Setting aside a transaction for a mistake - does it work for tax schemes?

The doctrine of mistake can be a useful tool if a professional provides advice that the transfer of an asset can save tax and it turns out that the advice was wrong. In circumstances where the structure of the transaction adopted involves a gift, then if a taxpayer can establish mistake, it is possible to unwind the transaction and remove the tax liability altogether (including interest and penalties).

There are two recent court decisions which considered the position where a taxpayer relied on mistake, but the structure they used was found to be a tax scheme.  In both cases the court found that the taxpayer understood the risks they were running – notably that the tax scheme might fail - and so refused to unwind the transaction finding that the taxpayer had not made a mistake of sufficient gravity.  Case law arguably draws a fine line between (1) negligent tax advice for tax planning where it may be easier to unwind a transaction on the grounds of mistake and (2) tax planning where there are risk warnings that the planning that it might not work where it may be more difficult for a taxpayer to set aside the transaction.

The test for mistake

Before looking at the two recent cases it is useful to recap the test for mistake.  The case law around unwinding transactions for tax-based mistakes was considered by the Supreme Court in Pitt v Holt and Re Futter [2013 UKSC 26].  The Supreme Court judgment is arguably best known for side-lining the so-called Re Hastings Bass rule (which was broadly used to set aside transactions where a trustee was mistaken as to the consequences of a transaction), but in the judgment Mrs Futter was able to rely on mistake in the alternative to the Re Hasting Bass rule to set aside a transaction with negative tax consequences.

The Supreme Court's judgment can be broadly distilled (as it has been in subsequent judgments considering the judgment) as follows:

1. A donor can rescind a gift by showing that there was a serious mistake, so it would be unjust for the donee to keep the gift;
2. A mistake is to be distinguished from mere inadvertence or misprediction;
3. Forgetfulness, inadvertence or ignorance are not a mistake, but can lead to a false assumption that the law will recognise it as a mistake;
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;
5. The severity of the mistake must be assessed in terms of injustice or unconscionability;
6. The evaluation of unconscionability is objective;
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;
8. The court needs to focus intensely on the facts of the particular case;
9. A mistake about the tax consequences of a transaction can be a relevant mistake;
10. Where the relevant mistake is a mistake about the tax consequences of a transaction, the court may refuse relief if the claimants accepted the risk that the scheme would fail, or on grounds of public policy.
11. The key factors to consider where the is tax advice which comes with risk warnings (which usually indicates a tax scheme) the most relevant factors are (4) and (10).

Bhaur and others v Equity First Trustees (Nevis) Limited and others [2023] EWCA Civ 534

Bhuar is a recent Court of Appeal decision.  The Bhaur family entered a tax scheme that was designed to avoid inheritance tax on a substantial family business.

The business was transferred to Safe Investments UK who then transferred it to a BVI trust company. This established an employee benefit trust (EBT) for the benefit of Safe Investments UK's employees and their families. The scheme operated on the basis that EBTs benefit from an inheritance tax exemption and the intention was for the Bhaur children to benefit from the EBT without the need to pay inheritance tax. 

In 2017 HMRC began investigating the scheme's promoter. As a result, the trustees donated funds to the NSPCC. The family disagreed with the transfer and applied to court for the initial transfer to Safe Investments UK to be set aside on the grounds of mistake. 

The High Court rejected the application and the Court of Appeal agreed with the High Court.  The Court of Appeal found that even if the Bhaurs had made a mistake rather than a misprediction and were innocent of any tax evasion, the appeal would fail. The Court of Appeal found:

"… the key point is that Mr Bhaur knew that there was a risk that a Scheme would not work – i.e. that it could be successfully challenged by HMRC.  It may well be the case they were badly advised (or indeed misled)… But … Mr Bhaur made a deliberate decision to implement the Scheme, knowing that there was a risk both that it might fail to achieve the desired tax benefits, and that he and his family might, unless they took certain steps to address the position, end up worse off than before… it would be unconscionable or unjust for a donee to be permitted to retain the benefit of a gratuitous disposition by a person who has deliberately run the risk that the scheme of which the disposition forms part might not work…"

Notably aside from the mistake as to the tax consequences of the transaction, the Bhaurs also asserted that they were mistaken as to the honesty of their tax adviser.  The Court of Appeal found that a mistaken belief as to the honesty of the adviser is not the type of mistake which warrants setting aside a transaction.

Dukeries Healthcare Limited v Bay Trust International Ltd and others [2021] WTLR 809

The taxpayer, Mr Levack, owned a number of nursing homes and private hospitals (Duckeries Healthcare) and sought advice to minimise capital gains tax on the sale of his various business interests.  He was recommended a "Renumeration Trust" by a tax adviser which broadly involved a structure where Mr Levack placed his various interests into trust from which he was lent monies (avoiding income tax) and where on his death the assets were intended to pass inheritance tax free (with the added benefit that the loans reduced the value of the estate in the interim).  There were problems with the structure which meant that it did not attract the intended tax benefits.  In light of the problems, an application was made to set the disposition in to a trust aside for mistake.

The High Court refused to grant relief finding that there was inadequate evidence that the claimants (Mr Levack and his company) acted under a mistake of so serious a character to render it unjust to unwind the gift.  The High Court also found that had Mr Levack shown sufficient understanding of what the trusts were expected to achieve, he was willing to run the risk of being mistaken as to the benefits – he accepted the schemes "warts and all".  The fact that he went ahead despite the fact he did not understand the schemes and chose not to consider the documents or obtain further advice also demonstrated a "cavalier attitude to risk" such that the claimants "deliberately ran the risks of the schemes not operating in the way [the adviser's] sales pitch had suggested…".  Further, the schemes were "properly characterised as being artificial tax avoidance" such that even if there was no actual assumption of risk the nature of the schemes alone was enough to conclude an acceptance of the risk of the schemes failing.

Tax planning vs Tax schemes

There are many examples of the courts setting aside transactions for mistake and as a result unwinding tax consequences, but these two cases show that where (1) the tax payer is found to have knowingly run a risk that the planning might fail (i.e. it starts to look more like a tax scheme) and/or (2) the court finds the planning "artificial", the court is less likely to set aside the transaction – leaving the liability for the tax.

When considering a claim against a tax professional where tax arises and the claimant taxpayer understood that tax would not arise, then it is worth considering whether an application to set aside the transaction for mistake.  Where such an application is made it is likely the tax professional will need to admit to an error (to reinforce the mistake) and so this needs to be carefully thought through at the outset.  HMRC also needs to be put on notice of such an application and that might be a factor.  Equally, if a claimant taxpayer seeks to make such an application where they are on notice of risks of the tax planning, the tax professional will want to consider making its position on such an application clear so that it can argue that the costs of the application (if it fails) are not something that should be sought against the tax professional as mitigation costs.

It is also worth bearing in mind that there are other options for tax professionals where tax advice goes wrong.  For example, rectification if an error in a document can be rectified to undo the tax arising or a claim based on breach of fiduciary duty where, for example, a trustee acts beyond their powers or fails to consider relevant factors and if established the transaction is left voidable – allowing the unwinding of the transaction and the tax arising.

This blog was co-written/prepared by Nikita Austin.