Equitable mistake; how a +£150,000 tax bill was cancelled

The High Court has agreed to set aside a father's gift of a house into trust for his daughter that attracted unexpected inheritance tax (IHT) charge of £156,000.

Melanie Freedman was an unmarried mother with little income or other resources. In 2010, she asked her father to lend her £530,000 to buy a house for her and her child to live in while she was selling her previous home.

Mr Freedman agreed on the condition that the loan was repaid. He also proposed that both properties should be settled into trust to protect them from any claim from Melanie’s previous partner, the father of her child. Mr Freedman also wanted to be fair to his son and other daughter and so he appointed them as discretionary beneficiaries of the trust.

Mr Freedman took legal advice but Melanie agreed to her father’s proposal without her own legal advice. Mr Freedman’s solicitor had not realised, however, that rules introduced in the Finance Act 2006 meant that the gift would be a lifetime chargeable transfer for IHT and triggered an immediate 20% 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 found out, they sought to have the trust 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 a case where the Judge had noted 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.

A key aspect of this case was whether the trust had been set up to avoid IHT.

The family members, except Mr 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 by Melanie's previous partner. Their barrister claimed that there had been a distinct and serious mistake and it must be unconscionable not to set the settlement aside. HMRC's barrister countered by claiming that there was no mistake just a 'disappointed expectation'.

The Judge disagreed and recalled that Melanie had read the legal advice from which she broadly understood that there would be no adverse tax consequences for her in entering into the trust. It was also sufficiently serious that the IHT due meant that Melanie could not repay the loan to her father's estate and the Judge set aside the trust on the ground of equitable mistake.

The law and practice referred to in this article or webinar has been paraphrased or summarised. It might not be up-to-date with changes in the law and we do not guarantee the accuracy of any information provided at the time of reading. It should not be construed or relied upon as legal advice in relation to a specific set of circumstances.

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