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A case of mistaken trust

John Melville-Smith summarises a case where a transfer of money into trust to mitigate tax achieved precisely the opposite.

Contentious Trusts and Probate Partner, John Melville-Smith, summarises a recently reported High Court case in which he acted for a claimant who had transferred money into trust to mitigate tax, only to discover years later that he had achieved precisely the opposite.

In the case of Abadir v Credit Suisse Trust Ltd, Seddons – acting for the claimant – successfully obtained the set-aside of a transfer into trust on the basis of mistake.

From November 2004, Dr Abadir (then Egyptian domiciled and UK resident) settled substantial cash assets into a Guernsey resident discretionary trust of which he was a discretionary beneficiary and Credit Suisse the trustee. It was intended to be a tax efficient structure such that money gifted to Dr Abadir by his father as a part of a lifetime division of family assets could be held in circumstances where a charge to UK tax would only arise if there was a remittance to the UK by Dr Abadir. Many of the transfers into the trust were effected by Dr Abadir’s father but, unfortunately, by far the most substantial one was the sum of some US$ 17 million in March 2005 which was made as a gift to Dr Abadir by his father and subsequently settled on trust, crucially by Dr Abadir himself.

It was only years later, in 2016, that it transpired that, contrary to the trust’s intended function and Dr Abadir’s understanding based on advice received at the time, he was deemed domiciled in the UK for inheritance tax purposes at the time the relevant transfer into trust occurred.  This meant that any property settled by him was subject to an immediate inheritance tax charge of 20% under s2(1) and s7 IHTA 1984, a ten-yearly charge under s64 (approximately 6% every ten years) and an exit charge where applicable under s65 (based on a proportionate amount of the ten yearly charge). The transfer also had significant and unexpected capital gains and income tax consequences for Dr Abadir. The unpaid inheritance tax, together with interest on unpaid tax and penalties, totalled some £4.6 million.

Such were the facts when Dr Abadir instructed me. A possible negligence action against Credit Suisse Bank fell foul of the relevant (Swiss) limitation law and so I began to investigate whether the whole transaction could be unstitched on the ground that, when Dr Abadir made the transfer, he had been mistaken as to the tax consequences.  The factors to which the court were required to have regard are detailed in the leading Supreme Court decision of Pitt v Holt.

First, there must be a mistake as distinguished from mere ignorance, a misprediction or a general assumption that everything would be fine. A mistake as to the tax consequences of a transaction may be sufficient. Carelessness on the part of the claimant will not preclude the identification of a relevant mistake provided that the claimant has not deliberately run the risk of being mistaken.

Secondly, the mistake must be sufficiently grave as to make retention of the property by a donee unconscionable. The test of unconscionability must be assessed objectively with an intense focus on the facts of the case.  Factors tending towards unconscionability include the fact that, but for the mistake, the transaction would not have occurred; that the mistake has ultimately led to the imposition of a substantial sum of tax or a sum of tax which represents a large proportion of the trust property; that the mistake ultimately leaves the beneficiaries in a worse position, for example, because their collective entitlement is significantly reduced; and that the intended result could have been reached by an essentially similar transaction without encountering the problem associated with the mistake.

Where the mistake relates to the tax consequences of a transaction, the fact that the transaction was not an artificial form of avoidance tends towards the unconscionability of denying the relief.

Chief Master Shuman found that Dr Abadir had been “transparent, fully frank” and had “assisted the tax authorities” as far as he could, before concluding:

… there is no question in my mind that there was a distinct mistake in this case. It was the mistake on the part of Credit Suisse that led to the Trust being set up in the structure that it was. It led to Dr Abadir transferring funds into the Trust in the mistaken belief that he would not incur the substantial liabilities that he has been faced with in relation to transferring money. Ironically that money was given to him by [his father], had the money been transferred directly by [his father] to the Trust Dr Abadir would not have incurred the substantial liabilities that he has incurred.

“I am satisfied that the mistake here, which is the operation of the deemed domicile rules and the way that they have worked in this case, with an immediate charge to IHT, is a relevant mistake ….

“Is the mistake sufficiently grave to render retention unconscionable? The sole purpose behind this transaction was to put in place a structure for effective estate planning and the IHT charges in this case are at odds with the purpose of the disposition. Had Dr Abadir both at the inception of the Trust and the subsequent Transfer understood the true IHT position, I am satisfied that the Trust would not have been established.

“As a result of the error caused by Credit Suisse, there have been significant tax consequences for the Trust …, the Transfer has left Dr Abadir in a very significantly financially worse position, and indeed the beneficiaries of the Trust as a class.

“To use the words of HHJ Hodge QC in the case of Hartogs v Sequent (Schweiz) …, the imposition of the trust structure in these circumstances is, vanilla tax planning.” It is not an artificial form of avoidance against which public policy would militate against setting aside the Transfer.”

So the transfer was set aside and Dr Abadir is entitled to recover the tax, interest and penalties paid (prior to the set aside application) consequent upon the mistake. The principles in Pitt v Holt typically assist trustees in reversing decisions which have had unfortunate consequences but as this case shows, they are equally applicable to settlors.

In order to read the full judgment, click here.

Should you have any questions regarding the above or any trust, probate, or will dispute related queries, please contact contentious trusts and probate partner John Melville-Smith on or 020 7725 8027.

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