Property Into Trust – No Turning Back?

Mark McLaughlin points out a possible ‘last resort’ remedy if transferring property into trust results in an unexpected tax charge. 

The tax implications of transactions are sometimes overlooked; or perhaps there may have been a misunderstanding about the tax implications. 

For example, an individual may transfer a property into a discretionary trust, without appreciating that the gift was an immediately chargeable transfer for inheritance tax (IHT) purposes, triggering an unexpected tax bill. HM Revenue and Customs (HMRC) will expect the IHT liability to be paid, whether or not it arose intentionally. 

However, in some cases it may be possible for the transaction to be set aside on the grounds of mistake, so that the adverse tax consequences do not arise.

For example, in Der Merwe v Goldman & Ors [2016] EWHC 790 (Ch), the claimant and first defendant (husband and wife) transferred the title to a substantial house to the claimant alone on 24 March 2006. On 27 March 2006, the claimant gifted the house to an interest in possession settlement, and transferred title to the house to the trustees of the settlement.

However, an unintended consequence of the above transactions (resulting from changes in the IHT legislation from 22 March 2006) was that the claimant became liable to a substantial IHT liability on the value of the house. In addition, the trustees became liable to pay IHT (e.g. on every tenth anniversary of the trust). The claimant and first defendant were unaware of those IHT changes when executing the transactions (nor for many years later), and believed that the transactions would not result in an immediate IHT charge, or future IHT charges for the trustees. The claimant therefore sought a court order setting aside the trust and the transfer of 27 March 2006, on the basis that he was mistaken as to the tax consequences of creating the trust. 

Fortunately for the couple, the High Court considered that they made a mistake for the purposes of principles concerning a gift made as the result of a mistake (as stated in Pitt v Holt – see below) because, being ignorant of the IHT changes, they wrongly believed that their transactions would not give rise to IHT charges. The court therefore held that the claimant and first defendant were entitled to an order setting aside the transactions of 24 and 27 March 2006 on the grounds of mistake.

Similarly, in Freedman v Freedman & Ors [2015] EWHC 1457 (Ch) the claimant created a settlement comprising two houses, relying on the advice of her father and a solicitor. However, the claimant’s father and the solicitor did not realise that the transfer into trust would be an immediately chargeable lifetime transfer for IHT purposes, or that there could be IHT charges for the trustees.

An application was made to the High Court for an order that the settlement be set aside on the ground of ‘equitable mistake’ (relying on decision in Pitt v Holt). The High Court observed that in order for relief to be given, there must have been a distinct mistake, a serious mistake, and it must be unconscionable not to set the settlement aside. The High Court concluded that a distinct and serious mistake had been made and granted the relief sought, setting aside the settlement on the ground of equitable mistake.

 

In both Der Merwe and Freedman, the Court referred to Pitt v Holt [2013] UKSC 26, which also concerned unintended IHT consequences on the creation of a trust. The Supreme Court in Pitt v Holt held that a voluntary disposition could be set aside on equitable grounds where there had been a mistake which was sufficiently serious to satisfy certain principles. The legal position is beyond the scope of this article, but it is important to note that whether or not relief is given is a matter for the court to decide.

It might be comforting to know that all is not necessarily lost if a property transaction results in unfortunate tax consequences. However, reliance on the courts to set aside transactions should probably be regarded as a last resort; aside from the uncertainty as to whether the court will accept such an application, the process can be complex and costly, requiring legal representation. Therefore, consider all of the tax implications in advance of a transaction taking place, and obtain expert professional advice, if necessary.