Tax avoidance schemes and the duty to warn

In a useful judgment summarising when a duty to warn arises, the Court of Appeal overturned the High Court’s decision and raised doubts over the applicable test when considering whether or not financial advisers have been negligent in advising on the risks associated with investments.

Background facts

A firm of solicitors advised on an employee benefit trust (EBT) structure designed to avoid both capital gains tax and inheritance tax. The scheme involved the transfer of company shares by way of a gift into the EBT and the creation of a sub-trust of which the beneficiaries were the family of the shareholder/transferor (the claimant). The relevant legislation prevented the application of advantageous tax treatment where beneficiaries of the trust were connected to shareholders of the company, as they were in this case. As such, the beneficiaries were excluded from receiving any benefits until after the death of the claimant (the so-called “post death exclusion”). In this way, the solicitors advised, on the death of the claimant and his wife, their remoter issue could receive benefits from the EBT free from both capital gains and inheritance tax.

After the EBT was put in place, a number of other advisers were involved in relation to the claimant’s tax a airs and the EBT structure. At no point did any of these other advisers raise the possibility that there was a risk the EBT would fail and tax fall due.

HMRC opened investigations into the EBT in August 2005. One of the bases of HMRC’s challenge was that the post death exclusion did not prevent the claimant or any person connected with him from benefitting from the trust’s assets. The claimant instructed Leading tax Counsel, who had previously considered the structure, and who expressly disagreed with HMRC’s arguments. Separate counsel was then instructed to consider the trust aspects of the structure and he advised that there were strong arguments that HMRC’s arguments were correct. Leading tax Counsel subsequently accepted that HMRC’s position was strong. The claimant settled with HMRC for nearly £11.3m and issued proceedings against his solicitors.

To find out more about the case and its implications when it comes to the duty to warn regarding investment risk, download the full update.