Mark McLaughlin looks at court applications to rectify trust deeds where trusts give rise to unintended tax consequences.
Trusts can be created for many reasons, including tax planning. Whatever the reason, the tax implications of creating and running a trust need to be considered in advance.
For example, professional advice is not always obtained; or if it is, the advice might not be complete or correct. Errors or misunderstandings about the tax treatment of transfers or chargeable events could result in unintended additional tax, interest, and penalties.
An escape?
However, in some cases it may be possible for the trust deed to be changed, such that the unintended tax consequences do not arise. This remedy (‘rectification’) requires court approval. HM Revenue and Customs might not approve of an application to have the trust deed rectified, but the final decision rests with the court. Rectification is a legal process, which was described well in Allnutt v Wilding [2007] EWCA Civ 412:
“…rectification is about putting the record straight. In the case of a voluntary settlement, rectification involves bringing the trust document into line with the true intentions of the settlor as held by him at the date when he executed the document. This can be done by the court when, owing to a mistake in the drafting of the document, it fails to record the settlor's true intentions…”.
Unexpected tax consequences
For example, in Ware v Ware [2021] EWHC 694 (Ch), the claimant and defendant were the trustees of two will trusts. In 2013, deeds of appointment were executed by the trustees. The intention of those deeds was to add family members as trust beneficiaries. However, their additional effect was to terminate the claimant's interests in possession in the trust funds and appoint new ones instead.
This had significant adverse tax consequences, including: an immediately chargeable transfer for inheritance tax (IHT) purposes (and a ‘gift with reservation’ while the claimant retained an interest in the trust funds); the trust being subject to future IHT charges; and no CGT-free base cost uplift in the value of the underlying property on the claimant’s eventual death.
Pretend it never happened
The claimant applied to the High Court for rectification of the 2013 deeds of appointment, on the grounds that the deeds mistakenly (and unnecessarily) included provisions which terminated the claimant's existing interests in possession and appointed new ones instead, when they were only intended to add certain persons as additional beneficiaries.
The High Court noted the significant adverse tax consequences and addressed the legal principles when considering the rectification of a document (these are beyond the scope of a tax article). However, the mistake was not merely about the tax consequences. It was clear what legal effect the trustees intended in making the deeds of appointment. In going beyond this, the deeds had an unintended legal effect. The court, therefore, granted the order for rectification.
Practical tip
The legal remedy of rectification is potentially helpful in terms of changing a trust deed and its tax consequences. However, while rectification can put right unintended adverse tax consequences, it is by no means a ‘get out of jail free’ card for tax purposes (e.g., see Allnutt v Wilding). Furthermore, the application process can be expensive and unpredictable. It should only really be considered as a last resort, and expert legal advice will be needed.
