHT. The family members (except Charles Freedman, who had died) all gave evidence that the trust had not been set up for tax-planning purposes but only to protect the properties from any claims that might be made on them by Melanie's previous partner. Their counsel accordingly claimed that there had been a distinct and serious mistake, and it must be unconscionable not to set the settlement aside.
HMRC's counsel countered by claiming that there had been no distinct mistake, only a 'disappointed expectation'. Moreover, Melanie's own failure to check carefully her father's legal advice implied that no mistake had been made by her, he said. Further, he said, for a mistake to be sufficiently grave it had to go to the heart of the transaction, and in this case it did not.
However, the High Court judge disagreed with HMRC. Melanie had seen and read the legal advice, and based on that advice she broadly understood that there would be no adverse tax consequences for her in entering into the settlement.
'Accordingly it seems to me that Melanie made a distinct mistake of the kind described by Lord Walker [in Pitt & Futter]', said Proudman J. She also decided that the mistake was serious in that the resulting tax charge meant that Melanie could not repay the loan to her father's estate.
Accordingly the judge decided it would be unconscionable for the donees to profit from that mistake, and duly set aside the settlement on the ground of equitable mistake (Freedman v Freedman, 2015 EWHC 1457 Ch).
The opinions expressed do not constitute investment advice and specialist advice should be sought about your specific circumstances.
Published on our website on May.27, 2015